HOW TO CREATE A FOOLPROOF TRADING PLAN
Every successful trader always says, “if you want to succeed, never enter a trade without a trading plan.” That’s all well and good, but I know when I was learning how to trade, a good trading plan to me looked like this:
- Stock to trade
- Entry point
- Exit point
And quite honestly I was lucky if I ever really stuck to that plan. Why is that? It was so frustrating. I did what I was supposed to, why wasn’t it working?
Because I was going in blindly. I didn’t understand why I was getting into that trade. Yeah, I had an entry point and an exit point, but I didn’t know why I had picked those points.
Failing to do my due diligence was detrimental to my trading and led to me taking a lot of losing trades. It’s easy to fix though! As long as you are willing to put in a little extra work into your trading plan, you will transform your account!
You will want to decide if you are longing or shorting, the type of trade, and at what entry price.
Is the stock trending up or down? Is it looking to break all-time highs (ATH) or break down past a strong support level? Does it have any catalysts? How long has it been trending in its current direction? Is buyer/seller pressure becoming exhausted? Determining factors like these will help you to determine if you should go long or short.
After that, you need to determine the type of trade you are going to make. Will it be an options trade or with shares only? Why? Is it going to be a scalp, day, or swing trade?
Doing your due diligence will help you to determine how far you think the stock will move and why. This will help show you how long you should hold this trade.
Lastly, your entry price needs to be determined by the type of trade you’re wanting to take (range trade, breakout, etc.). Buying when it bounces off support and selling when it hits resistance is great for a range trade.
The best entry point is buying after breaking high or day or all-time highs. Since this is a key psychological level being broken, there is almost always major buying pressure supporting the run.
This part of the trading plan consists of determining your position size.
How do you determine your position size when entering into a trade? This is a question that has stumped many and one that few know how to properly approach.
Many people think, “how much of my account should I put into this trade?” Well if you are extremely confident in it, we recommend no more than 50% of your account. We prefer using 15–25% of our account on a normal trade.
This is a personal decision, as each investor trades with different risk tolerances and account sizes.
A good rule of thumb picking a position size: if the amount you’re trading with gives you anxiety, stress, or greed, you’re trading with too much of your portfolio.
It’s easiest to start from a small position and work your way up to a bigger one over time. This way you learn how to master your trading psychology as well.
It is important to determine how much you are willing to risk for a reward.
You need to decide before entering a trade the amount of your portfolio that you are willing to lose if this trade goes south. Never go into a trade without knowing exactly what you could gain or lose.
I’ve seen it done two ways. Some people enter trades willing to risk no more than 1–2% of their entire portfolio. That means if they have a $10,000 account, they are not willing to lose more than $100-$200 on a trade.
I’ve also seen it where people do not want to risk more than 3–5% of what they go into the trade with. So if they enter a trade with $1,000 invested, they are not willing to lose more than $30-$50 on this trade.
No matter what you’re willing to risk, your profit-taking goals should always be double to triple your risk levels. You should always enter a trade with at least a 1:2 or 1:3 risk-reward ratio. This will ensure you cut your losses short and allow your gains to run further.
In addition to having these risk-reward levels in your trading plan, they also help determine where to place your stop-loss and profit-taking exit point.
The most important thing to look for when creating a trading plan are critical levels, price action, and/or patterns on the chart.
Determining critical levels can be overwhelming at first. But I promise it is a lot less overwhelming than it seems.
To determine a critical level, look for key points where the price has continuously revisited, but failed to breakthrough. These will be support or resistance areas to look out for.
Other critical levels look like all-time highs and all-time lows.
Breaking through any of these levels, as long as there is strong price action involved, will usually make the stock move greatly.
The further out on the time frame you go (15 min, 30 min, 4 hr, 1 day, etc.), the stronger the move is for the stock. So be sure to look at all time frames and not just one.
Don’t forget to determine any patterns, if you see them. Whether it’s an h pattern, flag, double bottom/top, these all have a lot to say about the strength of a stock and which way it may move next.
If you trade options, you will want to decide what the best contract is for you to trade.
The first thing to look into when trading options is how long do you want to hold this for? Have you determined if this is a swing, scalp, or day trade? No matter what you decide, there are multiple factors to look into when picking the best contract for you to trade.
First, you need to analyze liquidity. Look at the open interest and volume. For each contract you take, you want to make sure there is at least 250 in open interest and 100 in volume.
Next, check out your Delta and Theta. These are two of your most important Greeks when it comes to options trading.
Delta determines how much the price is going to change. The higher the delta, the higher the risk. Theta will determine how quickly time decay hurts your options contract. This number shows you how much you are losing each day on your contract.
These are all major factors in determining which call or put you need to pick to have a successful trade. Please note that the closer you are to expiration, the riskier the trade will be.
In conclusion…
Becoming a successful trader is something that can take years to master and minutes to destroy.
Implementing a strategic trading plan to make sure you have all your bases covered, will help you to have control over your trades and maximize your potential.
To do that, you need to:
- Determine if you are longing or shorting, the type of trade, and your entry price
- Decide your position size
- Determine your risk-reward ratio
- Decide critical levels, price action, and chart patterns
- Determine the best options contract for you to trade (if you want to trade options)
It can be overwhelming at first to create a trading plan, but rest assured you’ll be doing this in your sleep before you know it! Just like any other good thing in life, it takes time at the beginning but it gets easier the longer you do it.
