Last updated on April 26th, 2020
I’ve lost count the amount of times “having a trading plan” has either been written about in this trading tips blog, or mentioned in a trading article.
The reason you are inundated with “have a trading plan” by us is because it is something that if you don’t trade with, you are not going to maximize your potential in trading.
Even with all the writings, there are still some traders who either:
- Don’t think they need one
- Don’t know how to make one
- Have one but don’t follow it
Number three is easy to solve – just follow it!
Number one is someone thinking they will have success in trading without one. The short answer is – no, you will not.
I want to “bare bones” the second point and talk about how simple it is to set up a trading plan so there is no excuse as to why you don’t have one.
3 Simple Steps To Set Up Your Trading Plan
I know how hard it can be to watch momentum take hold in the market and not having a position. Look at this chart:
- Price bounces from support trend line
- Breaks a resistance trend line with momentum
- Gaps up which some traders will read as extreme bullish
By not following a trading plan, you are diving headfirst into a market move that is about to top out, rollover, and eat up half of the move.
- Where would you place your stop to manage risk?
- What would you enter this trade?
- What would you as a profit taking mechanism?
It is tempting to jump into large price moves as FOMO rears its ugly head but doing it in the context of a trading plan makes these a little less “risky”.
What are the three steps to a trading plan?
I just covered it. It was so simple you probably did not even recognize it.
- Know where your stop loss is going to go in the event you are incorrect about this trade
- How you enter the trade is based on the style of trading you are doing
- Taking your profit or having a way to milk profit from the market has been chosen.
Master The Big 3 – S.E.T. Your Trade From Start To Finish
Not only that, having a set way to approach each trade will allow you to diagnose issues when it comes to your trading strategy results.
Let’s now break down the “big 3” so you have a complete outline of setting up your trading plan for each trade.
Before you get into a trade, you must know where you will cut the trade if you are faced with adverse excursion. There are a few ways to consider your stop loss placement.
- Using pivots (not mathematical pivot points but price pivots) that had extreme price movements should keep you out of the market noise. The issue with price pivots is they can be discretionary which will cause some issue with consistency.
- ATR – average true range – has always been my favorite stop loss approach because it takes into account the volatility of the market. Common multiples of an ATR include 1.5 and 2X the 14 or 20 period ATR trading indicator
You need to enter the trade after you see a setup. The setup can be anything from a pullback in price to a breakout from consolidation. Trade entries don’t have to be complicated:
- A break of the high or low of the previous candlestick after the trading setup has shown itself
- Using an opposing trend line break – there is no true edge in trend lines but does show a rhythm change
- Using a failure test of support or resistance zones
When it comes time to end the trade and bank the profits, what is your favorite method to do so?
- You can use a multiple of the ATR as you did with the stop loss location. If anything, it does take the actual volatility into account so big moves on the chart can translate to bigger profits.
- Trailing stops are not true targets but do allow you to ride the trade until the market state has changed. Traders can use ATR trailing stops, trail 2-5-7 candlestick lows or highs, trail a moving average such as the 20 period SMA
Heading back to the chart from earlier, here is how it looks using S.E.T. as the basis for a trading plan.
- Price has broken up from a range and broken a downward trend line and we buy stop the high of the candlestick that break the trend line
- Our stop is set at 2X the 20 period average true range
- We trail our stop at 1.5X the 20 period ATR from highs and eventually get stopped out as price moves against us
No Emotions. Follow S.E.T.
In this example, you are positioned before the large upthrusting day that brought you quickly into profit. When you set you trade up, you also put in your stop loss in case price fails to advance.
Finally, since this is a daily chart, you check once a day and if price makes a new high, you subtract 1.5X ATR from the high price and move your stop up.
What you did not do was emotionally act.
As time goes on, you will have enough data to know if there has been some changes in the market action that may have you adjust parameters such as the ATR multiple.
There is no excuse for not putting together a three part trading plan to help keep you from taking actions that are not part of the way a professional approaches the market.