How to Develop a Sound Trading Plan?
Creating a trading plan ensures you enter the markets with a strategy. It’s all about discipline. Sticking to your plan can help you to avoid being impulsive and making emotional trading decision that you will regret later. A well thought out plan ensures that instead of focusing on just winning and losing, you focus on the bigger picture. And, that is what you need to do in order to become a professional long-term trader.
If you do not have a clear strategy in place, here are some ideas to help you create a strong trading plan.
Ask Yourself the Right Questions
Before creating a plan, it is vital to perform self-evaluation. For this, you need to ask yourself two very basic questions.
1. What do I want to achieve?
If the first thought that comes to your mind is “make money” or “become rich,” hold on. If you’re only thinking about ways to make quick money, this is a recipe for disaster. There is no such thing as “enough” money, so it is futile to start trading with such a mindset. Your main motive should be to effectively manage risks and, therefore, losses. In this way, you will be able to create an environment where you maximise chances of profit. Also, keep in mind your ultimate goal, such as long-term gains that can help you fund your child’s education, buy a home or plan for retirement.
2. What kind of trader do I want to be?
Making this decision can be tough because what you want to be can be completely different from the kind of trader you should be, based on your personality. After deciding on your long-term goals, make an assessment of your risk appetite, weaknesses and strengths. This will help you understand which trading style and what kind of trading strategy will suit your best.
Spend Time on Research and Learning
Increasing your knowledge of the trading sector is crucial. In fact, you should never stop learning.
Investing time in research includes not just reading guides and checking tutorials on trading, but also following global events that have an impact on the markets. Also, you need to stay aware of the latest analytical tools and decide whether you want to be a technical or a fundamental trader.
1. Understand Types of Analysis
Creating a trading plan requires some knowledge about the fundamental and technical analysis tools. You can choose either one or a combination of tools to help you create a good trading plan.
As mentioned earlier, staying up to date with the news can help greatly. This comes under the umbrella of fundamental analysis. Political, economic and even environmental events, can have an effect on the markets. So, fundamental analysis is imperative.
You could choose to only conduct technical analysis to make your trading decisions. This is a more definitive type of analysis and depends on the tools of probability and statistics associated with trading. Indicators are specific technical analysis tools and can be either leading or lagging.
2. Proceed Systematically
A sound trading plan can only be created if you follow a stepwise approach and adhere to a checklist. Here are some things that are generally included in an organised trading plan:
- The types of tools to be used (technical, fundamental or both)
- The time and manner in which the tools will be used
- The order in which analysis will be carried out
- A clear description of what is being searched for
- The types of orders to be used
Perform Risk Assessment
This is a crucial step if you wish to remain in the market for the long term. For this, you need to decide on the amount of money you are willing to risk on a single trade. This will completely depend on your level of risk tolerance and trading style. Generally, it is better to set this amount to 1% and as high as 5% of your total trading amount.
Once this amount is set, you need to follow the rule that when you encounter a loss equal to the risk value, you will exit the trade and stay out.
Fixing a uniform level of risk for each trade will make it easier to handle the ups and downs. Additionally, you will get an indication of whether your trade is going as well as you planned.
Understand Trading Times
Timing is a critical factor in trading. Questions like, “When do the markets open and close” and “Which currency pairs should I trade in” can help in getting better insights. There can also be higher volatility when the markets have just opened or there has been some major news or announcement. You can pick your own time to trade, based on such global events.
Document Everything
After you have conducted proper analysis of the various factors, it is time to frame your trading strategy. A well-documented plan can be used as a reference to remind you of the things to keep in mind while trading.
You can give your trading plan a name and also a version number, if you like. If, due to trading experiences, you feel that your plan requires some adjustments, you can always create a modified version. Constant improvements will increase the possibility of success.
Once you have created a robust trading plan, take it seriously and abide by it under all types of market conditions, since this will help develop a level of dedication and discipline.
