The Importance of a Trading Plan

When most traders think of making profits in trading and investing, they usually focus on methods of market timing or what to do based on certain news releases.

While market timing is extremely important for the purpose of minimizing risk exposure while maximizing profit potential, it will not help the trader or investor that goes about taking trades without a well thought-out plan.

One of the most common problems traders face is that of HOPE.

Now, I am not saying that there is a problem with having hope. Who does not ‘hope’ that their trade will come out profitable?

However, what often occurs is that a trade does not start off as expected, and the trader is then put in a position where a decision needs to be made, only to be completely controlled by HOPE. All reasoning goes out the window once the trade starts moving against the position, and the ‘plan-less’ trader is then holding onto the position due to HOPE.

Without a proper trading plan BEFORE the trade is executed, discipline is often the first to go.

When the decision was made to take a trade, there had to be a good reason for it. The trader saw something in the charts, or perhaps in the news (for those that dare to use such unreliable information) that suggested taking a position would likely result in a good profit. This would also be the time to decide what is to be expected from the trade and what to do if the market does not provide what is expected.

All this MUST be done BEFORE the trade is executed!

The disciplined trader would have all this written down. The items to list would be the ENTRY price zone, the price objective if there is one (not all trades need an objective if there is a plan on how to trail the trade with a stop-loss order), and what conditions would signal an immediate exit from the trade, such as price breaking below a certain price level.

Where the plan really shines is during the early stages of the trade, when the market has yet to move deep enough into profit territory to warrant a tightening of the stop-loss.

During the initial stages of a trade, the risk of loss is at its highest. The trader ‘with a trading plan’ knows this and has already determined at what price point the trade would be considered operating outside of initial expectation. The trader would prudently place a stop-loss order at that level and under no circumstances ever remove it other than to move it further into the direction of profit.

Without the trading plan and the discipline to stick to it, the trader can find the trade moving into the exit price zone only to start ‘hoping’ that it is going to be brief and that the market will soon turn around and all will be right with the world.

Most times, this does not happen! The trade continues deeper and deeper into losing territory, and the trader simply cannot accept such a loss so continues to ‘hope’ that it cannot continue for long and holds on rather than exits. Eventually the pain becomes too much and the trade is finally exited (unless the account is wiped out, which makes the exit automatic), only to then see the market finally turn around. This is very devastating to the trader’s psyche!

If you are going to trade, you must accept manageable losses as part of the process. You must be willing to write down your trading plan with your exit strategy clearly laid out. You must be willing to follow that plan that you wrote ‘with a clear head’ to a tee, with no exceptions.

One of the best lessons I have ever learned in my 30 years of trading came from writing and following (or not) my trading plans. I learned where the weaknesses were in my plans and had something I could look at and improve upon. It helped me build stronger ‘will’ and determination, pumping up my discipline muscles along the way.

So if you have a trading method that you believe is good for making profits, having the habit of making a trading plan and following it will tell you sooner than later whether your belief is well-founded or that it needs to be tweaked. A trading plan is really that good!

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