Before you start trading you MUST have a trading plan. Trading is a business and no person would even start a business without a business plan. And no, trading is not a “hobby”. Hobbies are for fun, not profit. No one starts trading without planning to make money at it, at least no one that I’ve ever met. As a minimum, your trading plan should include the following :
1. A Statement of Purpose for your trading plan
Just a brief statement that will help you remember why you are trading. In the heat of battle, it’s always good to refer back here for inspiration. The statement doesn’t need to be elaborate. Simply “help to get out of debt”, “pay for my kid’s college”, “buy a new car/boat/house/refrigerator/whatever”. Make the statement as inspiring as possible so when you take some hits – and you will take some hits – you will remember what it’s all for.
2. What instruments you plan to trade
What am I going to trade? There are lots of things out there for trading: equities (stocks), stock futures, index futures, grain/meat futures, precious metals futures, foreign exchange currencies (Forex), and options on all of the above. You can even trade on weather patterns and the eventuality of certain events occurring (although I wouldn’t recommend those instruments.) Every instrument has its own personality and quirks and will require different strategies to trade. In addition to picking your instruments, you will need to determine what brokers you will use to trade those instruments.
3. When and how often will you trade
Will you trade in the mornings/afternoons/evenings/nights when you’re home from work? Will you trade on the weekends from weekly charts – setting up your trades for the following week? Will you trade only the New York morning session? Will you trade only the “quiet time” between New York close and Sydney/Tokyo open? Will you trade when you’re sick/angry/sleepy/stressed/whatever?
4. How much you are willing to risk
How much money do you have to trade? How much will you risk on each position? How much will you risk each day? How many hits will you take before shutting down for a cooling off period? This is the most important part of your trading. Your trading account is your primary asset. Without your trading account, you won’t be trading at all, you need to protect it at all costs.
The following items come down to your actual trading strategy. You may have several strategies that you will use in different conditions. These things should be determined in advance – not during the heat of battle. Emotions run high when the market is running and it’s tough to make a decision during that time. Make your decision when you are cool-headed and stick to it. You will want to repeat these items for each strategy.
5. How you will determine entries
What techniques will you use to determine when to enter your trade and in what direction? Will you only enter a single position or will you split your trade into multiple positions? Will you enter a position in one direction and hedge in another direction with options? Where will I place my stop losses? Where will I place my targets?
6. How you will manage your trades
When will I move my stops to break even? When will I follow my stops to protect already-gained profits? When will I add to my positions? When will I reduce my position size to protect profits?
7. How you will exit your trades
When will I exit a profitable trade? When will I exit a losing trade? Will I let the market take me out by following stops, or will I close the trade when I perceive it’s peaking? Will I hold until my target is hit, or will I watch the market and determine exactly when to close based on criteria decided upon beforehand?
A trading plan doesn’t have to be long or elaborate. But it does need to include your trading rules. Then you need to stick to it, just as you would a business plan. That’s the discipline that will ensure that you are a profitable trader. Flying by the seat of your pants won’t do it. For more information, check this out.