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Creating a Trading Plan

The concept of a plan is accepted as standard practice in every walk of life, whether in business or in our personal lives, yet in trading, many people neglect to develop such a plan. I have often tried to rationalise why it is that most traders have no plan whatsoever. It seems to be a combination of several factors but the primary ones, I believe are as follows:

I am sure you have all come across the saying that goes something like this: "the person who fails to plan is planning to fail" - it has never been more appropriate than in the business of trading. Trading is a business. It is about making money, and like any other enterprise requires planning and attention to detail if you are to succeed.
Of the four points listed above, the one that I hear most often is the last one, which is that he or she has a plan in their head. Think about it: When approaching your bank manager for a business loan for a new venture, your response to the question "may I see your business plans" would be "don't worry, I have it all in my head" - I don't think the bank manager would be too excited.  One of the first rules of a trading plan is that it must be written down. Why? Simply that if it is written down you are more likely to stick to the rules you have written for yourself. If it is not committed to paper, you will not be committed to stick to it.
It is much the same as with a stop loss. When I ask traders where the stop loss is, they say: "I keep mental stop losses". The reason they do this is because of the fear that they will be stopped out of a losing trade. Maybe it will go up again is the catch cry. But remember: A 50% loss starts with a 5% loss. With a mental stop loss they can keep hanging in there just a bit longer, which defeats the whole purpose. Successful traders do not work with mental stop losses.
So where do we start to create our trading plan - as always: at the beginning.
We start by defining our goals and objectives before we can begin to write our trading plan.
The first step in developing our trading plan is probably the most difficult for many people, as we need to answer the following simple question: why do I want to trade?
Many people, when asked this question, simply say: " I want to make a lot of money" Such a statement written in a trading plan is hardly useful, as it is ambiguous and lacks any meaning.
What is a lot of money to you may be little to someone else. Try to have in mind the meeting with the bank manager and the business plan - if you sat in front of the bank manager and said that your objective for the business was to make a lot of money - would you be taken seriously - probably not.
People start trading for many reasons, and it is this that you must define in order to start writing a plan. Below are some of the questions which you will need to ask yourself, in order to begin the process:

For the purpose of this exercise we assume that you wish to trade in the Australian share market.
Now ask yourself: Is my personality suited to trading. For many people, the answer will be NO. You must understand the psychology of trading - understand your strengths, weaknesses, and core values.
The next question is: What do I want to achieve from my trading? Is it financial independence, a better understanding of the financial markets, self improvement, a part time hobby, a retirement project? Any of these are fine, but you must define them first so that you have a clear idea of why you are trading and what you hope to achieve. However for the purpose of this exercise I assume that you wish to achieve financial success.
It is helpful to have targets which define your progress towards your ultimate goals and objectives. Targets will help you to measure your progress. These need to be defined and achievable. These goals can be financial targets. You should measure them daily, weekly or monthly. Remember that your trading plan is a living document so you may need to review these from time to time as you learn and gain experience. There is nothing wrong with this - the plan can be fluid, but the rules that you write within it must be fixed. Your plan is in place to help you achieve consistency in your trading by removing the emotions from decision making wherever possible.
Ok, let us look at an overall strategy.
(amounts and % used here are examples only, you must define your own situation)

I plan to start my trading with a trading capital of $ xxxx. (For the purpose of this exercise, I assume $20,000, however you must replace this figure with an amount suited to your own financial situation.) If during the course of my initial trading, I exceed my targets then I will consider adding further funds in due course.

I propose to trade in only in the ASX 100 whilst I learn the basics of trading. I will use technical analysis as my predominant method for choosing stocks to trade.

I will select my prospect stocks based on the following criteria, using end of day data.

Trading Rules

Now you must set your rules for stock selection, entry and exit. How you set your selection, entry and exit rules is completely up to you, depending on your experience.

However in my opinion, the following 4 rules are a must:

1. The maximum loss per trade to be 1.5% of trading capital (In this case 1.5% of $20,000)
2. Position size to be set by loss size and stop loss position
3.  The maximum value of each position not to be more than 20% of capital
4. Stop loss to be set at a maximum of 5% below market price
5. Income from dividends to be reinvested in trading capital

Trading Targets

I feel that a return of x% (your target) on my trading capital should be achievable in the first year after costs. As I have no previous experience or track record I have divided this into 12 equal amounts giving a monthly target of $…….

Trading Records

1. I will keep a  trading diary every day
2. I will keep a  record of each trade, including the following:
           Stock
           Quantity bought or sold
           Price bought or sold
           Position of stop loss
           Date trade opened
           Date trade closed
           Profit or loss on the trade
           Cost of the trade
3. I will make a  daily balance of the overall account position, including cash in the account and the value of open positions
4. I will keep a  weekly summary of the total capital at risk
5. I will keep a  monthly P/L summary of closed positions

These outlines may help you to get started with the construction of a viable trading plan. Should you need any help, please do not hesitate to email me.
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Eric
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