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Building Your Trading Plan

Why Do I Need a Trading Plan?

Trading is a discipline as much as it is a skill. To succeed in trading, we need to create a system or routine that encourages the good habits and discourages the bad. Bad habits and poor decision-making often occur in the heat of the moment, when we might ‘shoot from the hip' and act emotionally instead of analysing a situation before deciding on a course of action. By building a trading plan, you'll define a set of rules or guidelines that you can always refer back to, allowing you to keep your trading disciplined, systematic and on track. 

Ground Rules

When we create our trading plan we start with the overarching goal or objective. It’s critical to ask yourself what you want to get out of trading. If your targets or objectives are financial, make sure they are realistic and attainable based on your experience with trading and the time, effort and resources you can commit to it. For example, if one of those goals is to make a million dollars in a year, spending just one hour a week on trading, then, that is not a realistic goal. There’s no reason why you can’t aim high but you do need to be pragmatic.  An example of a realistic goal may be: 

‘I would like to grow my capital by X% in the first year of trading and develop my knowledge and approach through 10 hours of work a week.'

Once you’ve established your motivation, you can start to think about how you can achieve that goal. Successful traders do not risk everything on a single trade. Instead, they take many calculated risks with small amounts of their overall capital and aim to have more winners than losers. We’ve said this before but it is very true that longevity is the key to success. 
The longer you’re in the markets, the more trading opportunities you’ll have.  It’s simple maths. So if you think you’ll get rich quick, abandon that thought immediately. You can make money through trading but you will do so through a disciplined and systematic approach, and your trading plan will be the foundation on which that approach is built.

Once we’ve established our ground rules, we need to ask ourselves some more questions.

How Am I Going to Trade? 

Before you trade, you need to decide whether you’ll do so from a desktop computer or mobile device, what kind of connectivity you’ll be able to access and what kind of environment you’ll be trading in. Be honest with yourself will you be able to concentrate without distraction? The quiet carriage on a morning commute might be an excellent environment for trading while a breakfast table with three toddlers craving your attention might not be.

When Am I Going To Trade?

Will trading be your full-time occupation or will it be something you do alongside other work? With more and more people working for themselves in this gig economy, this is more a legitimate question than ever. How much time will you be able to devote to trading on a daily and weekly basis and when will that time be? The answer to these questions will also likely determine your trading style

What Am I Going To Trade?

Once you know how and when you’ll be able to trade, you can start to consider the instruments that you wish to trade. Although FX markets operate 24/5 and many indices and commodity CFDs also have long trading hours, they are all more active at certain times of the day than others. Liquidity and activity are the trader's friends, so trading the Japan 225 in the middle of the afternoon in Europe probably won't be as effective as if you were trading the index during the Asian session.

How Much Money Can I Commit To Trading?

There is no right or wrong answer to this question. There is a minimum amount you’ll need to open a position, however, simply because you will need to have the initial margin and a buffer on your account to be able to open a trade in the first place, you are likely to want to be able to open more than one trade. 

The answer will, however, depend on your own personal circumstances. No matter what these are, the money that you commit to trading must be risk capital. Risk capital refers to money that you are not dependent on to pay the bills. The size of your deposit or trading capital will also help to determine how you trade and which products and trade sizes you will utilise.

Now we have established how, when and you’ll trade, we can start to think about your approach to the markets. 

How Can I Analyse The Markets to Identify Trading Opportunities? 

Traders usually fall into one of two camps: they are either technical traders, who use charts and indicators to highlight opportunities and make predictions about future price action, or they are fundamental traders, who look at macroeconomic data and other metrics to try to predict what will happen to prices of instruments, related to and influenced by, those data and metrics. 

As a rule of thumb, shorter-term active traders are usually technical traders, and less active longer-term traders tend to favour a fundamental approach, though there are some of us who like to mix and match the two flavours. Will your intended trading style and approach to the markets suit trending or non-trending markets? For example, scalpers do best in ranging or non-trending markets, however, swing traders are very much trend followers and so trending markets are what they are looking for. Include a paragraph or two in your plan that describes your trading style.

Money Management 

People trade the markets with the intention of making money. However, to do that they need to give consideration to how they will preserve their capital, protect their gains and stay in the game for as long as possible. This is perhaps the most essential part of a trading plan or indeed of being a trader in general. 

Capital is a Trader's Lifeblood

The rules you set out here will help to preserve and grow your capital, but only if you stick to them. You’ll need to set limits for the amount of capital you commit to a given trade, set out exactly how many trades you will have open at one time, your minimum risk-reward ratio per trade, the maximum loss per trade and the profit you will look for from each trade.

You might decide to commit no more than one percent of your capital to any trade and have no more than 5 trades open at any one time and therefore have a maximum of five per cent of your capital in the market. This money management scenario will help to determine your optimum trade size. You might choose to look for a risk-reward ratio of 3:1 on a trade and a maximum loss or draw down on an individual trade of $100, which in turn implies you are looking for a $300 profit each trade you open. Your maximum loss per trade will help to determine the placement of your stop losses which are an essential part of a capital preservation strategy. Note that the only time you should be moving stop losses (if they have been placed correctly) is behind a profitable trade to reduce risk and lock in returns.  

Trade Diary 

Finally, keep a record of the trades that you execute and their outcomes. You should list the reasons why you entered a trade and what your expectations and objectives for doing so were. List the result for each trade, be it to win, loss or scratch. You can add notes and comments as well, which you can look back on later. Creating this trading diary will allow you to track your performance and analyse your results to discover what works for you and what doesn’t. That information can feed back into your trading plan allowing you to modify your behaviour and your trading plan accordingly. The good news is that you don't have to keep this record manually, because MT4 and cTrader track your account activity and history, allowing you to export those records from the platform.

Don't forget that you don't need to create a trading plan all at once and that you don't need to risk your money in developing one. Our Demo Accounts were specifically created for traders to test develop and refine their trading approaches before taking the next step in trading on live accounts. If you haven’t already, why not open a Demo Account and test your strategies