The importance of a written trading plan.

Treating trading as a business should include having a written trading plan. There are several reasons why this exercise is necessary for long term success. Primary among these is that a written plan helps one focus on the action needed for the fulfillment of one's stated goals. But just what is a trading plan, what are its components, and why are they needed or helpful? With the help of Van Tharp's book Super Trader, I'll summarize the components and their purpose.

A business plan attempts to address issues that affect the daily and future direction of the business. A trading plan should do the same. So to begin, one needs to define why they are interested in trading, a mission statement, to define the real motivation behind their trading. For example, my mission statement states:

“I believe that the income from successful trading is scalable. Using leverage, I can increase my income without increasing the “hours worked.” Given this, I intend to replace my current occupation with trading so that I may free up time to spend with my family, while increasing our standard of living and quality of life.”

To achieve this mission, I need to state my interim goals and objectives. Or how I intend to get from point A to point B. Within this segment, I address my periodic goals, in terms of monetary gain, as well as if my trading focuses on taking positions based on fundamental analysis, or trades entered on analysis of price action, or a combination of both.

The next segment of the trading plan addresses trading and market beliefs. Tharp has asserted, in his several books, that traders trade their beliefs concerning markets rather than anything else. In this segment, one should address their beliefs concerning their trading strategy, their beliefs concerning the market traded, and how these beliefs impose limits, how they are helpful, and if not, if and how can these beliefs be changed.

 

Next, a statement of one's beliefs concerning the big picture, the macroeconomic situation, legislation which might affect the market, and other general considerations. This is kind of an big picture overview which guides the development of the big picture strategy. It is from this that the next section, the tactical trading strategy takes shape.

The tactical trading strategy should answer how it fits in the big picture, how it addresses quiet and volatile bear, sideways and bull markets, entry set ups, entry timing, worst case acceptable loss per trade (and how it is determined,) how profits are taken or what the exit set up and timing is. If your trading system is mechanical, a backtest should be able to statistically determine what the expectancy of the system is, and should be stated. If the trading system is discretionary, use a spreadsheet to determine the real expectancy of the system, and state it in the plan. The tactical trading strategy section should also address how your objectives will be met through position sizing.

A treatment of psychological challenges and problems should be addressed in the next section. Address how losing streaks are to be dealt with, how corrective action is to be developed and implemented, how discipline is to be reinforced and maintained, how emotional issues are to be dealt with, how self sabotage is to be identified and avoided, how trading efficiency is to be increased, and how developing problems are to be recognized and dealt with before they become self sabotaging.

Daily procedures follow in the next section. If you don't have a regularly schedule time to trade, you should probably make one. This is one way to start enforcing trading discipline. I use a time schedule to outline my daily trading procedures, as I constantly monitor the 24 hr market of forex. Some procedures would include a review of schedule data releases, time to complete a self assessment, establishment and up keep of trading result statistics, trade journal entries, review and modification of the trading plan, continuing trading education, etc.

Continuing trading education is so important that Tharp gives it its own section in his model trading plan, following the daily procedure section. This section could address what and how one intends to become a more efficient trader.

A business plan would not be complete without a disaster plan, and neither is a trading plan. How will you deal with a loss of internet access? What if Congress imposes a new tax on your trading vehicle? What if your broker goes bankrupt? Attempt to address any disaster now, so you can deal with it when and if it occurs.

Next is a budgetary plan, how are you going to fund your trading capital, where will you move your profits, and tax planning.

Then address general business system issues such as record keeping, dealing with broker and/or client issues, paying estimated taxes, etc.

Finally, the trading plan should explain how mistake avoidance is to be implemented. Trading mistakes have a big impact on overall performance, so it is important that a system is developed and put into action to quickly recognize mistakes and that corrective action is taken. Including this in your plan is a must.

To summarize, a trading plan can be outlined as follows

1. Mission Statement
2. Goals & Objectives
3. Trading & Market Beliefs
4. Macro Assessment
5. Tactical Trading Strategy
6. Position Sizing
7. Challenges & Problem Resolution
8. Daily Procedures
9. Continuing Education Plan
10. Budgetary Plan
11. General Business System Plan
12. Mistake Avoidance

Review your plan daily, and make updates as needed.