When it comes to trading, a solid trade plan is often the difference between success and failure. Surprisingly, many traders overlook the importance of comprehensive planning, simply because they are unsure of what elements a trading plan should include. In this article, we will provide you with a step-by-step guide to developing an effective trade plan that covers all the essential aspects. If you want to apply this with the least amount of friction, I suggest using a pen and a sheet of paper on your desk.
How to Plan a Trade
Stock
To begin, jot down the symbol of the stock you are considering. This simple step ensures that you have a clear reference point throughout the trading process.
Long or Short
Avoid any assumptions or memory lapses by explicitly noting whether you plan to buy the stock (go long) or sell it short. Putting it in writing enhances clarity and eliminates unnecessary decision-making or recall during the heat of trading.
Stop and Reasoning
Determine the price level at which you would exit the position, both to protect yourself from excessive losses and to maintain discipline. Clearly articulate the reasoning behind this decision, based on your analysis and strategy.
Trade Reason
Articulating why you are taking the trade is crucial. If you are employing a pattern-recognition strategy, back it up with a quantitative rationale rather than relying on qualitative factors like someone else's recommendation or a hunch. The more precise and logical your reasoning, the better. Imagine explaining the trade to someone else; if you struggle to do so convincingly, it may be a sign that the trade isn't worth taking.
Risk per Share
Calculate the difference between your entry point and the stop level. This figure represents the risk per share, providing you with a clear understanding of the potential loss associated with the trade. Enter this information once the trade is placed.
Profit Levels
Plan ahead by identifying specific price levels at which you will take profits. Having predetermined profit targets helps you remain focused on your objectives even after the trade is executed.
Updates
Every trade plan should include an update section where you can record your observations and emotions during the management of the trade. This section plays a vital role in your growth as a trader, enabling you to reflect on your mindset and learn from past experiences. Include details such as the ultimate closing point of the trade and the resulting gain or loss.
Implementing Your Trade Plan
Remember, the key to effective trade planning lies in its implementation. The goal should be to go through this process before every trade. Make it a habit, engrained in your trading process, so that it becomes second nature and part of your subconscious. Don't get too caught up in perfecting the details at this stage. Understand that your trade plan will evolve as you evolve as a trader. By treating this process seriously, you'll have a written record of your growth and be able to witness the improvements you make over time.
Conclusion
Developing a comprehensive trade plan is an essential step towards becoming a successful trader. By following the guidelines outlined in this article, you can create a roadmap to guide your trading decisions, enhance discipline, and achieve better results. More importantly, the practice of creating a trade plan is key to making sure you are considering every aspect of your trade. The very nature of this exercise makes it so you can totally eliminate impulse trading. Remember, consistent practice and continuous refinement of your trade plan will lead to improved trading performance and increased confidence in your abilities.