Trading Strategy: Creating a Stock Trading Plan

What is a Stock Trading Plan?

A stock trading plan is a strict set of rules and actions which formulate your stock trading strategy. A stock trading plan defines when to buy and sell stocks and at what prices. Every trade you make should be governed by your trading plan.

A stock trading plan is very similar to a company Business Plan. A Business Plan is a device for the owner which sets out how the company intends to operate the business. A business plan is also a road map to tell investors and others how you expect to get there. A business plan covers all aspects of the company, from overall strategy and marketing to finances and the company’s goals. In the same fashion, a trading plan lays out how the trader will make trades – the time, price, volume, and news are all essential components of the trade. While your trading plan may not necessarily be for others, it is still your own road map to tell yourself, and reaffirm to yourself, how you expect to get there. Include goals in your business plan: 3 month, 6 month, 1 year, 2 year, 5 year, 10 year, and even 20+ year goals you would like to reach through your trades and investments.

Trading Criteria to Consider

There are many things you need to consider and think about when creating your trading plan. Here are a short few your trading plan should cover. Any additional criteria you can think of should be included.

• When to enter a trade (buy a stock) – timing.
• Price when buying a stock.
• Current news about the stock.
• Liquidity of the stock. Liquidity is the ability to buy and sell stocks at the volume you want, when you want, at the price you would like.
• How long to hold the stock.
• When to sell if the stock price goes up.
• When to sell if the stock price goes down.
• What to do if the price does not move. Hold the stock longer? Sell the stock?

Trading Plan Essentials

There are many essentials you should include in your business plan. These essentials lay the foundation of your plan and will help you reach your goals. Here are some essentials you should include. Again, if you have other essentials please leave a comment so others can build on your information or contact me so I can include them in future versions of this article.

• Statement of Purpose

  • Why do you want to trade and invest in the stock market?
  • What do you hope to gain from trading?
  • What are your trading goals?
  • How do you plan on becoming a better trader?
  • How are you going to use your trading plan?
  • Clearly define your purpose for trading and investing.
  • State your goals and what you hope to gain and achieve through trading.

• Strategy for Buying

  • How are you going to find stocks to trade? Examples: screener, news, research, technical analysis, fundamental analysis, etc.
  • How will you refine your “buy list” (stocks on your radar you are considering buying)? Examples: valuation, screening further, great news, great earnings, strongest technicals, strongest fundamentals etc.
  • What price are you willing to pay? Sometimes the current price may not be the best price for buying. Will you wait for a better price? Move to the next stock in your list?
  • Does the stock have good volume? Very low volume history means you may not be able to sell the stock at the price or time you want. Keep this in mind. High volume means high liquidity and are generally easier to sell and more actively traded.
  • Using Technical Analysis: make sure you absolutely understand how the technical analysis indicators you use work. Your favorite indicator may not be useful in many situations. You must know when to use technicals and when not to use them.
  • Using Fundamental Analysis: again, make absolutely certain you understand how fundamentals work. This means reading through past earnings reports and the company’s balance sheet, income statement, and cash flow statement. Sometimes a stock will have great fundamentals but will not move in the direction you expect due to other factors, such as news, or future outlook.

• Strategy for Selling

  • Set a desired minimum goal for each trade. You may be happy making $50 per trade. Or $500 per trade. Set a price goal you are happy with making from selling the stock. Don’t be angry if the price goes up after you sell. You can’t see the future and mentally it can be unhealthy for you to second-guess yourself. Set a minimum desired goal and stick to it.
  • Use Stop-Loss Orders to reduce risk by automatically selling at a pre-determined lowest price. Read more about stop loss orders: Using Stop Loss Orders to Reduce Risk
  • After you buy the stock, what is the lowest price you are willing to sell at?
  • How much are you willing to lose if this trade goes bad?
  • Most traders are willing to risk or lose 1% – 2% of their entire portfolio value per trade. Example: Your entire portfolio value is $10,000. On this trade you use $1,000 to buy. At 2% risk, you are willing to lose $200 of your $1,000. The stock price can fall 20% before this 2% loss dictates selling.
  • Will you sell the stock immediately, before your stop-loss price is met, if other factors arise? Such factors may include poor earnings, weak or declining market, market corrections, poor news, lost contracts, etc.
  • When will you sell the stock if the price rises and continues to rise?
  • Some traders set a specific goal, perhaps 10% gain or 25% gain, and then they will automatically sell.
  • Some traders continually raise their stop-loss prices as the stock price climbs. This is called trailing stops or raising stops and can be a very useful tool for locking in gains and reducing risk. I use trailing stops.

• Strategy for Holding

  • What will you do if the stock price does not move at all after you buy? Sell it and move on, or hold it and wait for action?
  • Some traders will hold on to the stock until more activity and volume pick up. They are comfortable waiting it out. This action may require more capital in your trading account, as you may have to hold on to more than one non-moving stock.
  • Some traders will sell a stock that does not move after a very short time period – perhaps minutes, hours, or a couple days. These traders like to move their money to move active or lucrative stocks on their list. They may not feel comfortable holding this stock for a length of days, weeks, or months.

• Money and Risk Management

  • How will you keep your risks to a minimum?
  • How will your keep your total account value at a maximum and grow it?
  • Research money management techniques – there are many. This can include how much money or what percent of your entire portfolio value to use in each trade.
  • Research trading risk management techniques – again there are many. This can include how much money or the percent of your entire portfolio you are willing to lose, and may lose, in each trade.
  • Keep extra cash available in your account. You will see many opportunities but you must be prepared to take advantage of them. If you have little or no available cash, you will not be able to execute this trade. You may want to have 10% – 20% of your entire account value available.
  • Margin: margin can be a very useful tool for many traders, but can be scary and risky if not used properly. You can get a margin call from your stock broker at any time, which means they want to collect their money now. Margin gives you extra buying power. Margin also gives you additional risk. Use margin cautiously and wisely. Some traders do not use margin at all.

Inspiration For Your Stock Trading Plan

Luck is When Preparation Meets Opportunity

This is one of my favorite quotes which is very inspirational to me, not only in my trading and investing, but also in my everyday life. This is also one of Oprah’s favorite quotes. Look how successful she has been!

For a trader, the preparation means making your plan, developing your strategies, testing your techniques, and continually refining it all. The opportunities are there for us to take advantage of. We will only find success when our preparation intersects with our opportunities.

Your Trading Plan Means Success

A well thought out and detailed Stock Trading Plan is the solid foundation for building your wealth, keeping your wealth, and successfully growing it. You must be dedicated to your plan. Following your plan part-time will give you part-time success. Don’t second guess your plan, but make changes as necessary. A trading plan is one key that can unlock your trading potential and help you make more money while losing less money. Every Trading Winner must have a Stock Trading Plan.