Trading Plan: A Comprehensive Guide to Successful Trading

A trading plan refers to a systematic approach used to identify and trade securities based on several variables, such as investment objectives, risks, and time. A trading plan lays out procedures and conditions under which to search for asset classesAsset ClassAn asset class is a group of similar investment vehicles. They are typically traded in the same financial markets and subject to the same rules and regulations. and execute trades.

The underlying elements of a trading plan include the conditions under which to buy and sell securities, the size of the position to be taken, how to manage positions, the types of securities to trade, among others. Investment professionals observe that traders should not risk capital until after a trading plan is developed. As a written document, the plan is typically built on research to help traders avoid potential and common trading risks.

Summary

• A trading plan refers to a complete set of rules based on research that incorporates an investor’s objectives, time, and risk tolerance to cover every aspect of a trading period.
• The range of architectural features available and the price inform the choice of a trading platform.
• A trading plan serves as a guide for traders and investors to maximize profits and minimize market risks.

Understanding Trading Plans

The basic philosophy is that trading plans are customized to suit investors’ objectives and personal goals. Details and amount of guidance of a trading plan depend on the type of trader. For example, trading plans for swing traders or day tradersDay TraderA day trader is an individual who opens and closes all of his or her trades before the end of the trading day; no open positions are are quite lengthy and contain detailed information.

Trading plans can, at the same time, be simple. For example, a trader planning to use the same mutual funds to make an automatic investment every month until retirement may require a simple trading plan. With their plan, investors can monitor their performance and evaluate their investment strategies.

In the case of amateur traders with no trading plans, they often enter the market ill-equipped with information about profit objectives and risks. Hence, they are vulnerable to market losses due to buying too speculative securities or trading on emotions.

Simple Trading Plans and Automated Investments

Periodic contribution plans enable investors to execute automatic trading continuously and on a regular interval basis. Investors usually prefer an automatic investment method to pool a certain amount of money into mutual fundsMutual FundsA mutual fund is a pool of money collected from many investors for the purpose of investing in stocks, bonds, or other securities. Mutual funds are owned by a group of investors and managed by professionals. Learn about the various types of fund, how they work, and benefits and tradeoffs of investing in them or other assets every month.

A well-documented and detailed trading plan acts as the basis for the trading process. It is to prepare investors for potential outcomes and provide them with alternative options if the market does not perform as expected.

For example, a 35-year-old male employee may decide to deposit $250 into a mutual fund every month. Upon checking the balance after four years, he may find that he lost money. He managed to deposit $12,000, and his holdings summed up to $10,000 only. A better trading plan would outline how to monitor the investments, and what to do to get into and out of positions.

Investors, such as buy-and-hold investors, may decide to invest automatically without doing anything else until they retire. In other cases, investors may choose to invest following a stock market collapse by a certain margin, such as 20% or 30%. It prompts them to start channeling significant monthly contributions into mutual funds.

Alternatively, some investors may choose to invest automatically every month but have stop loss rules if their investments start to devalue considerably. Therefore, a trading plan can be structured to be useful in automatic investing, with controls in place to identify when an action needs to be taken.

Tactical Trading Plans

Investors with short-term and long-term objectives should establish a tactical trading plan. A trader aims to enter and exit a position at an exact price level or under special requirements in tactical investing.

A tactical trading plan contains rules that guide the trader when to enter a trade based on price movement, statistical bias, chart patterns, and technical indicatorsTechnical IndicatorA technical indicator is a mathematical pattern derived from historical data used by technical traders or investors to predict future price, among other factors. The plan must also set forth how an investor should leave positions, either with a profit or a loss.

Tactical traders commonly employ limit orders to leave options with profit, while stop orders are useful when investors want to leave their loss. The amount of risked capital on each trade and how to develop position size are also elements of tactical trading plans.

There are also other rules that specify the appropriate and inappropriate time of the trade. For example, a rule may argue that if volatility is below a certain level, a day trader is not allowed to trade since market movement and opportunity may not be enough.

Adjusting a Trading Plan

Details contained in a trading plan are composed of market information researched by an investor or trader. The information provides a roadmap for what other traders and investors have done to realize maximum profit from the markets.

Trading plans should not be altered in the face of losses or when there are many challenges. The research-based information should prepare traders for every challenging situation associated with investing and trading. Nevertheless, if a trading plan does not cover all situations investing, it should be changed.

Related Readings

CFI is the official provider of the global Capital Markets & Securities Analyst (CMSA)®Program Page - CMSAEnroll in CFI's CMSA® program and become a certified Capital Markets &Securities Analyst. Advance your career with our certification programs and courses. certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

• Investment Policy Statement (IPS)Investment Policy Statement (IPS)An investment policy statement (IPS), a document drafted between a portfolio manager and a client, outlines the rules and guidelines that the portfolio
• Momentum InvestingMomentum InvestingMomentum investing is an investment strategy aimed at purchasing securities that have been showing an upward price trend or short-selling securities that
• Six Essential Skills of Master TradersSix Essential Skills of Master TradersJust about anyone can become a trader, but to be one of the master traders takes more than investment capital and a three-piece suit. Keep in mind: there is a sea of individuals looking to join the ranks of master traders and bring home the kind of money that goes with that title.
• Trade OrdersTrade Orders - TradingTrade orders refer to the different types of orders that can be placed on trading exchanges for financial assets, such as stocks or futures contracts.