What is a Trading Plan?

Now that you're about half way through college, here's one piece of advice you should always remember.

Be your own trader.

Don't follow someone else's trading advice blindly. Just because someone may be doing well with their method, it doesn't mean it will work for you. We all have different market views, thought processes, risk tolerance levels, and market experience.

Developing a Trading Plan and sticking to it are the two main ingredients of trading discipline.

But trading discipline isn't enough.

Even solid trading discipline isn't enough.

It has to be rock solid discipline.

We repeat: rock solid. Like Jacob Black's abs.

Plastic solid discipline won't do. Nor will discipline made from straws and sticks.

We don't want to be little piggies. We want to be successful traders!

And having rock solid trading discipline is the most important characteristic of successful traders.

A trading plan defines what is supposed to be done, why, when, and how. It covers your trader personality, personal expectations, risk management rules, and trading system(s).

When followed to, a trading plan will help limit trading mistakes and minimize your losses. After all, "if you fail to plan, then you've already planned to fail."

A trading plan removes any bad decision making in the heat of the moment. Your emotions can consume you when money is on the line, causing you to make irrational decisions. You don't want that to happen.

The best way to prevent it from happening is to minimize (notice we did not say eliminate) thinking by having a plan for every potential market action.

With the right trading plan, every action is spelled out, so that in the heat of the moment you don't have to make any rash decisions. You just simply stick to your trading plan.

Before we continue, we have to quickly distinguish the difference between a trading plan and a trading system.

A trading system describes how you will enter and exit trades. A trading system is part of your trading plan but is just one of several important parts, i.e., analysis, executions, risk management, etc. Since market conditions are always changing, a good trader will usually have two or more trading systems in his or her trading plan.

Trading systems will be covered more in-depth later on in the lesson, but we thought that it was important to point out the difference between the two upfront to avoid any confusion.

Why Do you Need a Trading Plan?

A trading plan will make trading simpler than it would be if you traded without one.

Think of when you use a GPS device. You enter where you want to go. It then figures out where you currently are and then shows you how to get to where you want to go. You're able to constantly check on your GPS to see if you're still on the right track. When you make a wrong turn, it knows to make adjustments, and it points you back in the right direction.

A trading plan is your trading GPS. It will show you where you currently are as a trader and help you get to your destination: consistent profitability.

Traveling without a GPS wouldn't be smart idea. You wouldn't know how to get to your destination and it's highly likely that you'll drive around lost like a chicken with its head chopped off. You're probably thinking that one could use an ancient object called "maps" instead, but we have no clue what that is. Please don't make such absurd suggestions again.

Trading without a trading plan would be the same thing as driving without a GDP--a bad idea. You're trying to get to this Promised Land called "Consistent Profits," but since you have no way of knowing whether you're headed in the right direction, you'll most likely end up blowing out your account.

With a trading plan, you're able to know if you're headed in the right direction. You'll have a framework to measure your trading performance. And just like a GPS, you're able to monitor this continually.

This allows you trade with less emotion and stress.

Without a trading plan, this would be nearly impossible. Instead, you'd be a "cowboy trader", shooting from the hip, trading by the seat of your pants, relying on your gut, guesses or signals from strangers. That ain't trading - that's gambling!

Whenever you trade, you'll probably end up a nervous, emotional wreck, crying yourself to sleep as your rollercoaster account balance grinds at your psyche. (Okay pretty drastic, but we think you get the picture).

Just as you use a GPS to both figure out the route to be taken and to judge the progress that has been made, your trading plan defines how you'll become consistently profitable and tells you if you're on track.

Most importantly, if you suck at trading (and you will in the beginning), you will know it is down to one of only two reasons: either there's a problem in your trading plan or you are not sticking to your trading plan.

If you're trading without a plan, it's impossible to know what you're doing right from wrong. You have no way to evaluate your results, so you'll never know how to stop sucking.

We can't emphasize this enough..."if you fail to plan, then you've already planned to fail."

Obviously, a trading plan doesn't guarantee success, but a good plan that is followed will help you stay in the forex game longer than traders who don't having a trading plan.   

SURVIVAL is better than failure and it should be your first goal as a newbie trader.

Remember, 90% of new traders don't make it. You want to be part of that special "10%" that does make it.

You're probably thinking, "Ba humbug! Trading plan, schmading plan. I can be part of that 10% without a stinkin' trading plan!"

It may be tempting to trade by the seat of your pants, but if you don't develop clearly defined trading plans and be disciplined enough to follow them consistently, you'll have much difficulty making consistent money as a trader.

Justified vs. Unjustified

What's wrong with deviating from your trading plan if you make a profit anyway?

Making an occasional winning trade, even when you throw your trading plan out the window, may provide short-term pleasure, but entering trades haphazardly can adversely influence your ability to maintain discipline in the long term.

Trading is a marathon, not a sprint!

When you stop following your trading plan, you become rewarded for lacking discipline and you may start believing that abandoning a trading plan is no big deal.

An unjustified reward may increase your tendency to abandon trading plans in the future. You may be prone to think "I was rewarded once, maybe I will be rewarded again. I'll take a chance." But the positive outcomes of undisciplined trading are usually short-lived, and a lack of discipline ultimately produces the long-term trading losses.

It's important to distinguish justified wins from unjustified wins.

A justified win is when you create a very detailed trading plan and FOLLOW the plan. A win that results from following a trading plan is justified and reinforces discipline.

An unjustified win occurs when you make a plan but don't follow it or if you have no plan at all. You might be rewarded, but the outcome occurred by chance. You might as well flip a coin or hang a printed copy of your charts on the wall and throw darts at it to help you make trading decisions. The win is unjustified and can reinforce undisciplined trading.

Maintaining discipline is vital for consistent and profitable trading. Trading is a matter of getting the law of averages to work in your favor. You trade proven trading strategies, over and over, so that across a series of trades, the strategies work enough to produce an overall profit. It's like making shot after shot on the basketball court so as to accumulate a winning number of points. The more shots you take, the more likely you will amass points. Just look at Kobe Bryant or Dwayne Wade.

The winning player is the person who first develops the skill to make the shot consistently, so that at every possible opportunity, the ball is likely to go through the basket. They've developed the skill to learn how to shoot the ball the same way every single time. Consistency is crucial!

It's the same for trading. One must trade consistently, following a specific trading plan on each and every single trade. If you trade one approach this time, and a different approach at another time, your performance will more than likely be haphazard.

We can't stress this enough...

You have to allow the law of averages to work in your favor, so that across a series of trades, you will make an overall profit.

If you follow the plan sometimes and abandon it at other times, you throw off the probabilities, and you will most likely end up losing overall.

With discipline comes profitability. Don't let unjustified wins interfere with your ability to maintain discipline. Follow your own trading plan, and cement in the mindset that if you follow your plan, you will end up more profitable in the long run.

Now that we're done explaining how important a trading plan is (can we stress this enough?), it's time for you to learn what should go inside a good trading plan. 

Motivation and Goal Setting

What motivates you to be a trader?

Is it to become filthy rich? Is it for the thrill? Is it because you want to do something challenging and exciting? Is it because the girl you like trades currencies and you want to impress her?

It is important to know what your true motivation is, or whether you should even be trading at all. Traders who aren't serious or committed to the craft will be quickly eliminated by the market.
For example, seeking thrills and seeking consistent profits don't go together. You might enjoy the thrill of putting on a humungous "I'm betting the farm" position, but believe us, you won't be smiling once your trade blows up in your face.
If thrills are what you seek, go to the casino, jump out of a plane or try driving an F1 racing car.
Better yet, if you want a real thrill, drive an F1 racing car out of a plane and land in a casino. Now that's a real thrill! And you might even lose less money than if you were trading.

What have you determined to be your goal(s) for trading?

This can be expressed monetarily using a profit goal (either in currency or percent return) per unit of time. For example, you might choose a goal like making $4,223,834,145.53 per month, or achieving a 529% return every week.

This doesn't necessarily have anything to do with money. Like "My goal for trading is be able to buy them new Space Jam Jordan 11s so I can impress my lady crush and she can fall in love with me and we can live happily ever after."
Or "My goal is to have enough money to have plastic surgery so that I can look like Halle Berry and have everyone eating out of my hands."
Okay.
We lied.
Everything has to do with money. 

Whatever you decide, just make sure it's specific and measurable. Set trading goals that will help you develop as a trader.
It can't be vague like "I want to be rich". Changing it to "I want to be super rich." does not count.
Be specific!
"I want to make 1% every week."
"I want to be winning 50% of the time by the end of this year."
"I want to double my account in six months."
"I don't want to make any trading mistakes for the day."
By making your goals specific and measurable, not only will you know what you really want, but you'll be able to monitor your progress and see whether you are improving or not.

Risk Capital

What is your risk capital? How much money can you trade with and afford to lose all of it?

You need to determine if you can even afford to trade.
Trading should only be done with risk capital.
Risk capital is money that you can lose.
This is the kind of money that if you lost, you wouldn't lose your home, car, spouse, limbs, electricity, etc.
Don't risk what you can't afford to lose!
If you're playing with money that you need to pay the bills, it will have a huge negative impact on your ability to make objective trading decisions.
Imagine how stressed you'll be while your trade is open knowing you might not be able to put on the food on the table if you get stopped out.
Every time a pip goes against you, you'll be thinking, "There goes tomorrow's lunch!"
You don't want to end up starving, homeless, and broke now do you?
Unless you do.
In that case, go ahead and risk all your hard-earned money in forex. 

Don't be stupid!

If you can't afford to make dough in the kitchen, then you can't afford to make dough in the forex market.

Stick to demo until you really know what you are getting into!

Later on, we'll teach you all about risk management and how you should manage your capital.

Expectations

Which kind of returns do you expect to make?

Ahhh. Of course, anybody who's interested in trading certainly has ambitions of raking in some dough. It make sense - trading involves risk, and we expect to be compensated for those risks.
There's no doubt that every trader expects to make profit.
The question that you should ask yourself though is this:
What kind of returns do you expect to make?

Your answer to this question will play a huge role in determining what kind of trading style you will implement, what currency pairs and times you will trade, and most importantly, the risks involved in achieving your goals.
Let's look at an example to help explain this better. Let's say there are two traders, Bruce and Mike. Bruce is looking to score 10% a year while Mike is a little more ambitious - he wants to DOUBLE his account and make 100% returns
As you can imagine, a trader like Mike, who is looking to double his account, is in a very different situation.
It is very likely that Mike will have to take a lot more trades and/or risk more than Bruce. He will have to expose himself to more potential losses if he ever wants to achieve his goal of 100% returns.

Traders will also have to take into consideration drawdowns.
A drawdown is normally calculated as the distance from the highest value of your account to next lowest point. (We'll explain this a little bit more in a following lesson. For now, pay attention in class!)
Each trader must decide how big of a drawdown he or she can accept in order to hit their profit target goals.
On the one hand, there are traders who are risk averse and would rather have small drawdowns. The tradeoff is that this will also limit potential reward.
On the other hand, there are traders who are comfortable with large drawdowns, just as long as their system also yields huge returns.
You will also have to take into consideration how much time you can dedicate to trading. If you can't dedicate a significant amount of time working on your system, reading up on the markets and learning new trading techniques, recording/reviewing your journal, then we can guarantee you that you will have a difficult time hitting your goals.
If you can't make this time commitment, you may have to readjust your expectations as to how much you can make your account grow. We highly suggest that you check out Pipwcrawler's thread about setting newbie expectations
In the end, just know that success depends on YOU.
Do you have the discipline to grind it out consistently to tweak your skills and gain the experience needed to navigate the markets?
If you don't, then expect inconsistent returns, if any at all, over the long term.

Stick to the Plan

A trading plan is only effective if it's followed. You have to stick to it. It sounds simple to do. It is really just common sense but most traders still can't do it. Why, oh, why?

Trader incompatibility. A trading plan should be a personalized plan for you, a plan that fits your own goals, risk tolerances, and individual lifestyle. You must develop each component on an individual basis, never losing sight of the fact that it must be custom tailored to YOU and YOUR needs.

Not your girlfriend's. Not your boyfriend's. Not your basketball coach's. Not even Ronald, your weirdo best friend whose head is shaped like a hamburger who likes to wear pink polka dot pants and is an aspiring rapper.

Your trading plan must be made based on reality, not on hope. If you're simply trying to copy somebody else's trading plan or yours is based on false assumptions, then you will not be compatible with it and will have trouble following it.

Solution: Be honest with yourself. Then revise your trading plan.

Trading plans are intended to be long-term. Many traders give up on their trading plan, or often more specifically, the trading system in the trading plan, after suffering a string of losses rather than sticking it out through the inevitable rough times.

Solution: Be patient!

No discipline: Trading according to a plan requires sticking to it through thick and thin. That takes discipline. Rock solid discipline. Traders lacking discipline do not stick to their trading plans. You need to be disciplined. Rock solid. Does it sound like we're beating a dead horse? Well, good.

Solution: Stay disciplined!

Self-destructive behavior: Some traders have deeply ingrained psychological issues that will sabotage them. This can be resolved with hard work on one's self, but the trader must be self-aware of such issues first. You can't figure out a solution if you don't know the root problem.

Solution: Look in the mirror. Hopefully you don't turn to stone.

If you're personally having trouble sticking to your trading plan, most likely it's one of the reasons above. If it is, refer to the solution below it.