A trading plan maps out your market exposure. The failure to create one before engaging in the art of speculation is like leaving the house without shoes. You may not notice you're without them until you step in a puddle, but rest assured, the realization will be unpleasant when it happens.  So, if you haven’t done so already, draw up this required document before taking one step further on your market journey.

A successful trading plan addresses four key aspects of trading: prediction, timing, volatility and risk. An approach to each of these factors works synergistically with your techniques for addressing the other three and results in the expansion of your skill sets, the prevention of pitfalls and the generation of the success needed for you to keep your eyes on the prize.  Miss one and rest assured that Murphy’s Law will kick in, punishing you for that particular oversight. So don’t be lazy, jotting down your plan on a napkin while eating lunch. Instead, wait for a quiet time and consider each element in detail.

Prediction

You have far more choices in prediction than you might think. Of course you can choose scenarios in which securities are expected to move higher, playing uptrends and breakouts like the majority of the crowd, but you can also choose to sell short or play range-bound markets with a swing trading strategy. Better yet, create a plan that utilizes multiple strategies, going long when the wind is at your back, short when major averages roll over and both sides when a two-sided tape controls price action.(For related reading, see article: How Do I Effectively Create A Range-Bound Trading Strategy?

In addition to predicting direction, you also need a system that gauges odds for each strategy you employ. For example, a typical breakout pattern will produce different outcomes depending on broad market tone, emotional intensity of the trading crowd and resistance levels above the trigger price. It’s your job to weigh these elements and come up with the perfectly-sized position and holding period to account for unique conditions in play. (For more on trading breakouts, see article: The Anatomy Of Trading Breakouts.)

Timing

You have to trade at the hard right edge, paying attention to each price bar and its potential impact on the strategy you’re employing for an open position or in your broad analysis.  No factor is more critical to this equation than the time frame you choose for executing your strategies.  Pick this holding period wisely because advancing price needs to complete the movement you’re capitalizing upon within its constraints.  In turn, that demands an understanding of market cycles, realizing that profit-killing retracements are likely after each trend wave. Get it wrong and you’ll exit at the worst possible price. Get it right and your small gains can turn into windfall profits. (For related reading, see article: Market Cycles: The Key To Maximum Returns.)

Newer traders should choose a single holding period and stick with it, until it's been mastered.  Shrink and stretch this number in alignment with market conditions, but be ruthless in your discipline, keeping a bad trade from turning into an investment and preventing greed from clouding your vision, which can happen if you hold on too long, thus paying a steep price during a reversal as a result.  Multitaskers can add additional holding periods after gaining experience, but keep in mind this requires mental acuity that many traders lack.

Volatility

Become a student of volatility, understanding how it impacts price movement and profit-production. Each trading opportunity carries a volatility profile that’s easily visualized with a range-measuring indicator like Average True Range (ATR) or a well-placed set of Bollinger Bands.  In addition, volatility oscillates through contraction and expansion cycles that roughly align with the trends or swings you’re capitalizing upon.   You’ll find that entering a trade in low volatility conditions while anticipating a shift into high volatility conditions can produce the most favorable profit mechanics.

Volatility also describes the nature of the security you want to trade. For example, typical momentum plays can traverse many points in a single session, yielding a high volatility signature. Newer traders are drawn to these plays like moths to the flame, but avoid them at all costs until experience builds the skills required to manage the volatility aspect. This is accomplished through position size reduction, reduced holding periods and sophisticated stop and exit strategies.(For related reading, see: Volatility's Impact on Market Returns.)

Risk

Your capitalization and risk management skills need to match perfectly, or you’ll take unnecessary losses. Most new traders bring less money into the game than needed to play the strategies they choose, setting themselves up for failure. Start with the premise that you’re unlikely to trade your way into a full-sized account by chasing over-leveraged markets, like forex, where insiders make their living ending the dreams of undercapitalized traders.

Choose instead to play slow and steady, within the boundaries of your stake. For traders with small accounts, that means taking risk in small- sized positions in less volatile securities. Continue to trade within these restrictions until life brings you additional risk capital or your trading discipline pays off, allowing you to expand your strategies and position size. 

The Bottom Line

Build a successful trading plan by detailing your approach to prediction, timing, volatility and risk. Then stick to your plan until positive results build confidence and trading capital, allowing you to expand on your profitable ideas.