What Is a Trading Plan?

A trading plan is a systematic method of identifying and trading securities. It considers several variables, including time, risk, and the investor’s objectives. A trading plan outlines how a trader will find and execute trades, including under what conditions they'll buy and sell securities, how large of a position they'll take𝕴, how they'll manage positions, and what securities can be traded.

Most trading experts recommend that no capital should be risked until a trading plan is made. It's a researched and written document that guides a trader's decisions.

Understanding a Trading Plan

Trading plans can be built in a variety of ways. Investors will typically customize their trading plans based on their personal goals and objectives. These plans can be quite lengthy and detailed, especially for active 澳洲幸运5开奖号码历史查询:day traders or 澳洲幸运5开奖号码历史查询:swing traders. They can also be very simple, such as for investors who just want to make automatic investments each month into the same mutual funds or 澳洲幸运5开奖号码历史查询:exchange-traded funds (ETFs).

Automatic Investing and Simple Trading Plans

Brokerage platforms allow investors to customize automated investing at regular intervals. Many investors use automated services to invest a specific amount of money each month into 澳洲幸运5开奖号码历史查询:mutual funds or other assets.

The process should still be based on a plan that's written down even though services are automated. The investor will be more prepared for what will happen each month and the planning process will likely also force them to consider what to do if the market doesn't go their way.

A 30-year-old might decide to deposit $500 each month into a mutual fund. They check their balance after three years and realize that they've lost money. They've deposited $18,000 and their holdings are only worth $15,000.

Buy-and-hold investors might simply automatically invest. They don't sell anything until retirement. They may even have a rule of not looking at their holdings. Other investors may choose to automatically invest only after the stock market has fallen by 10% or 20%. They then begin to make larger monthly contributions. Other investors may choose to automatically invest every month but they have sell rules in place in case their investments start to decline too much in value.

Automatic investors should also decide how much capital they're willing to allocate to each investment. This isn't a random decision. It should be well thought out and researched and then written into the plan and followed.

Tactical or Active Trading Plans

Short-term and long-term investors might choose to create and use a tactic trading plan. A tactical trader is typically looking to enter🅰 and exit positions at exact price levels or only when very specific requirements are met, unlike automatic investing where the investor buys securities at regular intervals. Tactical trading plans are therefore much more detailed.

A tactical trader should come up with rules for exactly when they will enter a trade. Th🌠is could be based on a c🐠hart pattern, the price reaching a certain level, a technical indicator signal, or a statistical bias.

A tactical trading plan must also state how to exit positions. This includes exiting with a profit or how and when to get out with a loss. Tactical traders will often use limit orders to take profits and 澳洲幸运5开奖号码历史查询:stop orders to exit their losses.

Additional rules can be added to specify when it's acceptable to trade and when it isn't. A day trader might have a rule that they don't trade if volatility is below a c🍬ertain level because there may not be enough movement 🥂or opportunity even if their entry criteria are triggered.

Altering a Trading Plan

Trading plans should only be altered if a better way of trading or investing is uncovered. A trading plan should be scrapped if it turns out that it doesn't work. No trades are placed until a new plan is created.

Examples: Position Sizing and Risk Management

A trading plan can be quite detailed. At a minimum, it should outline what, when, and how to buy, and when and how to exit both profitable and unprofitable positions. It should also cover how risk will be managed. The trader may also include other rules, such as how securities to trade will be found and when it is or isn't acceptable to trade.

Let's assume a trader has determined their entry and exit rules. They've determined where they'll enter and where they will take profits and cut losses. Now they have to come up with risk management rules. Rules or topics to include in the plan might include a few provisions.

Risk Only 1% of Capital Per Trade

The distance between the entry point and the stop-loss point multiplied by the position size can't be more than 1% of the account balance. This rule governs position size because this is the only unknown and must be calculated. The trader might opt to risk 2%, 5%, or 1.5%.

Assume a trader has a $50,000 account. They can risk $500 per trade or 1% of $50,000. They get a trade signal that says to buy at $35 and place a stop loss at $34. The difference between the entry and stop loss is $1. Divide the total amount they can risk by this difference: $500 / $1 = 500 shares. They'll lose $500, which is their maximum risk, if they buy 500 shares and lose $1. They'll buy 500 shares if they want to risk 1%.

Leverage or No Leverage

The trading plan should outline whether leverage can be used and how much can be used if it's allowed. Leverage increases both returns and losses.

Correlated or Uncorrelated Assets

Part of the risk management process is to determine whether correlated assets are allowed to be traded and to what degree. An investor must decide if they're allowed to take full positions in two stocks that move very similarly. Doing so could result in double risk if both hit the stop loss but also double profits if the targets are reached.

Trading Restrictions

A trading plan can include curbs that stop trading when things aren't going well. A day trader may have a rule to stop trading if they lose three trades in a row or a certain amount of money. They stop trading for the day and can resume the next day. Other trading restrictions can include reducing position size by a set degree when things aren't going well and increasing position size by a set amount when things are going well.

The risk management section of a trading plan can include all these rules, customized by the trader. It can also include other rules that help the trader manage their risk according to their objectives and 澳洲幸运5开奖号码历史查询:risk tolerance.

The Bottom Line

Trading plans are meant to be well thought out and researched. They're written by the trader or investor as a roadmap for what they must do to profit from the markets. Plans shouldn't change whenever there's a loss or a rough patch. The research that goes into making the plan should help prepare the trader for the ups and downs of investing and trading.

The comments, opinions, and analyses expressed on Investopedia are for informational purposes online. Read our 澳洲幸运5开奖号码历史查询:warranty and liability disclaimer for more info.