Tips for successful trade planning and management
Most traders would have experienced this scenario, the market is going in your favour and you decide to move either your stop loss, profit target or even add on to your existing position. The result, the market turns against you and you make a larger loss than you previously planned for. You have just made the most fundamental trading mistake.
It is a common occurrence when in the heat of the moment; traders make decisions which they regret later. This highlights the importance of trade management and having a trade plan. Without which, trading could be akin to just a toss of the dice.
What is the difference between Trade Management and Trade Planning?
Essentially trade management is what one would imagine it to be, the managing of one’s trade. This sounds simple enough however it is one aspect that is often neglected by traders.
Like the old adage, when you fail to plan, you plan to fail. Often it is difficult to manage trades successfully without a plan to follow as you would probably be making it up along the way which could likely become a recipe for a failed trade.
Ideally, a trade plan is crafted prior to entering a trade. A good trade plan provides you with necessary inputs, thresholds and scenarios to deal with potential market movements. The aim of this plan is to help you guide your trade towards the best possible outcome desired; a winning trade.
Factors to consider when crafting a Trade Plan
A trade plan should include predetermined position sizing, levels for entry, maximum risk and potential gain before entering a trade. Below are a few basic points to consider when planning for a trade.
- Entry levels
- Risk Reward Ratio
- Position Sizing and Management
- Setting Stop Loss and Profit Target levels
Where to enter a trade would largely depend on your trading strategy, when the “signals” you are looking for occur, such as near support or resistance, or a confluence of trading indicators, tools or techniques, converge at a certain price point to “trigger” your trade.
Risk Reward Ratio
The following two points is linked with risk to reward ratio (RRR). A change in any of them would impact the other two. The most common risk reward ratio traders subscribe to is either the one is to two (1:2) or the one is to three (1:3) ratio. This means for every one part of stop loss, there will be a targeted 2 or 3 parts profit.
The commonly accepted thinking for position sizing is not to risk more than 2% per trade in relation of your total trading equity. This means that if you have $1000 for trading, then the maximum you should risk for each trade (stop loss) is $20. Some might disagree as there is no hard or fast rule to this. The 2% rule could be a starting point, but ultimately it is based on your personal risk tolerance and the amount of disposable trading equity you possess.
Setting Stop Loss and Profit Target Levels
A stop loss is important to ensure that your risk reward ratio in correlation to the position size and entry is maintained. While one can argue not to set profit targets in stone, stop loss levels should be immutable as moving your stops could begin a slippery slope to disaster. Some traders would highlight trailing stops as an effective way to move stops. However, although trailing stops can help to maximize potential profits, it is very susceptible to sudden price spikes which could trigger the stop.
Bonus Tip #1: Write it down
All the planning in the world would be time wasted without committing it to paper. Being human, we might simply forget. You can write down your trade plan in a notebook, even a scrap of paper or type it into your computer, whichever suits you the most. The point is it should be there for you to refer to easily when the trade is ready for you. A plus point to keeping a record of your trade planning is it allows for a periodical recap of trades and actions done so you can weed out detrimental actions and sieve out the good decisions to keep.
Bonus Tip #2: Currency selection
Ever had that moment, you see every currency pair moving except the one you traded in? Choosing a currency pair is an integral part of effective trade planning. Economic news and data releases could be important factors to determine which currency would potentially move more. For example, a rate decision from RBA (Reserve Bank of Australia) would likely move the Australian dollar more than other currencies without any data release that day. Understanding how data affect currencies could add another aspect in building a successful trading plan.