Trading Plan 101

by The StockSavvy Editorial Staff

The trading plan is perhaps the most overlooked tool in a trader’s arsenal. In fact, most day traders don’t even have one. Then most of them also go broke in their first six months. In our opinion, this is no coincidence. A pilot doesn’t leave the ground without a checklist, a builder doesn't begin construction without a blueprint, and a successful trader doesn’t take a trade unless they have a carefully crafted trading plan.

Much like a business plan, a trading plan is used to define your goals, identify your costs, and lay out the trading strategies you need to reach those goals. Unlike a business plan, it must be adhered to with absolute discipline in order to be of any use at all. It is this intractability that gives the savvy trader an edge. A measure of consistency in the way they approach an ever uncertain market. The one caveat is that the trading plan itself is a living document that will change over time as you improve as a day trader. But never on the spur of the moment, never during market hours, and never when you are holding a position.

The first step in writing your trading plan is understanding exactly what you are writing about: The business of day trading. And thus the language and the format of the plan should be in keeping with a business like tone. Furthermore, it must be written well enough to convince a hypothetical banker that trading is a worthwhile enterprise and that you are up to the task of running it as CEO. So if you were thinking about dashing off a few quick paragraphs, think again. Writing a good trading plan takes time, careful thought, and commitment to the idea that it will work. Otherwise you are just going through the motions of what in the end will amount to a futile exercise.

The next thing to remember is to be realistic. For example, if you state that you expect to make a 200% return on your investment in your first 3 months of trading, your hypothetical banker is going to turn you down for a loan as your assumption is naive and points to your inexperience. Also, traders who make unrealistic rules such as, "I vow to exit all trades before taking a loss...," are only setting themselves up for sure and immediate failure. Any trader worth his salt knows that losses are unavoidable and that trading fees and slippage would quickly bleed their trading accounts dry.

Another key ingredient to your trading plan is the details. Details that cover every facet of your trading strategies: market indicators, money management, when to get into a trade, when to get out of a trade, when to take profits, and when to stay out of the market altogether. The more details the better. Because at the moment of truth when your adrenaline is rushing, the details are the hard and fast rules that keep you sane. You don't need to think about what to do, because you've already written it down. An added bonus is that your hypothetical banker likes the details too. It shows that you've done your homework and that you take your trading seriously.

With these guidelines in mind, its time to organize your thoughts into a cohesive outline that will eventually become your trading plan. A good way to start is by defining the major sections of the outline and posing the questions that must be answered in each section as illustrated in the example below:

I.      OBJECTIVE

§         Do I intend to day trade for a living or augment my income?

§         What financial instruments do I intend to trade (stocks, options, futures)?

§         What timeframes do I intend to trade (swing, day, scalp)? 

§         What is my initial investment?

II.    GENERAL GUIDELINES

§         What are the basic tenants of my trading philosophy?

§         What are the general trading rules that apply to all trades?

§         How much time will be devoted to education?

§         What type of charting will I use?

III.  MONEY  MANAGEMENT

§         What is my maximum dollar position for a single trade?

§         What is my maximum dollar loss for a single trade?

§         How do I calculate share size?

§         What is the maximum dollar loss I am willing to incur for a given day?

§         How and when will I take profits?

IV.  TRADE STRATEGIES

§         What specific trading strategies do I intend to employ?

§         Identify the following attributes for each strategy:

§         What type of computer hardware is required?

§         What type of communications line(s) do I need?

§         What type of trading platform will I use?

§         What services / trading rooms / publications will I subscribe to?

§         What are my long term projections?

§         At what point do I give up on trading and divest my account?

§         What type of  records will I keep?

§         How will I measure my progress?

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