Why every trader must have a business plan?

Why every trader must have a business plan?

This is what we are going to discuss today in the first episode of our brand new series – “How to become a successful trader”

Why every trader must have a business plan

Simple, A trading plan is a trader’s business plan. Putting together a proper plan will force a trader to focus on his strengths while letting him avoid conditions that are unfavourable.

Very few businesses succeed without a business plan, so why should a trader think he’s above it? Trading is a business and don’t ever forget it or take it as less than that.

Business plans are made either before going into business or when trying to raise more capital once in business. This should hold true as well for traders. Before you get serious about trading full-time, you should take some time and put together your business plan. Basically it should include objective, strategy, risk, costs, and expected returns. You should first document and you should do it before you risk a dime.

Before you transfer your money from your bank account to your trading account, you should have a detailed plan of what you are going to do, how you plan to do it, how much is at risk, and what are the chances of losing this money. Now, this plan is the most important thing as it’s your freaking money on the line when you are trading.

So let’s discuss about the importance of business plan and how to create one in this episode, as this is the first and foremost step every aspiring trader should take before they start trading. Most of the new trades end up losing money as the skip this most critical part.

How to make a Business plan for trading? We can simply call this as TRADING PLAN.

Trading is like any other business and doing a business without a proper business plan will end in disaster. So hopefully, by now you understand the importance of a trading plan (i.e business plan for trading), so it’s time to start making one. Though a proper trading plan can have anything you feel should go into it, it should account for the following parameters mandatorily.

They are:

• What to trade.
• Trading time frames.
• Condition for Entering a trade.
• Condition for Exiting a trade.
• Condition for Stop placement.
• Positional sizing.
• Money management.
• Risk vs. reward ratio.
• Back testing.
• Periodic Performance review.

Each one of these things is a critical part of trading, but when combined they become an invaluable and powerful trading tool. Other things that are not so easy to pinpoint but should be taken into account are your emotional state and your trading style. Each trader will have a unique trading style and risk style, which is why it is impossible to have a fixed trading plan that anyone can use.

If a trading plan doesn’t fit your trading style and thoughts, you will have trouble following it no matter how good it is, which means each trader should custom build his own. So we won’t give you a trading plan directly, but will guide you to create one that fits your trading style and risk tolerance.

People think having a strategy is enough to trade. But Trading strategy is only part of the trading plan. Without money management, positional sizing and backtesting, any strategy is useless.

As you start making a more elaborate and professional looking trading plan you should go back to the idea of doing a business. First step is convincing yourself to invest in some business. If that’s case, you would want to know some basics about the business like, what kind of returns are reasonable to expect? Does this include all the costs? How much you can lose at worst? Are there any unexpected variables that can wipe out your business?

Likewise, you should ask similar questions for your trading business. So when it comes to your trading plan, it should cover which markets, stocks, or sectors you will trade; what will be your holding period; where would you enter and exit; how will you use stops; did you back test this system, and so on. You will also want to have proper money management plan, which will tell you how much you will risk at once, how you will prevent yourself from losing all of the money, how many positions you will be trading at the max at any point in time, and so on. If you can answer these questions you will be a much better trader than someone who can’t.

So, when you make a Business plan for trading, we need to have all this information.

Now, let’s create a trading plan.

Trading Strategy/System:

First part of creating a trading plan is to create a trading system or trading strategy you will use to trade with. A trading system or strategy is basically a set of rules and conditions that will give you signals to get you in and out of the market.

A signal in a strategy can simply be like – “buy a stock at opening today if it had hit upper circuit yesterday”. Or it could be a complicated strategy using several indicators and then make a decision based on them in combination. It doesn’t matter what type of strategy it is as long as you’re consistent and have rules to follow.

Also, regardless of what type of strategy it is, make sure you back test the strategy over historical data. The main drawback of complex strategy is that it’s much harder to back test it. You can also test it in live market and learn the hard way whether your strategy works by losing money in the market. It is totally your call. I prefer back testing, even if it manual back testing by using bar replay option. You want to make sure your ideas have a history of working, because if they didn’t work in the past, they probably won’t work tomorrow.

By having a system or strategy, you will know how and what you will trade; nothing should come as a surprise and you will reduce the number of bad trades you make. I’m certain you will still make lots of bad trades. But you’ll probably make lot less by following a trading strategy. Bad trades are different from losing trades. Many good trades will not work out and you may lose money on them, however, bad trades are stupid mistakes that a system/strategy can prevent. With a strategy in place, you’ll know that if a certain condition is met you will get in and get out of the market. However, no matter how bored you are or how much extra margin you have, if these conditions or criteria are not met you shouldn’t do anything.

Getting Out

One thing I need to stress is that entering a trade is only half a trade. You need to get out of them as well. Too many people come up with great buy signals but then forget they have to exit a trade. Even more important than getting you into a trade, a system must have rules for getting you out of the trade as well. Don’t ignore this part of trading, the exit really is the difference between what makes a winning or losing trader. A good system will have options for getting you out of winning, losing, or break-even trades. I would say that before you even enter a trade, you should know where or why you would get out, both with a winning and a losing trade. What is the most important reason for having an exit strategy? Reason is simple – once you are in a trade, having predetermined exit rule will help you to relax during trading and not have to look at the market tick by tick.

Money Management:

Though a trading system is important, money management and risk parameters are an even more important part of the trading plan than the actual buy and sell signals. You need to know how much to risk, how many contracts or shares to trade, when to increase or decrease position size, and which stocks or markets you can afford to trade.

A money management plan will let you know how many total trades you can have on at once and how much you should risk in each and/or in total. Knowing how to use the proper position size is a large part of money management and also of determining how well you do.

Risking more than you can afford to lose can easily get you into trouble, even if you are right on a trade. If you trade above your risk potential, you may not be able to hold the position when there is a little blip against you. So even though you were correct in the direction of the trade, you may end up exiting with a loser.

If you work on a good risk plan, you will reduce the chances of blowing out. I know that anytime I took a really big hit, it wasn’t because I was wrong (yes I was wrong, but the reason I blew out was I used poor money management and traded too large a position or allowed myself to risk too much on a trade).

So, do yourself a favor and take the time before you trade, to come up with a good risk or money management plan.

Knowing Your Trading Mentality

When making a trading plan you should figure out which stocks, sectors, or commodities you will trade. Stocks move differently from each other, some trend more often, while others are choppier, some are wilder than others with wider ranges, and therefore you have to trade less size and use wider stops. People have preferences for some stocks over others and this is all part of their trading mentality. Your trading plan should be tailored to the stocks or commodities you will be looking to trade.

For some people it’s fairly easy, they just trade the indices, others may only trade commodities like crude, while others may include any stock with huge volume. It’s not important what you plan on trading, just know it in advance so that during market hours you can focus on trading and not have to worry about finding stocks.

Another part of the trading mentality is determining your trading time frames when you are making a system. Some people can hold stuff for weeks while others get fidgety after few seconds. The shorter the term you hold, the more you will trade and the smaller your stops and targets will be.

I can’t follow a system that needs holding a stock for few months. I prefer holding for a maximum of few days to a couple of weeks. So I have larger targets and wider StopLoss. When it comes to intraday trades, I prefer very quick trades with tight stoploss and small targets. Again, everyone is different and this difference should be incorporated into your trading plan.

Back Testing

If you want to succeed in trading, take the time to make sure your ideas work. Back testing your systems is so critical it can’t be overstated. Though there are softwares like Amibroker that will help you to do it with simple scripts, if you are not good at programming, you can take a chart and do it manually by going through it either directly or using bar replay feature which will help you to simulate the market conditions.

When you do back test, keep in mind trading costs. Do not make the stupid mistake of back testing a system and forgetting to include how much brokerage, taxes, slippage, exchange fees, and so forth that will be taken out of your account. Make sure these are accounted for or you will be in for a surprise.

Takeaway

The main reason for the lack of trading plans is that they can be time consuming and difficult to make. Most people want to get right to trading and don’t want to spend the time and energy needed to write out a trading plan, so they ignore it. This is one of the biggest mistakes a person will make, because the lack of guidance from a trading plan will just lead to many, many more mistakes.

Having a plan on paper will help you establish and keep to concrete rules, while helping you avoid emotional decisions made when the market is heated up or you are losing.

People are irrational and can become horrible traders when under the gun and losing. If you have well defined rules, hopefully you will follow them and will keep you on track.

Finally, I want to say that you should keep reviewing your performance and plan. You can’t improve unless you learn from your mistakes. Reviewing is an important aspect of trading as it will help you to improvise continuously.

This brings us to the close of first episode of our series. The objective of this series is to “create successful traders” and creating a business plan for trading (i.e creating a trading plan) will be a very big first step in the right direction. So, sit down and create a business plan today, you will definitely thank me later.

In the forthcoming episodes of this series, we will talk about every single major and minor aspects of trading that will “help you to become a successful trader”, so subscribe to our YT channel right now to not miss any of it.

If you have any queries about creating a trading plan, please drop it in the comments section of this video, we will be happy to answer it.

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