How To Quickly Create Trading Rules And A Trading Plan

How To Quickly Create Trading Rules And A Trading Plan

Define a 'Trading System', get a Trading Plan

Some people’s concept of a training plan includes all manner of peripheral questions and elements such as the reason you’re trading, your goals, the hardware you use, the software you use, your backup facilities, your Internet connection, etc etc.

Whilst all these things are of course important considerations, they do not belong in a trading plan, as far as I am concerned. These things are more appropriate for a business plan. A trading plan, in my view, should strictly focus on the actions you must take to enter a trade, to manage the trade, and to exit the trade.

This makes the creation of a trading plan much easier than if one tries to also encompass all the elements appropriate for a business plan. And the simpler, easier and quicker it is to create a trading plan, the more traders will actually get the job done.

And, given that the lack of a trading plan is such a major cause of trader failure, anything we can do to make the job easier is a big bonus.

An Example Set Of Trading Rules

First let's define 'trading system'. I am talking here about a simple set of rules:

  • to initiate a trade
  • to manage a trade
  • to exit a trade when it is profitable
  • to exit a trade when it is losing.

It is crucial that you have a written trading plan which covers each of these points.

In the article on high probability in trading, we said that we should keep records from our trading, and that these numbers can give us invaluable information.

But this is only true if the trades were all taken on the exact same basis.

The only way we can achieve this is to define and write out our trading rules, and formulate them into a step-by-step trading plan, which covers all the actions we need to take from the beginning of a trade to its end.

Following A Trading Plan Enhances Trading Performance

From a trading performance point of view, following a trading plan will allow you to know what you should be doing at any time you are in a trade. You have no decisions to make whilst in a trade. Your only job is to follow the rules, based on decisions you have already made ahead of time.

This does many things for your trading. Critically, it removes much of the stress and propensity for error. Making decisions under stress, is never ideal. You will almost always make the wrong decision due to human cognitive biases.

So, make the decisions ahead of time, when there is no stress, and collate them into a simple trading plan. This also allows you to see definitively when you have made an error. An error is simply anything outside your rules.

Trading Errors Cost You Money

In nearly all cases, trading errors will cost you money. And you can easily see the difference in profits if you take the trade according to the rules. So, you teach yourself not to make errors by seeing how much more money you would have if you did not make them.

These trading rules do not need to be in a computer, although they can and could be if they are written correctly. But they do need to be written rules. It is no good keeping your trading rules in your head.

Your trading rules must cover 4 scenarios, as touched upon above:

  1. why, how and when you will initiate a trade
  2. where you will place your initial stop loss (this would be how you exit a trade when it is losing)
  3. why, how and when you will exit a trade with profits (this could be multiple exits)
  4. why, how and when you will adjust your stop loss

Rules To Cover Anything That Can Happen In A Trade

These four scenarios cover anything that could happen whilst you are in a trade. Either:

    • It moves up and triggers a rule, or it moves up and doesn't trigger a rule
    • It moves sideways and triggers a rule, or it moves sideways and doesn't trigger a rule
    • It moves down and triggers a rule, or it moves down and doesn't trigger a rule

So, whatever happens while you are in a trade, all you have to do is check whether it has triggered a rule or not.

Your only job whilst in a trade is to monitor for rules being triggered, and take the appropriate action when they are triggered.

There is no decision making whilst in a trade. The decisions are made ahead of time and defined in your trading rules and trading plan.

There should be no ‘What do I do now?’questions. No ‘Should I still be in this trade or should I get out?’. These questions must be covered in your trading plan.

Remove Stress From Your Trading

When you set your trading up like this, it removes a huge part of the stress.

You always have to deal with uncertainty, because the market can do anything at any time, and you can never know what is going to happen. But, you can remove the extra uncertainty about what you will do.

If your actions and reactions are defined ahead of time, life becomes a whole lot easier. And it is also not only one of the best things you can do for your trading, it is crucial that you do it.

This is one of those things that successful traders know. Either through the pain of learning from their mistakes, or through the good fortune of having a good mentor. Make a resolution to set your trading up like this, and see the benefits for yourself.

You can do some or all of this automatically. For example, stop losses and profit targets can be resting orders entered with your broker, so that you have to do nothing to have them executed.

Simple Example Trading Plan

I'll give you an example of how simple this trading plan could be. What follows is not a trading system to be traded, it is a simple example of how all the requirements for a trading plan can be defined and met.

Again, this is not a trading system to be traded.

  1. Entry: I will enter a long trade at tomorrow's open when price closes above the 50-period Moving Average for the first time in 10 days
  2. Stop: I will place my protective stop 20c beneath the last pivot low
  3. Adjust stop: I will not adjust my initial stop, I will leave it where it is for the duration of the trade
  4. Exit at a loss: If my protective stop is hit I will exit the whole trade immediately
  5. Exit at a profit: I will exit the whole trade 20c below the last pivot high

In real time trading, you would also need to define your trade size, but I want to stay with the core subject here.

OK, so with a few minutes work, we have a system and a trading plan. You have only 5 blanks to fill in.

In real time trading, you must actually have a system that has a positive expectancy. You will put in a bit more work to find that, but more on that later. For now we have enough to work with to understand some truly important stuff.

We have achieved two very important things by defining our trading system and writing it into a plan.

The first is that our trading system can now be evaluated. We do this by recording the results of a number of trades, and gathering some metrics for this trade set.

See: What High Probability Trading Really Means - The Ultimate Guide

Data from a set of trades taken randomly cannot help us much. But, because all the trades were taken with exactly the same rules, we can evaluate how those rules performed.

And, secondly, because we understand exactly how to take the kind of trades that are in our dataset, we can replicate those trades going forward, and we have a benchmark -- we can check that we are seeing similar results.


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