October 13, 2020
What is a Trading Plan and Why Do You Need One?
Many traders, both new and experienced, go through this at some point...
Imagine you are in a trade and the result is better than you initially expected. At first you have a wave of excitement that the trade is doing so well. But then you realise “S**t what do I do next?”
Do you take your profits and run?
Leave the trade to run some more?
You’re left feeling flustered, rushed and may struggle to make logical decisions under pressure.
Operating under these conditions, you are significantly less likely to perform at your optimal ability. The decisions you make may be extremely different to how you would react when looking at the situation in hindsight.
So, how do we overcome this?
The Magic of Having a Trading Plan
In any situation, not just in trading, the people that are the most composed and confident are those that have a logical and well-rehearsed plan.
Therefore, if your goal is to achieve elite-level performance in trading, a great tip is to always be over-prepared rather than under-prepared, so you can stay a step ahead of what happens in the market.
We all know that the markets are erratic, so no matter how great our analysis is there will always be a possibility of several different scenarios playing out. Each scenario will have a different likelihood of taking place, but they are still all possible.
This means, a great trading plan will outline what action you will take as soon as you have the earliest indication that one of those scenarios is or isn't taking place. In the same way we have criteria for entering a trade, we should have criteria for what action to take with our trade at critical decision points.
Here's are some steps you can follow to start doing that...
Before entering a trade, consider as many of these different scenarios as possible. We often refer to these as the 'different potential outcomes'. You'll need to plan how you will deal with each outcome.
- What happens if the trade picks up momentum in the opposite direction to the one I'm trading?
- What if it consolidates around my entry point?
- What if it goes well and moves beyond my first decision point or target with a lot of momentum?
- What should I do if the price starts reacting to a particular significant level?
These are just a few questions for a generic hypothetical situation and they may differ depending on what you're facing in the market. The answers that you give for each of the questions should be aligned with your system, which will leave you with clear actions in line with your system that you can take with complete clarity at critical moments.
When you have these actions planned, I would recommend writing them down either directly on your chart or in your trading journal.
It may sound just like extra work at first, but this is a lot less effort and stress than having to react to market movements in the heat of the moment!
We know we trade at our best when we can think with clarity and our clearest moment will always be before the trade is open. Once we start experiencing the physiological and psychological effects of being in a trade, it will often lead to illogical and rash decisions. So taking this approach will reduce the number of errors you make.
Execution and Discipline
A perfect plan is completely useless without adequate discipline and proper execution.
To illustrate this, here’s a quote from the boxing legend, Mike Tyson.
Tyson would intimidate his opponents during face-to- face encounters and claims he could see in their eyes that they had already lost. As a result of this, rather than sticking to their plan during their fight, they would immediately go into survival mode and act like a deer in the headlights.
This is what happens to traders in the markets!
A trader may have the most precise and detailed plan. They may be ready for whatever the market is going to throw their way...
Then they catch the chart staring them in the eye from across the desk. The trade has moved heavily one way and emotions start rising.
The adrenaline starts flowing. Dark thoughts of holding onto the trade creep in, even though the plan says to exit.
BOOM, the market delivers a knockout blow.
Every time it happens, you vow you will never go against your plan again (until the next time...)
So having a great plan is one ingredient, but it won't be a successful recipe without adding some strong self-discipline.
If you would like tips for becoming a more disciplined trader, here is another article that may help: