Trading Plan Strategy (Backtest And Example)
Last Updated on April 18, 2023
There is a common saying that “he who fails to plan, plans to fail.” That is the case in financial trading. In fact, the difference between making money and losing money in the financial markets can be as simple as trading with a plan or trading without one. So, it is critical to have a trading plan strategy when playing the financial markets. But what is a trading plan strategy?
A trading plan strategy refers to having a framework that guides you through your entire trading process. It is your guide to executing your trading system, factoring in risk management and personal psychology. It defines the conditions under which you identify markets, enter trades, exit trades, and manage risks along the way. Your trading plan ensures accountability and keeps you focused on your personal strategy.
In this post, we answer some questions about the trading plan strategy. At the end of the article, we provide you with an example of a trading plan strategy backtest.
What is a trading plan strategy?
A trading plan strategy refers to having a framework that guides you through your entire trading process. It is your guide to executing your trading system, factoring in risk management and personal psychology. It defines the conditions under which you identify the markets to trade, enter trades, exit trades, and manage risks along the way.
Your trading plan ensures accountability and keeps you focused on your personal strategy. This is why most trading professionals advise that you should never risk any money until you have developed a trading plan strategy.
Why should I use a trading plan?
Your ultimate goal as an investor or a trader is to attain consistent profitability. A trading plan strategy is a road map that helps you remain on track to your targeted objective. Here are some of the reasons why you should use a trading plan:
- It makes things easier
- It keeps you on track at all times
- It helps you to make objective decisions, rather than emotional decisions when the going gets tough
- It helps you to know when to tweak your trading system
- It helps you to maintain trading discipline
Steps to building a trading plan
The following are the essential steps to building a successful trading plan:
- Identify your motivation: Identifying your trading motivation and the amount of time you’re ready to spend is critical in developing your trading strategy. Ask yourself why you want to be a trader, and then put out your goals for trading.
- Determine how much time you can devote to trading: You need to factor in how much time you can devote to your trading operations. Can you trade while working, or must you handle your transactions early in the morning or late at night? Your answers can help you plan better.
- Establish your objectives: Your trading aim should be explicit, quantifiable, realistic, relevant, and time-bound rather than stated (SMART). ‘I hope to grow the value of my whole portfolio by 15% in the next 12 months,’ for example. This objective is SMART because the numbers are explicit, you can assess your performance, it is reachable, it is about trade, and it has a time range.
- Define your trading personality and style: You should also consider your trading style. Your trading style should be determined by your personality, risk tolerance, and the amount of time you are prepared to devote to trading.
- Determine how much funds you have available for trading: Consider how much money you can afford to invest in trading. You should never put more money in danger than you can afford to lose. Trading is fraught with danger, and you might lose all of your trading capital if you don’t know what you are doing.
- Specify your account risk per trade: This is very important, as it would determine your position sizing and risk management methods. You can state that you risk only 1% of your capital in any trade. That is what you use to calculate your position size or stop loss when one is known.
- Determine the markets to trade: You should specify the markets to trade: stocks, futures, cryptos, commodities, and so on.
- Specify your trading strategies: You must document the strategies you want to use and the market conditions to use each, or whether you want to trade all the strategies at all times.
- Document how to keep your trading journal: Your trading journal can be electronic or manual if you are using a manual trading method. For an automated trading system, the journaling is automated as well.
- Specify how often you evaluate your trading performance: This could be done monthly or quarterly, but it may be better to base it on the number of trades taken. You specify the number of trades that constitute a good sample size for your evaluation.
What is an example of a trading plan?
A trading plan can be quite detailed, but at minimum, it should contain an outline of what, when, and how to trade the markets you want to trade, and it should also cover how risk will be managed. Here is an outline of what a trading plan for a forex trader can look like:
The markets to trade: Only trade currency pairs; no indices or commodities, as they are too volatile
Account risk and position sizing: Only risk 1% of your account balance per trade; use this to calculate position size after finding a suitable stop loss level.
Leverage: Always ensure you are not using more than 3x leverage!
Trading restrictions: Do not trade during news releases!
Trading strategies: Momentum and mean reversion strategies; can trade both at the same time. For mean reversion, entry and exit triggers are stated. For momentum, entry and exit triggers are stated.
Trading journal: electronic journaling
Performance assessment schedule: Evaluate performance after every 50 trades! Tweak or replace strategies if the profit factor is less than 1.5!
Note that the trader may also include other rules, such as how securities to trade will be found, if different markets can be traded at the same time, and whether to diversify across different timeframes if the strategies can work in multiple timeframes.
What key elements should be in a trading plan?
A trading plan entails establishing criteria for entering and exiting trades, determining how much money to trade with, and developing a profit strategy. Here are the five key elements to include.
- Your time horizon
- Your entry strategy
- Your exit plan
- Your position size
- Your trade performance
Can you alter or change your trading plan at any time?
You may choose to adjust your trading plan over time if there are new realities in the markets that you need to include in your plan. This is because market circumstances, your financial state, and your financial objectives may change, and you may need to revise your trading plan to reflect this. For example, if you have not been in the crypto market and your research shows that your strategies can make money in cryptos, you can update your plan to include crypto markets.
However, you should not change your trading plan in response to short-term market developments, such as when stock prices fall. While you can always tweak your strategy, your trading plan is a document for a long-term project.
Do professional traders use a trading plan?
Professional traders follow highly precise trading plans almost obsessively. This is one of the qualities that distinguish them as experts. Furthermore, the trading methods in their plans have often been extensively back-tested and refined over time through a trading log and frequent trade outcomes reviews. Professional trading plans will have stringent money management requirements and particular entry and exit procedures.
Trading plan template
As the name indicates, a trading plan template is an outline of instructions that a trader follows to execute their trading strategy and risk management. A trading plan template may also contain advice for a healthy trading daily routine and chores that will assist you in managing your account and controlling your emotions.
A trading plan allows you to describe your trading objectives, strengths and weaknesses, risk management method, trading technique, entry rules, exit rules, daily routine, and so on. With a trading plan template, you have an outline of what to do each trading day to be able to identify and execute qualifying trades for the day if you are a manual trader or how to monitor and assess your trading system if you are using a trading algo.
For a manual trader, a trading plan template may look like this:
Premarket routines: Setting up your screen, analyzing the markets, and planning trades
Trading routines: timeframes to trade; market sessions to trade
Trading strategies: markets to trade; entry setup
Risk management plan: account risk per trade, position sizing, stop loss, profit target, reward/risk; when to exit all positions for the day
How to write a trading plan
The procedures for creating a trading plan are as follows.
- Choose the financial instruments you will trade.
- Determine your market indicators.
- Determine particular pricing entry points.
- Make a plan for how you will monitor each deal.
- Set the settings for trade exits.
- Include a trading hours section.
- Examine your trading strategy
Benefits of having a trading plan
Overall, a good trading plan will benefit you in the following ways:
- To determine your objectives.
- Make a plan for your market research and trading operations.
- Determine when and in what direction to take a stance.
- Once you’ve entered a position, control your emotions and trading risk.
Types of trading plans
While there can be different types of trading styles and trading strategies, a trading plan is simply a guide on how you go about your trading business. Trading is a business and must be treated as such — your trading plan is your business plan in that regard, and there are no types.
However, based on the type of trading method you implement — manual trading or automated trading, the key features of your trading plan would differ. A trading plan for manual trading focuses on every step of the trading process, from your choice of the market to how you execute trades, exit trades, manage risks, keep records, and evaluate results.
On the other hand, a trading plan for an automated system details your chosen markets, strategy, risk management, and trade evaluation schedules.
Developing a risk management strategy for your trading plan
Developing a comprehensive risk management trading strategy is an essential part of your trading plan. You must specify your account risk per trade, your position sizing, whether to use a stop loss and how to set it, when to exit all positions for the day, and so on.
Setting goals and objectives in your trading plan
Setting trading objectives is vital for two reasons: it helps you keep to your trading strategy and allows you to trade more regularly. For people who are new to trading, this means focusing on the process rather than the result. Goals based on tight risk management and good technical analysis, for example, as well as a daily routine combining exercise and a healthy diet, will inspire more consistent trading.
Reviewing and adjusting your trading plan
When creating your trading plan, you should include a section for assessing your trading results, as well as events that can lead to reviewing your entire trading plan. Your trading plan is a roadmap for your long-term trading journey. You get to review or adjust it only when new realities in the market warrant it, such as introducing a new strategy, entering a new market, and changing your trading style.
Sticking to your trading plan: discipline and emotional control
The importance of emotional control in trading cannot be emphasized. You must be disciplined enough to stick to your trading plan at all times until there is a need to review your plans.
Common pitfalls to avoid when creating a trading plan
The following are some common pitfalls to avoid while setting up a trading plan:
- Inadequate research
- Not capturing all the essential aspects of your trading process, thereby leaving some things to guesswork.
- Not documenting the plan
- Frequently tampering with your trading plan
FAQ trading plan strategy
Can having a trading plan help me become a successful trader?
Yes, but you must be disciplined enough to follow your plan to the letter until you have a genuine reason to update the plan.
What does it mean to be a successful trader?
Being a successful trader entails being consistent over time. This entails discipline, learning from your errors, and controlling your emotions. Keep your risk tolerance in mind and don’t go beyond your risk tolerance.
What leads to unsuccessful trading?
Trading too often, succumbing to fear and greed, and herd behavior (following the crowd).
Trading plan strategy backtest
A complete backtest of a strategy with strict trading rules and settings is coming shortly.