The Difference Between A Trading Strategy And A Trading Plan
A solid trading plan is the cornerstone of your trading business.
Many traders think that all they need is a trading strategy.
This is NOT the case!
Let me explain the difference between a trading strategy and a trading plan.
First, let’s talk about…
What Is A Trading Strategy?
A trading strategy is surprisingly simple. Because it only has 2 main elements.
A trading strategy tells you…
When to enter and
When to exit
The entry rules can be based on fundamental analysis or technical analysis such as indicators or chart patterns.
As an example, an entry rule for a trading strategy could be:
BUY when the 3-day moving average crosses the 7-day moving average from below
And there are 2 types of exit rules:
Exit rules for taking profits and
Exit rules to limit your risk, a.k.a stop losses
Here’s an example for a profit-taking exit rule:
==> SELL after the stock moved 10% in the desired direction
And here’s an example for a stop-loss exit rule:
==> SELL if the stock moves 5% against you
As you can see, a trading strategy is fairly simple.
On the other hand, a trading plan is more complex – but absolutely necessary!
What Is A Trading Plan?
A trading plan covers at least seven elements:
The market(s) you want to trade.
The timeframes you want to trade, e.g. 5 min, 10 min, tick or range bars.
A brief description of the strategies you want to trade and when to use what strategy.
The entry rules of the strategies.
The exit rules of the strategies.
Other important rules, e.g. when to trade and when not to trade.
The money management approach you are using.
Let’s talk about each element in more detail:
Do you want to trade stocks, options, futures or forex?
I personally like to swing trade stocks and options and day trade futures markets.
It’s important to define the markets you want to trade in your trading plan so that you don’t get distracted. One of the biggest mistakes that traders make is “chasing shiny objects.” Some traders trade stocks this week and binary options the next week – for no apparent reason.
Often traders switch markets after a few losing trades or reading another exciting email promising them “trading success if they trade THIS market.”
Don’t fall for that!
Learn about the different instruments that you can trade and then decide which one(s) you want to trade.
And that’s the FIRST element in your trading plan.
You can trade on many different time frames: daily, weekly, monthly, … or even intraday, e.g. 60 min, 30 min, 15 min, 5 min.
Choose the timeframe based on your availability to trade the markets:
If you can watch the markets every day, even if it is in the evening, then you should choose a DAILY timeframe.
If you only have time to focus on the markets on the weekend, you should use a WEEKLY timeframe.
And only if you can watch the markets throughout the day, then you should use an INTRADAY timeframe, e.g. 5 min.
Some traders think that day trading is more dangerous that swing trading.
And that’s not true!
As a rule of thumb: The bigger the timeframe, the more money you have to risk.
Let me give you an example:
The image below is a WEEKLY chart of Apple (AAPL). As you can see, the Average Weekly Move is $10.30.
Weekly Chart of AAPL
If you are trading a WEEKLY timeframe, then your stop loss should be at least $10, preferably even $15.
Here’s an image of a DAILY chart of Apple (APPL). As you can see, the Average Daily Move is $4.
Dail Chart of AAPL
If you are trading a DAILY timeframe, then your stop loss should be at least $4, preferably even $6.
Here’s an image of a 5-min chart of Apple (APPL). As you can see, the Average 5-min Move is $0.30.
5-min Chart of AAPL
If you are trading a 5-min timeframe, then your stop loss can be as low as $0.40 – $0.60!
As you can see, the lower the timeframe, the less money you need to risk!
Choosing the right timeframe that is best for you is the 2nd element of a trading plan.
3. Brief Description of the Trading Strategies
Each trading strategy has an underlying idea. As an example…
A Trend Following Trading Strategy takes advantage of trends in the markets,
A Trend-Fading Strategy looks at overbought and oversold situations,
An Earnings Strategy is designed to take advantage of explosive moves after Earnings are being announced,
A Scalping Strategy takes advantage of small moves in the markets, often only a few ticks.
You MUST know the underlying rationale and assumption behind your trading strategy so that you know about the best time to trade the strategy.
As an example, if you are day trading and want to use a trend-following strategy, then it’s best to trade this strategy shortly after the open and then again before the close. That’s when most markets have the best trends.
Often markets are just going sideways during the lunch hour and also in overnight trading. So if you plan to trade during these times, you might want to focus on a scalping strategy.
Including a brief description of the trading strategy or strategies is the 3rd element of a solid trading plan.
4. Entry Rules
The next element in your trading plan are the entry rules of the trading strategy. As discussed above, THIS is the easy part because every trading strategy comes with specific entry rules.
Just copy and paste the entry rules from your trading strategy into this section of your trading plan.
If you choose to trade multiple trading strategies, make sure to post the entry rules from each trading strategy, sorted by trading strategy.
5. Exit Rules
Same as entry rules: simply copy the exit rules from your trading strategy into your trading plan.
Make sure that you have rules for exiting with a profit and rules for exiting with a loss.
The biggest mistake of traders is that they don’t have specific rules and exit “when I made enough money.” Trust me, there is never “enough money” in a trade. You want to make sure that you don’t let a winning trade turn into a losing trade by holding onto it for too long.
Have specific rules for exiting your trade as part of your trading plan.
6. Other Important Rules
The more you specify in advance, the less you have to make decisions in the heat of the moment.
In your trading plan, you should clearly define…
How to trade around holidays, e.g. “Black Friday” or the days between Christmas and New Year.
How to trade around major economic reports. This is important when day trading because often markets go crazy when a major economic report is being released. As a rule of thumb, I don’t trade 5 minutes before and after a major report.
Do you have daily or weekly targets? Some traders stop trading after they achieved a daily or weekly profit goal. I think that’s a great idea! Do YOU want to incorporate it into your trading plan? Or do you prefer to trade without any targets?
What to do when you feel sick: I personally don’t trade when I don’t feel 100%. After all, in order to succeed with trading, 2 conditions have to be met: The markets have to be ready and YOU have to be ready. It’s a good idea NOT to trade if you don’t feel 100%.
You get the idea!
THIS section of your trading plan is very important, and you will add to it as you get more experience. Over time, you will have a super solid trading plan that keeps you out of trouble and helps you to grow your account!
7. Money Management
Money Management tells you how much to risk on any given trade based on the amount of money you have in your trading account.
The easiest Money Management approach is the “Fixed Rational Money Management.” When using this approach, you risk a fixed amount of your trading account on any given trade. One of the most popular approaches is “The 2% Rule” which says: “Never risk more than 2% of your account on any given trade.”
The problem with this approach is that your account will grow rather slowly.
I personally recommend the “Fixed Ratio Money Management” approach to my private students. With this approach, you increase your risk based on the number of profits that you make. This approach is the fastest way to grow your account, and I will write another article about it shortly. It would take too long to explain it right now.
As you can see, a trading plan is much more comprehensive than a trading strategy.
The main purpose of a trading plan is to define what trading strategies you trade and when.
It’s not that difficult. And now you know the 7 important elements of a rock-solid trading plan.
Take the time to write your trading plan, and then test on a trading simulator to make sure you’re getting the results you expect.
Trading Futures, options on futures and retail off-exchange foreign currency transactions involves substantial risk of loss and is not suitable for all investors. You should carefully consider whether trading is suitable for you in light of your circumstances, knowledge, and financial resources. You may lose all or more of your initial investment. The lower the day trade margin, the higher the leverage and riskier the trade. Leverage can work for you as well as against you; it magnifies gains as well as losses. Past performance is not necessarily indicative of future results.