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Key Aspects of Building Your Trading Plan

by | Nov 8, 2021 | Portfolio Management

A trading plan is an important part of what it takes to become a consistently profitable trader whether you have a short term focus in the markets or a long term perspective. There are all sorts of plans that you can devise and use in order to stay disciplined and treat trading more like a business rather than a hobby but either way you formulate your trading plan you must focus on these key factors. Why am I trading? What is my approach? What are my goals and objectives? What am I willing to risk on each trade idea? What is my timeframe for each idea?

Why am I trading?

Just like anything in life that takes effort and hard work, understanding WHY you want to trade is important in order to figure out WHAT your goals are and HOW to achieve them. If you start a nutrition plan to eat healthier you are doing so to provide yourself the benefits that come with a new diet. Losing weight, feeling more energy, longer lifespan. Whatever the reason may be, you are better off defining it because that adds to your purpose of “doing it” even when you lose motivation. Of course most traders get into trading stocks for the allure of large profits and freedom from having to work. But you still need to drill down and pinpoint what kind of money you are focused on making. Are you a swing or day trader, or will you focus more on position trading longer term for a more active investing style if you can’t watch the markets all day? Neither way is right or wrong, everyone just needs to define how much time they can put forth into this endeavor and then focus on that style for themselves. I know plenty of longer term traders that use trend following and make more money than most day traders do who stare at the screen all day. More focus on the market does not equal more profits. 

Some examples of reasons you might be trading:

  • to create weekly cash flow
  • to generate long term wealth
  • to gain competence in the financial markets
  • to have a better understanding of taking risk
  • to create a additional source of income
  • for the love of the game
  • to build mental toughness

All of these points at one time or another have or still do drive me to be better at trading and continuously focus on improvement. This is one of the toughest games to master because it is always changing and what works one year in the markets generally does not work forever. Constantly learning from every angle of the markets and being naturally curious about them I believe is a great quality of top traders or investors. No matter what the market does from year to year, understanding your strategy and how to manage your risk will always be key.

What is my Strategy?

  • Standard Swing Trades Using Options 
      • If you are mainly focused on swing trading then come up with an approach that utilizes options between 30-60 days till expiration and become the best you can be at understanding how these move with the underlying market or stock group you have an eye for. Are you going to focus on trading pullback dip buys to support or long term breakouts? Or both?
  • Day Trades When Stocks Are Volatile
      • Everyone wants to day trade but when stocks are quieter and volatility is low, it might be best to focus on multi day swing trades that offer a persistent trend higher. Volatile markets with large ranges are best for scalping intraday or when stocks are in play with specific news or catalysts creating volatility.
  • Trend Following Long Term Position Trades
      • If you can’t watch the market intraday as much, there is nothing wrong with leaning on trend following tactics like riding the 8/21 EMA’s and trading multi month new highs. A lot of time it pays to watch the new 52 week high list as a longer term trader because new highs tend to produce more new highs.

What are my goals? Weekly / Monthly / Quarterly / Annually / 5 Year?

  • Are you focused on cash flow and taking money out of the market each month? Or are you more willing to let the short term noise not influence things and shoot to maximize quarterly or annual returns by riding trends? Even if you have short term goals related to trading I think it’s worthwhile to think about your long term return goals going out 3-5 years and creating a separate account to potentially invest in long term growth themes that are disrupting industries. This is how you find homeruns. Separate these multi-year goals from the short term and focus on the forest from the trees aspect of why you are trading.

What are my objectives through trading?

  • Monthly cash withdrawal
  • To create an account equity curve from the lower left to the upper right, regardless of what I think should be happening next.
  • To trade options with zero emotion. Using strategy instead of reactive bias.

What Markets will I trade? What timeframes will I trade? What Setups will I trade?

These are all important specifics to define when you are trading. A lot of traders might only trade options or stocks, but others may add futures and crypto to their regular products they trade setups on. The timeframe of your trading focus might be one of the most important but least discussed. A short term intraday trader can be taking a bearish trade on a stock that a long term investor may be looking to buy. If you swing trade then define the timeframe of the chart you will take signals from. A daily chart or weekly chart is a good default but sometimes looking at a 4 hour or 195 minute chart is beneficial to catch the smaller 3-5 day moves that a daily chart might not pinpoint. Either way, by looking at the highest timeframe first and then drilling down to the short term is a good way to understand what the trend of a market actually is. Once you know what timeframes are your main focus, understanding the setup to execute from is easier. If I am trading price reversals off support on a daily chart I know that I want to focus on strong trends and take advantage of those times when my stock is pulling back to a volume area support zone or 21 or 55 EMA. Whatever you use doesn’t actually matter. It’s more about being consistent with that method. Making consistent profits as a trader starts with being consistent about what your setups are. If you are just chasing the newest meme stock then you are going to have a tough time using that method in the future when the markets change character. Just like in training or exercise, consistency builds confidence to push beyond limits and if there is one thing that can devastate a developing trader is lack of confidence from getting blown out taking too much risk. 

What am I willing to risk on each trade idea?

  • Entry Rules
      • Building swing based trend trades by adding at the 21 EMA until a full position has been established.
      • Or perhaps buying new 50 day highs in a stock breaking out.
  • Exit Rules
      • Using previous highs or Fibonacci extension based targets can be considered when taking profits or exiting trades. Volume profile levels such as VPOC or value area’s are helpful in having defined targets as well. These are high probability zones of support and resistance.
      • A close below the 50 day EMA might be a reason to sell and move on.
  • Stops – How will I define my risk?
      • 100% of risk can be calculated prior to entering a trade. If using a stop then its important to use one wide enough to not get whipped around by normal volatility in the stocks average true range. 
      • By trading options, it’s often easier to define risk by only buying what you can afford to lose. Or if selling spreads, be able to risk the width of the spread and let duration play out till expiration.
      • You may like using a rule such as no position should ever lose more than 5% of my account and more commonly should not exceed 2-3%

Some other questions to consider answering in your trading plan:

  • What is my Pre-Market routine?
  • What is my Post-Market routine?
  • How will I find new stocks to trade?
  • What tools or online resources will I use for my trading business?

Trading the markets is a hard thing to do. Trying to do so without having a defined risk plan and knowing what your goals are makes it even harder. These are just some examples of things to consider to formulate your own plan but everyone is different and each trader needs to personalize their plan to their personality. If you try to excel at something that doesn’t match your personality then consistency and longevity is even more difficult, and likely not enjoyable. Anything can happen. Always make sure your maximum risk is under control. Volatility expands quickly, and it often won’t give a warning on the way. Every moment in the market is unique. I don’t need to know what’s going to happen next in order to make money. And most importantly, don’t lose your ass on a Friday after trading hard all week.