Recently, I was reading through a 29-page document, "Trading Plan Template," that someone in a trading group had mentioned. Not far into the document, I came across a section that explained the difference in a trading plan and a plan for a trading strategy. A trading plan references all the parameters of one's trading life, the document asserts, while a trading strategy applies to the guidelines you'll employ while trading a particular type of trade. A trading plan might dictate how much of each day will be devoted to research. A trading strategy might tell a butterfly trader how many days before expiration she'll open those trades. A trading plan might or might not include trading strategies. It probably should include those, but it should go further.
Would you be surprised to know that the author of this pdf document believes that the trading plan is possibly more important than specific trading strategies (4)? How could that be, you might be asking. It's the trading strategy that tells us how to adjust, what the planned profit target and allowable maximum loss will be. Aren't those the most important aspects of trading?
The author wasn't saying that writing down trading strategies lacks importance: that author instead believes that the overarching plan for your trading life ranks higher in importance. How will you decide how much of your account to allocate to actively traded strategies, and how will that amount be subdivided among income-type strategies and more speculative trades? How will you decide whether a strategy is working? Will a certain number of months of losing trades prompt a reevaluation, and how will that reevaluation take place? Back-trading the strategy, going over losing trades with an experienced trader or mentor, decreasing the size of losing trades or going to paper trades all might be viable choices when a strategy doesn't seem to be working. Without an overarching plan, however, the trader lacks an objective guideline for which of those steps should be taken at what intervals.
Perhaps when the trader decided to begin trading a strategy, that trader had intended a six-month trial period with small trades before the success or failure of the live trades was reevaluated. If the first two months of live trading produced small losses, however, the trader's emotions might urge that the strategy be abandoned. The overarching plan reminds the trader that losses were anticipated--the reason for the small size of trades--and that the six-month period was set up so that those small losses could be endured. The plan also reminds the trader that the strategy was tested and should prove workable over the long run. That's easier to remember if the first few months were profitable before the first loss was encountered but harder if the first few months produced losing trades.
What if you happen on a discussion of a new way to scan for trades on different underlyings? Your overarching plan took into account all your experiences as a trader when you noted the number and types of option strategies you would employ. That accounting included all the times that you've jumped into an options trade on an unfamiliar underlying, only to find that when the trade went wrong, an illiquid options market resulted in a terrible fill and a loss much higher than the maximum loss you intended. Your overarching plan has set aside a way for you to test new strategies or old strategies on new underlyings. That plan will remind you that you intend to paper trade a new strategy for a certain amount of time, or that you'll upload information on volume and open interest on a new underlying's options and watch them for a certain period of time to determine if there's enough liquidity to meet your needs.
An overarching trading plan might tell a trader that, no matter how well each strategy is nailed down, that trader will avoid entering a new trade when markets have been zooming around too much. That "zooming around" might be determined by days with greater-than-a-standard deviation move, days in which prices ping-pong from a lower Bollinger band boundary to the top Bollinger-band boundary, when Average True Range begins expanding or some other standard specific to that trader's strategy plan.
An overarching plan might tell a trader when the size of trades might be scaled up or when they must be scaled down. They might tell a trader how often profits will be moved to another account, and what percentage of profits will be moved and what rolled into new trades or left for tax purposes.
I talk with some frequency about the need for both strategy plans and overarching trading plans, and that article I read prompted yet another one. I don't feel that it's overkill, however, to cover trading plans or trading strategies with some regularity. They help us set objective goals for evaluating a new strategy or underlying or an old one. They remind us of our well-thought-out plans when we're tempted to jump on a new trade or discouraged when a planned one isn't working out well. If I'm any example, I know we can't keep all emotion out of our trading lives. However, these trading plans do help us when we're caught up in the emotions of live trading because our plans are thought out and written down when we're calmer.
I haven't included a link to the trading plan discussion that prompted this article because it relates to forex traders. However, interested traders can usually locate a CBOE or other webinar on trading plans, and an Internet search will turn up this template, too, if wanted.