,

7 Important Reasons Why You Should Have a Trading Plan

By Chika

-

Last Updated: March 12, 2022

Share

811
0

The value of having a trading plan cannot be emphasized, but the number of traders without one considerably outnumbers those who do.

It's easy to stray off track without a well-thought-out strategy. It's not necessary for your plan to be extremely extensive; a few pages would suffice. However, the more specific the information, the better. The goal here is to systematize and replicate as much of your procedure as feasible.

There are a few fundamental elements that should be included, but there is plenty of potential for customization to meet your individual requirements.

 

Importance of having a trading plan

Markets are far too dynamic and fraught with risk to attempt to navigate without a sound foundation in place.

If you want to obtain consistent trading success, you'll need a plan. They are also fantastic at assisting you in identifying your strengths and shortcomings so that you can focus on what works and avoid what doesn't. Here are some reasons why you must have a trading plan. 

 

#1. Risk management

Risk management is the most critical aspect of successful trading. One factor that separates newbies from experienced traders is the focus of their trades.

While new traders tend to concentrate on how to make a profit, experienced traders first look for how to reduce risk and potential losses. Without an appropriate risk management strategy, the trading plan will not make sense, regardless of how good it may be on paper. 

Risk management entails knowing your risk tolerance and adopting a risk management strategy that fits you. Know how much you intend to risk-per-trade and total account risk across several positions. What is the max number of positions you will hold at once? 

You should have a maximum drawdown percentage in place as a ‘kill switch’ when things aren’t going well. For example, if you have a 10% maximum drawdown, you will either take a break or at least reduce your trading size. Remember, your priority as a trader is capital preservation. 

 

#2. Analytical approach

Every trader should have an analytical approach to their trades. This is like a compass that tells you what direction to take in the market i.e. when to place trades or when to exit the market. 

To do this, there are a couple of technical tools which traders can use to identify set-ups. 

This could be some combination of:

What is important is having a process in place. At first, it will be difficult to know which tools to best identify a profitable set-up. However, with constant practice and observation, it will become second nature. 

Albeit, a caveat must be added here. You also have to cognize the type of market cycle, depending on one set of technical tools to identify potential set-ups. Understand that markets are dynamic and can change anytime, as such you have to be flexible in your choice and use of technical tools. 

 

#3. Each market is unique

Each market is unique and reacts differently to macroeconomic cycles. For example, while rising inflation or benchmark interest rates may be bad for equities, it is good for fixed income and bonds.

As such, it is always a good idea to trade in a single market and build your proficiency in it. This helps to keep things simple and enables you to understand how the market would react at any given economic event.

You can even extend your much e knowledge by focusing your trades on particular trading sessions (U.S, Europe, or Asia), or chart time frames (daily, weekly, 4-hour, 1 hour, etc.)

 

#4. Determine your holding period

An effective trading plan always stipulates the holding period.

This is born out of your risk management system as this determines how long a trader would want to maintain their position. Those with a huge appetite for risk usually stay in their trading position for longer periods, as against those that have a lower appetite for risk.

This inadvertently determines your trading style i.e. scalping, day trading, swing trading, or position trading

Beginner traders who are interested in trading should start with smaller time frames and work their way up to the faster pace of intra-day trading. It's a good idea to concentrate on only a few time frames at most, as managing trades over multiple time frames can be challenging even for experienced traders.

 

#5. Handling losses and gains

What will you do to ensure that a potential loss does not lead to a blow-out?

Or how do you handle a profitable trade to ensure that you do not leave some money on the table? It is critical to have a strategy in place to handle your trades especially if they don't go the way you envisaged.

Sometimes when you are experiencing a run of losses, it is best to reduce your trade size or stop trading for a while to relieve tension and figure out what's wrong. 

Likewise, when things are going the way you anticipated, it's equally crucial to have a plan in place. If not properly controlled, overconfidence can be deadly and lead to a downturn.

While being more aggressive when market conditions are favorable and you're doing well is a wonderful thing, you must do so wisely. Increasing your risk by 50% isn't uncontrollable, but suddenly quadrupling your risk is a recipe for a disastrous outcome. 

 

#6. Helps keep your emotions in check

Having a trading plan helps traders build profitable trading psychology which entails avoiding emotional responses to market swings and volatility.

The hallmark of a successful trader is entrenched in an unwavering attitude regardless of market direction or lack of it. The savvy trader seems to be composed no matter what the market circumstances.

Common human emotions like greed, fear, and hope can cause serious trouble when trading thereby leading to losses. So, having a good way to manage your emotions is critical to your success as a trader. 

Many traders have lost their entire account because of the lack of discipline to follow their trading plan. Once discipline is lost when trading, the trader will then be much more likely to trade emotionally and can potentially incur devastating losses as a result.

Accordingly, for the best chances of success when trading, remember to prepare yourself before you begin to trade by planning your trades objectively and then proceeding to trade your plan as strictly and calmly as possible. Having a well-defined trading plan helps to keep emotions in check and avoids following the crowd. 

6 Emotional Biases You Should Avoid When Investing in the Stock Market

#7. Helps to make you a better trader 

One major advantage of having a trading plan is that it improves your approach as a trader.

This is because a trading plan provides the avenue for you to assess your trading strategy frequently and make any necessary changes. This entails setting aside time to think about the events of the week and how you traded. 

Periodic reviews of your trading history and keeping a trading journal are fantastic strategies to evaluate the efficacy of your trading plan, as well as spotting patterns in your trading that can lead to further plan tweaking. Save trade set-up charts so you can see what excellent and bad deals look like regularly.

 

Key Takeaways About Having A Trading Plan

As you go through and construct your plan, it is important that you keep it simple and do not overcomplicate things.

Find a market you have a deep interest in, study it, and build your proficiency. A trading plan is only good if you stick to it no matter the outcome.

This helps you build discipline and reliance which are characteristics of successful traders. Most importantly, do not assume that your plan is sacrosanct. Regularly review and adjust according to the market cycle.  

 

 

YOU MIGHT ALSO LIKE

Leave a Reply

Your email address will not be published.

This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.

LATEST

Subscribe for daily financial content

Daily articles, financial messages and affirmations to best help you navigate your financial future.