How To Develop A Trading Plan
You must have heard various traders talk about their trading plans, how they follow them, or how they prefer to be flexible despite having one. What does that mean, and do you need a trading plan? Let’s break it down.
What is a trading plan?
One of your main goals as a day trader is to become consistently profitable. But how does one become consistent? That’s where a trading plan comes in.
As you’re learning the ins and outs of day trading, you’re collecting a huge amount of data. You start recognizing patterns, and now you need a good action plan that will help you trade well and try to make a profit.
Let’s say that you’re getting into a trade at $1.10 and you’re willing to lose $0.10. That means that as soon as the stock price hits $0.99, you should be out of the trade. If your profit target is a ratio of profit 2 to loss 1 ($0.20 profit vs $0.10 loss), it means that you shouldn’t exit the trade until the stock price hits $1.30 (you win) or $0.99 (you lose).
The main benefit of having a plan is that you already know what to do before entering the trade. This way, you are more in control of the outcome.
A trading plan consists of three main parts:
- Loss Limit
- Profit target
The most important part of your plan is the exit strategy. Once you have your exit, then you have your entry. The closer you enter to your exit point, the bigger the range for your reward.
Taking our previous example, you’ve established that your exit is at $0.99. If you buy at $1.05 instead of $1.10, you now have more room for making a profit and less room for taking a loss.
Now, your profit target depends entirely on you. Some traders are more risk-averse, and some are willing to risk more. You may focus on 1:1, 2:1, 3:1 based on your strategy and risk tolerance. Keep in mind that no strategy will ever be 100% successful. With every plan, you’ll lose some trades, but you’ll win some too. And if your plan proves to be successful 70% of the time, and your reward-risk ratio is 2:1, the numbers will make sense, and you will post a profit in the long-term.
Can I go without a plan?
On the other hand, you could just wing it and follow your instinct. The benefit of being flexible is that you can exit the trade as soon as it unfolds the way you didn’t expect it to. But then you have no way of telling if your tactic works or not. Of course, you’ll know if you won or lost that particular trade, but you won’t know if it could be a plan that works or doesn’t work most of the time. When executed well, a plan can be successful only 50% of the time and still lead to profits. But without sufficient data to back it up, you may dismiss the tactic altogether and miss out on potential gains.
The fear of missing out (FOMO), is another huge topic in trading, and it’s definitely worth talking about. We’ll soon post a video about FOMO, and you’ll learn how to overcome the anxiety that comes with it. To give you a sneak peek, having a solid trading plan in place is the first step.
Not knowing what to expect can really hurt people when they first start trading. It’s especially true at the start. As a beginner, you may still not be sure how to trade. A trading plan can be incredibly helpful at this time. With it, you’ll have a starting point and a system that will help you figure out your weaknesses and your strengths as a day trader.