This article is an excerpt from John Forman’s book The Essentials of Trading, published by John Wiley & Sons, Inc.
What’s A Trading Plan?
The starting point of effective trading is the Trading Plan. One can think of it as a Business Plan for the trader. Just like the Business Plan, the Trading Plan is a specific outline of current status, objectives for the future, and the expected path to reach those goals.
In plain language, the Trading Plan is a set of rules governing the trader’s efforts in the markets. It brings together all of the whats, whens, wheres, whys, and hows of trading in an all-encompassing definition of what the trader is seeking to accomplish and how they will go about trying to make it happen. The Trading Plan is the starting point for every trader looking to succeed in the markets.
Please note that while we may be speaking here in terms of the trader as an individual, everything presented is equally applicable to a fund or company environment. The Trading Plan still must be constructed, albeit from a different perspective. Similar assessments to the ones following are required.
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Why Does One Need a Trading Plan?
The very simple answer is that it allows the trader to measure their performance in a very clear, straightforward manner, on a running basis. Just as one uses a map to both establish the path to be taken and to judge the progress that has been made, the Trading Plan defines the trading system and gives the trader benchmarks for use in judging the execution of it.
Be aware that a Trading Plan and a trading system are two different things. The latter is, in brief, the way one determines entry and exit points – the timing of trades, if you like. The former is more overreaching in that it includes the trading system, plus other important things like money management. We will address the various parts of the Trading Plan, each in its proper place in the pages to come.
What Is the Purpose of the Trading Plan?
There are several reasons to have a Trading Plan, but probably the biggest is the way it simplifies things. A good, well-thought-out Trading Plan takes a great deal of excess thinking out of the trading process.
Decision making is very clear cut. The Plan defines what is supposed to be done, when, and how. Trading can be a very emotionally charged venture. That can lead to all kinds of less-than-optimal behavior as was demonstrated in earlier chapters. The Trading Plan takes that out of the equation.
Just follow the plan. The Trading Plan is also very, very handy in helping one to understand the reasons for performance problems. If one is suffering from losses beyond what would be expected (as defined by the Plan), there are only two possible reasons. Either the Plan is not being followed, or there is a problem with the trading system. That’s it. Without the Trading Plan, resolving performance issues is a much more complicated process.
While a Trading Plan is intended to help the trader succeed in the markets, having a Trading Plan is not a guarantee of generating profits. A Plan is only as good as the components in it.
John Forman, author of The Essentials of Trading, is a 20+ year veteran of trading and analyzing the markets. He is currently an equity market analyst for Thomson Reuters, where he provides intraday commentary and trading recommendations for institutional subscribers, having previously held similar positions in forex and fixed income. John has authored dozens of magazine and website articles on trading and market analysis and provides information and insights on his trading education blog, http://www.theessentialsoftrading.com/Blog