Trading Plan and Strategy

Part 11 Trading Plan and Strategy
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Ever feel like the more you learn about trading, the more confused you are? People can trade for years, spend thousands on education, trade rooms and signal services. 

You yourself may be at a point where you have already learnt a lot. Your technical analysis may be near perfect and you can analyse and produce amazing charts.

But despite all that you are still not consistently profitable? Well, if that is the case then you may have missed the most fundamental element of trading – a trading plan and strategy!


Difference between a trading plan and a trading strategy.

In simple terms a trading strategy is a set of rules for entering and exiting trades. A trading plan is a broader set of rules that covers the markets, timeframe and times you trade as well as your risk (money management) rules.

As such, a trading plan could involve one or more trading strategies. Just in case you are thinking about a shortcut you can’t have one without the other! 

So where to start? Well, there is some back and forth between the two which I will explain but the best place to start is with your trading plan as this is the framework for your strategy.

Trading Plan and Strategy

Trading Plan

There are 4 key elements to your trading plan:

  1. The market(s) you will trade
  2. The timeframe you will trade and the time you will trade (your trading day)
  3. What strategies you will apply to each market
  4. Your risk management rules

Trading is a probability game, your plan is about setting up a system where you move the balance of probability in your favour until you are consistently profitable and then you repeat that same plan over and over and over again.

Trading Plan Overview

Market Choice:

Ever been in a store with 20 variations of a single product and not able to make a decision. Choice causes confusion and confusion is not a good state for a trader to be in at any time!

Picking your key markets is an important first step in narrowing down your focus. Successful trading is all about focus and less is more. Not only will choosing fewer markets help you focus, the other important factor to remember is that every market is different.

Each market moves differently, has different volatility and will be moved by different sets of fundamental news and correlated markets. 

You don’t meet many doctor dentist rocket scientists do you? That’s because becoming an expert in a subject takes time and effort. In the same way you should limit your markets so that you can become an expert in that market. This will give you your first edge in the market when you implement any strategy.

Choose A Market That Improves Your Odds

The market you choose is up to you but if you are a retail trader you need to remember that you already have the odds stacked against you compared to the professionals. So don’t make your life difficult by picking exotic markets or complex derivatives. The major currency pairs and indexes are your best options; they have good volume, low spreads and plenty of free analysis and ideas for strategies you can use as a basis for your own trading.

Time Frame:

In the same way that each market moves differently, each time frame will be different in what strategies can be applied to it. 

Some people say that trading a lower time frame is riskier. Trading on a lower timeframe like 5 minutes does not mean you trade more. 

It just means you base your trading strategy on signals or rules in that timeframe. Risk is a function of the choices you make such as stops and targets and how often you trade.

Another factor with timeframes is that for retail traders especially, the higher time frames can actually be riskier to trade. The reason for this is with lower capital, in order to make a return you need to employ margin. 

The market range over a daily or weekly time frame is much larger than intraday time frames. Meaning wider stops required and more risk. Retail traders will also often face higher fees and carry charges which eat into the margin and make holding long term positions less profitable.

Lower Time Frame Does Not Have To Mean More Trading

What time do you have and when will you trade?

Finally, an important factor is your time. If you can only commit a few hours in the evening your choices will be different than if you are trading full time. There are two factors to consider here. The time you have free to dedicate to being in front of a screen and the time in which you will place your trades.

If your time is limited then your best option is to use your screen time for analysis, strategy building and testing and not trading.

As a retail trader many people are tempted to trade out of hours. For many people this will be a mistake as the market is working against you with low liquidity which means less opportunity for profit and unexpected spikes that can stop you out of a margin position.

The second part of this, the trading day or the time during which you will place trades will be determined as part of your strategy and will most likely be a period such as the US session, London session or Asian session.

What Time Do You Have To Commit?

Trading Strategies

Trading strategies are where we get down to business and trade the markets. So what is a trading strategy? Well, it is nothing more than a set of rules that you follow for entering and exiting markets. This has three elements: Entry, Stop and Target.

A Trading Strategy Is A Set Of Trading Rules

In order to define your rules you will need to follow a process for idea generation and then analysing the market. 

You will often hear strategies referred to by names like: Trend following strategy, scalping strategy, breakout strategy, support and resistance strategy and so on. These are just ways of describing an element of a strategy not fully built strategies. 

In a way, all of these are ideas for building a strategy. And this is a good place to start building you rules.

For example a breakout strategy.

The Idea is that markets will consolidate after a trend and then could break out of that range (up or down) 

Next, you scan the market and see how often this happens (look for multiple examples in the past), how big are the moves and are they viable for trading?

Then use analysis for rule setting: This is the key point that many people miss, being able to identify a breakout is just the first step, what is really important is what set of rules can you build that could give me a justifiable entry.

These rules need to be:

  • Credible: based on more than just a hunch, what technical or fundamental signal are you working off.
  • Quantifiable: you should be able to write these rules down and explain them. No intuition here
  • Consistent and repeatable: The same set of rules are applied over and over. Any exceptions need to be built into the rules and not just made up on the spot.
Strategy Setting Process – Breakouts

A strategy is more than just an idea, it is about taking that idea and applying technical and or fundamental analysis to build a set of rules.

You may think this is the final step but no, before you implement your strategy on a live market you need to complete a vital step. Strategy validation through backtesting.

Backtesting

So you have a set of rules that are credible, quantifiable and repeatable. So why not just start trading! Well, I’m sure you are trading for a reason and I’m pretty sure that the reason is to make a profit!

What is missing from our strategy is: do these rules produce a consistent profit over time? The only way to answer that question is to backtest.

The more defined your rules are the easier and more realistic your backtesting results will be. And you need more than a few weeks of data, in fact you will probably need a good year’s worth. 

Any strategy will have ups and downs and you will need to understand how well it works over time to make good decisions.

A good set of backtested results will give you information that is very important to your trading plan such as average risk and potential draw down (number of consecutive losses). It will also allow you to refine your strategy through a process of filtering your backtesting results for different scenarios.

Other Rules

Although it is best to simplify your trading rules as much as possible there will be scenarios you don’t think about. Don’t let these stress you out, if you follow this process you can modify and add or remove rules and work them through the process.

Just Keep Following Your Process

Risk Management

Often referred to as money management, the final part of the trading plan is your risk management rules. This is such an important element that it is a topic by itself and will be our next unit.

For the purpose of this unit you just need to be aware that trading is very risky and you will never achieve consistent profitability if you don’t manage your risk well. You could actually have a profitable strategy but draw down your account to zero, if you don’t manage your risk properly. 

Poor Risk Management Will Even Kill A Good Strategy

Summary

So to summarize: a trading plan is your overall framework for trading which includes your markets, timeframes, trading times and your commitment for analysis. Your trades will be implemented in your chosen market via clear backtested strategies and with defined risk management rules. 

I believe the reason why 99 % traders fail is because they don’t create their own trading plan and strategy as it is probably the most difficult thing to do.

Justina Nothard

Justina Nothard

Hi, I’m Justina Nothard, a retail investor trading Stock Index Futures.

I understand how hard it can be for the ordinary trader to learn the basics and find useful tools and practical information.

This is why I decided to create Nothard Trading to help you take control of your trading.

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