How to Build a Winning Trading Plan
Learn how to build a winning trading plan and put it into action.
With a good trading plan you can act on opportunities with maximum rationality. You will know how to manage your positions and what to do in any scenario.
What is a trading plan?
A trading plan is like a business plan. Moreover, it's an action plan. It's your own personal strategy on how to win the trading day, week or month.
The capital background and goals differ from person to person, that's why a trading plan is your own personal plan. You could be trading your own money, an industry mandate or work at a prop firm. There might be different limitations and allowed products and practices, this all has to be considered when making your personal trading plan.
There are things that should always be in a trading plan:
- Your trading goals
- The market(s) to trade
- The frequency you look at your market(s)
- The maximum amount of trades per day/week/month
- Your technical entry setups
- Your trade management practice(s)
- Quality tracking plan
Without a trading plan, any statistical, fundamental and technical analysis is useless. It's theory and can not achieve practical trading results. A trading plan is the link to put theory into practice and is the warrant for keeping you responsible for your actions and stop you from taking emotional, undisciplined decisions during market hours.
Why do you need a trading plan and a journal?
It is all about Quality: You need to make high quality trades in order to achieve a positive expectancy in trading. An edge from statistical, fundamental and technical analysis can only come to fruition with clearly defined setups, that you are obliged to wait for. Otherwise you're only interpreting, only gambling.
A trading plan is not set in stone. Like I said, it's a business plan and should be adjusted according to your insights about yourself and trading. It is therefore the reaction to your own trading.
This can only be done when you have a way of tracking what you're doing. You need any form of handwritten or typed journal, where you think about your trading and your actions. If you don't adapt according to what's right for your situation you're still bound to fail, even if you had a trading plan.
What you need is weekly or monthly meetings to analyze how well you're doing certain things and what you need to improve and change on.
Make a meeting with yourself to discuss the next trading plan, that gives you the best possible way to deal with trading and life.
How to create a winning trading plan?
- Outline your trading goals
- Define your opportunity set
- Define the frequency you look at trading opportunities
- Set your limitations
- Define your technical setup(s)
- Define trade management for each setup
- Start tracking what you're doing with a journal
Outline your trading goals
Your trading goals have to be aligned with your limitations. In some situations your limitations are clear, but if they are not, think about them first.
What draw down are you willing to accept? Do you want to make monthly withdrawals or do you want to compound your profit over 5 years? What would be a satisfactory goal, that makes your trading worthwhile? By when do you want to achieve it? Or do you just want to get a good track record for 1 year to attract investors?
Each scenario has different limitations and different best practices that will go into your trading plan's trading goals.
Make sure you do monte carlo simulation to know your expected and highest draw down as well as how likely certain outcomes are with a set amount of trades and profit metrics, that you aim for.
Define your opportunity set
Which markets can you trade with your capital and with your broker? How different are the underlyings in terms of volatility? Which markets are suitable for your average holding time and which markets have high liquidity and trading range during the time you're available?
Write them down and then stick with it. Know, that you can always make improvements to your opportunity set, your watchlist candidates in your trading plan meetings. Be on the lookout for new markets, that could be suitable for your trading style and be able to drop markets if they become untradeable or don't give you the results you want.
Define the frequency you look at trading opportunities
It can be detrimental if you look at your opportunity set too often. There are times where you need to look, but times where you don't have to.
To find a good way to commit the right amount of time for finding good trading setups in your market(s) you need to come up with a strategy for exactly that.
You could, for example, make an analysis about long term trends and fundamentals in the morning to create a watchlist, and define hypotheses on what levels in which market you want to look for certain setups. Then get an alert to your phone, and from then on have a look at the technical aspect of the market every 30 minute.
If you happen to manage a trade you have to decide again on how often you want to take action to move your stop or check for exit conditions.
Set your limitations
When I talk about limitations I mean time-bound limitations to stop overtrading and also about keeping your profits if you happen to reach a profit target.
It depends on what average holding time you have. If you're a daytrader one of the most important rules is your daily loss limit and with how many trades you can reach that limit. And also there should be a maximum number of trades you are allowed to take in the day or even a certain amount of time.
This could be out of an insight on how much actual opportunities are given with a certain stoploss relative to the standard deviation of the underlying. If you're trading against the statistics, then you'll have a hard time taking real chances that are uncorrelated to each other.
Define your technical setup(s)
An entry setup consists of the following things:
- Technical formations like candlestick patterns, gaps or other measurable price action details
- Where to put your stop (percentage, fixed, last swing high/low, ...)
- Which trade management style goes with this setup (next point)
- How you enter the market (market order, limit order, scaling in, ...)
Make sure to define these rules very clear and make sure you have enough knowledge (can include backtesting) about the setup.
Define trade management for each setup
How to get out of the trade should be already clear when getting in a trade.
Here's some trade management rules you can apply to your setups:
- Trailing the stoploss on EMA, SMA, Parabolic SAR or other indicators
- Trailing the stoploss with fixed percentage or points
- Start trailing only after a certain risk reward
- Fixed targets like 3 points or fixed risk/reward ratio
- Candle trailing with setback
- Point counting trailing
- A mix out of all the above with partial profits
Start tracking what you're doing with a journal
You're only as strong as your trading plan AND your trading journal.
Here's what can be recorded about each trade you take.
Name of the setup
Every setup should have a name. You can write down a setup, similar to the trading plan on one sheet of paper or word document. Attached to a setup are the entry criterias, the tradeable markets for this setup and the trade management of the setup.
Direction, W/L & Screenshot
Short or Long.
How much you made in terms of R-Multiples (Risk/Reward Units), percentage or currency.
Get all this information in a Screenshot that you copy in your word document or print out. On a screenshot you can make notes, draw lines or circle interesting zones or situations in the trade.
How was your behavior and what were your thoughts before the entry, during the trade and after the trade? Were you relieved when getting out? Was it stressful to manage the position? What were the reasons for it? Things like this should be in here.
Anything interesting about the trade?
How well did you execute upon you idea? Be honest and give yourself a score from 1 to 5.
Things to Improve
What are clear things to improve going into the future?
One Tip: Don't only look at trades you actually traded, also print out or copy in screenshots of trades you did not take, that were interesting or whom you missed. Write down why you didn't get them and how to not miss them in the future.
All of these things can be repeated on a more general base. For example you can ask yourself how well you're doing in general for the week and what are your personal reasons for a profitabe or unprofitable behaviour. What did you do good and what should you avoid doing?
Out of these insights you can adapt your trading plan, to get better and better at each meeting with yourself.
Remember, that trading is a serious business and what differentiates professional and unprofessional traders is often how much work they put on analyzing charts and themselves.
A winning trading plan is what makes your trading strong and ensures you're a Quality trader who puts in the work to find the right trading style and the right reactions to his trading.
If you want to learn more about trading and risk management, make sure you check out my courses and the Risk Simulator, a tool which lets you project your trading outcomes into the future and helps you find the perfect position size for you.