How To Build a Successful Trading Plan

In this article, you will learn how to construct a trading plan and what items are essential to include in it. Traders who are better organised and who plan their actions in advance are usually more successful than those who do not.

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What is a Trading Plan and Why is it Important? 

A trading plan is a template that details all the processes you need to trade successfully.

What’s the difference between a trading plan and a trading system? A trading system covers the rules used to enter and exit trades. A trading plan contains the system but covers more: e.g., risk management, daily routine, etc.

Every profession with complex repeating tasks, from surgeons to pilots, relies on a decision-making framework and checklists to navigate. Of course, each patient a doctor meets and every weather condition a pilot encounters is unique. But these professions have a consistent process to deal with each type of scenario. Trading should be no different.

What does a trading plan give you?

• It allows you to operate under tested circumstances. When you enter a trade based on a process you have used before, you have an estimated probability of success and the potential size of your win based on experience.
• A consistent process prevents you from jumping in and out of the market for different reasons each time, avoiding what would be erratic results.
• Operating with a trading plan helps you analyze your trading and find the causes of any problems.
• When you adjust your trading and try new ideas, you can compare performance before and after your applied changes to see if there was a net improvement.
• In times of stress and heightened emotions, you can rely on your plan as a map. Sometimes, we feel overconfident and want to risk a lot. Occasionally, we are fearful and unsure if we should enter a trade. A trading plan can help you avoid overreactions.

One of the most successful traders I know, Tom Dante, describes starting his journey without a plan. “I read various strategies, and I began trading. Straight away, I started losing money because I was just trying things out, but with no real rhyme or reason.”

To get consistent results, you need a consistent decision-making framework. This is the real holy grail of trading.

How Do You Create a Trading Plan? 

To create a trading plan, you need to decide how you will trade in three main areas:

Part 1: Trading strategy or method

At a minimum, a trading strategy should contain the following elements:

1. Criteria for entering a trade
2. Rules for taking profit
3. Rules for exiting a trade at a loss

Part 2: Managing risk

1. What’s your minimum risk/reward ratio?
2. How much of your account will you risk per trade?
3. What maximum drawdown will you tolerate?

Part 3: Routine & record keeping

1. Daily routine
2. Screens and charts set-up
3. Record keeping & improving your trading

Before we get into the details of each part, let’s consider the question of discretionary versus systematic trading because this will affect how you construct a trading strategy as an important part of your trading plan.

Discretionary vs. Systematic Trading 

Discretionary trading: open to subjectivity

Let’s take an example of an entry rule for a discretionary trading strategy: “When I see a reversal pattern on the 4-hour chart or higher, and price breaks and retests the most recent support or resistance level, I will enter a trade.” So, this rule is subjective: one person may see a strong reversal pattern, and another may think it is too weak to be called a reversal. They may draw their support and resistance levels in different places, etc. This is a discretionary trading rule because it is open to subjective interpretation.

Systematic (mechanical) trading: no room for subjectivity

Let’s look at this entry rule: “When the 9-EMA (exponential moving average) crosses the 21-EMA from below, I will enter long immediately after the next candle closes above the 21-EMA.” That’s a systematic entry strategy because it has objective rules. Two people following this rule will make identical trade entries.

Which is better—discretionary or systematic?

1. Discretionary strategies generally take longer to learn and master.
2. Systematic strategies can be programmed. Discretionary ones cannot be.
3. Systematic strategies are easier to back-test compared to discretionary ones.
4. Discretionary strategies can be more open to your emotions and rationalizations for getting in and out of a trade.
5. Systematic strategies cannot be adapted to market conditions.
6. Discretionary strategies can be more adaptable to market conditions. I think that this is their core strength.

You should consider your psychological preference. Some people are happy following fixed systematic rules, and others want the discretionary room to judge each trade. Another option could be starting as a beginner with fixed system rules, and then making it more discretionary as you gain experience and see the outcomes of many trades.

A strategy can be a mix of discretionary & systematic.

For example, I could say that I will look for reversal patterns (the discretionary part) but only enter when a particular indicator is at a specified level (which is a systematic rule).

Now we have that covered, let’s look at the three parts of a trading plan.

Components of a Trading Plan 

Part 1: Your Trading Strategy 

The key is to state your entry and exit rules as clearly and objectively as possible so you can follow a known procedure. Let’s look at the essential elements the rules should contain.

Entry rules

1. What do you want to see in the market for you to enter a trade? Focus on clear and repeatable circumstances to create trade entries.
   1. If you are a technical trader, you can choose between pure price action (e.g., support and resistance and chart patterns) or using technical indicators in conjunction with the price.
   2. You should also ask yourself if you wish to always trade in line with an established trend or if you prefer reversals, ranges, or even countertrends.
   3. All markets have fundamental data and economic news that drives price and provide regular opportunities to enter trades if you have a method to back up your entries.
2. What timeframes do you want to analyze?
   1. Most traders will examine multiple timeframes. Let’s say you want to capture trends on the 5-minute chart. You probably don’t want to trade into a support or resistance level that’s obvious on the 4-hour chart. It is common practice to execute on one timeframe but check higher timeframes to see if they align.
   2. Keep in mind that if you want to execute on small timeframes, e.g., 5-minute charts, you must be available to sit at the screen at certain times. If instead, you want to trade higher timeframes, e.g., daily charts, you can pretty much trade any time of day that is convenient for you.
3. Which markets do you want to trade? There’s a lot of choice—Forex, stocks, equity indexes, crypto, commodities—and they all have nuances. Be specific with your list of markets: if you choose Forex, which pairs do you want to trade? If you are trading stocks, do you want to filter out companies below a certain market capitalization?
4. Which instruments do you want to trade?  Again, there are choices: CFDs, futures, spot market, and options, to name a few. Many markets have multiple ways to trade them: for example, you can trade EUR/USD as a CFD, as a spot pair, or as a futures contract.
5. What times of the day will you trade? This is most important for short-term traders. Let’s say you day trade Forex—there are times of the day that are far more liquid and active than others, so these are usually more fruitful times for day traders to be active.
6. Are there scenarios to determine when not to enter the market? For example, many traders avoid entries before major news announcements.

Rules for taking profit

There are several methods which can be used to exit trades profitably:

1. Wait for the price to reach a technical level. For example, a previous support or resistance level.
2. An indicator or price action turns against your trade. For example, if you are in a long (bullish) trade, you may see a double top chart pattern form, or the MACD turn negative, demonstrating that momentum has turned against your trade and giving you an exit signal.
3. Use a trailing stop loss. You can adjust a stop loss to protect gains as a trade moves into profit. For example, if the price has moved 75 pips in your favour, you can move the stop loss to +50 pips. If the price turns against you, you have protected 50 pips of profit. Another way to move a stop loss is to trail it by moving it up to behind new support or resistance levels which are printed.

You can combine the above profit-taking methods. For example, you could trail the stop loss to protect gains but automatically exit when the price reaches a certain level. Whichever method(s) you use, it can be helpful to have a main profit target in advance because you will know your potential risk/reward ratio before you enter the trade.

Stop loss rules

The most important stop loss rules for any trader are:

1. Never trade without a stop loss!
2. Never widen your stop loss and increase the risk once you are in a trade.

Where do you place a stop loss?

1. Your stop-loss should be at a point where you know you are wrong on the trade if the price reaches it. For example, if you are in an uptrend, you can place your stop loss below the last significant support level in the trend because if it gets broken, it signals the trend is over.
2. If you cannot find a good place for your stop loss, then don’t take the trade. Let’s say a long (bullish) trade has a target to a previous resistance level that is 50 pips away, but the last support level is 100 pips away. Most traders would not take the trade because they are risking twice as much (100 pips) compared to the reward (50 pips).

Part 2: Managing Risk 

Risk/reward ratio

Your risk/reward ratio is how much you want to gain compared to how much you are willing to risk. If a profit target is 150 pips and the stop loss is 50 pips, the risk/reward ratio is 1:3. Traders usually express this by saying their “R is 3.”

Psychologically, it feels good to have a high number of winning trades compared to losing trades. But your risk/reward ratio is just as important to your profitability.

Some traders take profits too early to protect gains and enjoy the feeling of banking profits, but they harm their risk/reward ratios and become less profitable or unprofitable overall by doing so.

Your trading plan should contain a minimum risk/reward ratio for all your trades.

1. Most traders do not accept risk/reward ratios lower than 1:1, i.e., they do not enter trades where they risk more than they can gain.
2. Low risk/reward ratios need higher win rates to be profitable.
3. High risk/reward ratios can be more profitable even with lower win rates up to a certain point.

Percentage risk per trade

Establish a maximum percentage per trade to risk on your account. This prevents a single trade from destroying your account and ensures that you risk more when you are winning and risk less when you are losing. This is a robust money management method.

1. For example, if your account balance is $10,000, and you decide not to risk more than 2% per trade, the next trade cannot cost more than $200 if it loses. So, if your stop-loss is 50 pips, each pip cannot be worth more than $4.
2. Many traders keep a fixed percentage risk (rather than a maximum percentage) for each trade. Otherwise, some trades will cost them more than others if they lose. For example, they could have a few small wins where they only risked 0.5% per trade but take a loss on a trade with a 2% risk. Even though they had more wins, their account balance could still be down because of the one large losing trade.

Maximum drawdown

If your total account size is down by a certain predetermined percentage or amount, stop trading with live money or reduce your risk percentage per trade. Maybe you are not in sync with the market, or the market conditions are temporarily not suited to your system. You don’t want to keep losing and reduce your account to a point you can’t recover from.

If you reach your maximum drawdown rule, switch to demo trading, or reduce your trade sizes. Wait until you see profitable trading before returning with real money or normal trade sizes.

Part 3: Routine, Logistics, and Psychology 

Daily routine

Have a daily routine, especially if you are a short-term trader, to ensure you don’t miss anything. For example, before trading, mark out support & resistance on higher time frames, and check the economic calendar so you know which markets will be affected by pending high-impact news announcements.

Journal & record-keeping

If you have a problem or want to improve, you need records to check.

You can use a homemade journal or spreadsheet, but online trading journals are also available. One of my favourites is “Edgewonk” because it connects to many trading platforms, e.g., MetaTrader, cTrader, Ninjatrader, and can directly import your trade records.

Don’t just record your trades but also analyze them afterwards to see what you did right and what you could have done better.

How to improve your trading results

1. Make more money from winning trades
2. Lose less from losing trades
3. Generate more winning trades

Let’s look at each in turn.

How can I make more money from my winners?

1. Analyze the difference between active management of your trades vs. walking away. E.g., Some people will adjust stop losses or targets when they are in a trade. Surprisingly, most traders are more profitable by leaving the trades alone once they have placed the initial stop loss and target!
2. Maximum Adverse Excursion. This term means how much your winning trades go against you. Let’s say you keep 50 pip stop losses, but none of your winners ever go more than 25 pips against the entry price. You could then reduce your stop loss to 25 pips and double the size of your trades without taking any more risk overall. Looking at this data, you might see that you could become more profitable by using tighter stop losses.

3. Risk allocation. Do certain types of trades work better than others? For example, you may be better at trading trends rather than reversals. If so, you could decide to trade larger position sizes in trend trades as they have had a higher payoff.

How can I lose less from my losers?

Look for patterns in your losers to help you avoid them. For example:

1. Are there specific times or weekdays that cause more losses than gains?
2. Are there specific markets you tend to do poorly in?

How can I generate more winning ideas?

1. Maybe you are missing trades, and you need an alert system.
2. Maybe you are cancelling trades because you are nervous, but most of them would turn out to be winners if you left them alone.

To answer all the above questions, you need detailed record keeping.

Screen setup

Spend time laying out your charts before you begin a trading session, so it is visually easy to access the information you need. Use the same template each time so it becomes familiar and you’re not spending mental energy looking for a particular chart or timeframe.

Example of a Trading Plan 

Here is a template diagram that can be an example of everything you need in a trading plan.

Final Thoughts 

A trading plan documents your trading system and routines to ensure you always have a guide to hand showing the correct practices for profitable trading – at least in theory. It is worthwhile putting some effort into working on a trading plan and from time to time, trying to improve it. It is a living, breathing document: as you grow as a trader, you can improve your plan and document what works and what does not. You will likely find that as time goes on and you become a better trader, you will make some changes to your trading plan. This is OK and natural if you make sure you don’t get bogged down changing too much too often as a substitute for actual trading – you will learn by doing, the most important thing is to not lose too much money doing so.

You might also be interested in reading the below articles:

• Introduction to Forex Market Structure
• Swing Trading Strategies in Forex that Work
• Stop Loss Hunting Strategy and Secrets
• Long & Short Trading Explained
• Top Strategies for Forex Algorithmic Trading