3. Prerequisites And Components

Here is a list of components found in a solid Trading Plan along with some prerequisites for building one. They are each important individually as well as collectively.


Determine what you are willing to invest to reach your monetary goals and be realistic with the numbers. Many traders try to make a living trading with an insufficient capital base. Being under capitalized relative to their monetary goals forces them to trade too aggressively. As a result, losses are severe and create unnecessary frustrations. Resist the temptation of taking large risks in hope of big rewards so as to avoid the resulting negative emotional impacts that will condition your trading afterward.

Capital Allocation

If you are trading multiple accounts, are you going to allocate your capital according to different levels of risk or different strategies? You may also decide to fund a sole trading account with a certain percentage of your investment capital, and make use of a higher leverage. This would be appropriate if you are using margin stops for example (see Risk Control Measures under Chapter C03).

Consider at this stage not only how much capital you intend to start out with but also at which equity level you might interject more cash if need be. If you do not feel absolutely confident when going with real money the first time, why not opening an account with half of the investment you intended to go full with and trade that amount until you are profitable for a certain time, let's say, three months in a row?

Budget & Costs

Consider operational expenses of different sorts in your plan. These can be for instance: transaction costs, data feeds, analysis tools, software and equipments, Internet service, educational material or coaching tuition.

Compare your budget and costs to your trading capital and your possible earnings and estimate an hourly wage. Then compare with the wage from your last job- does it compensate?

Instruments & Currencies

A trader typically centers his trading plan on a specific instrument or currency. When talking Forex, this means for example, those pairs where the trader has acquired more knowledge and experience. Choosing an instrument to trade means you have carried out the necessary research and testing. Without having done this, your trading plan will have many unanswered questions as well as vague answers. It is imperative you ascertain how fertile a certain pair is for you or your strategy.

You may also think, why only trade spot Forex and not currency instruments like ETFs, Futures or Options? No one will master every single market and succeed in all of them. But unless you attempt to trade different instruments or currency pairs, you will never know which one is best for you.

A closer look at your track record will tell you what you thrive best at. Remember, specialization is necessary!

Brokers & Platforms

Choosing a reputable broker is of paramount importance and spending time researching the differences between brokers' policies as well.

The charting and order-entry platform are probably your biggest considerations when it comes to identifying the most appropriate trading tools for your style of trading. For example, if you need to hedge positions, then be sure the broker's platform allow you to do that. Or if you need to export your trading results in a specific format, ask the broker if that is possible. While in the case you need speed of execution to scalp the London session open, you probably want to trade off the charts. There are so many aspects to consider, and they are so dependent of your particular requirements, that listing them here would be not viable. Check Chapter A02 for more details on how to exercise proper due diligence regarding broker/dealers. With this in mind, you may have different accounts for different types of strategies.

Trading Style

It is said the time horizon for finding opportunities and holding positions is what determines the type of trader you really are. There are advantages and disadvantages to these different styles and the time frames associated with them.

Day trading on intraday time frames is probably the style which requires the most abilities, strongest discipline, most agile analytical skills and fastest decision making. For example, if you cannot stomach going to sleep with an open position then you might consider intraday trading. In turn, intraday trading will provide you with lots of opportunities and action if that is what you are searching for.

On the other hand, it has its disadvantages as Sam Seiden describes:

Day trading is attractive to many individuals because of its “get rich quick” mindset. While some traders do very well in a short period of time, most end up losing money in this venture. Emotions tend to run very high when day trading, making rule-based execution difficult for those who have any issues with discipline. There is also the added difficulty of competing with market makers at the day trading level. Day trading is the most time-consuming trading style because it requires you to be in front of your computer screens each day while you are trading. Traders who are not good at making quick decisions are not likely to succeed at day trading.

The other extreme is the position trading style, which makes use of large timeframes such as daily, weekly and monthly. It is very hands-off because there is plenty of time to prepare trades, and it requires little time for analysis and trade management.

In between, there is the swing trading style, which is about holding positions for one day to several weeks. Sam mentions a series of advantages belonging to this style:

From my experience, swing trading is where I see the largest number of aspiring traders succeed. Swing trading captures the market niche with the least competition. It falls in a timeframe that is too large for day traders and too small for longer-term investors and institutions. Proper swing trading does not require a big time commitment. Spending an hour or so performing your market analysis two or three times a week will suffice.

No matter what style of trading you undertake, be sure that your personality has been considered - a mismatch will lead to unnecessary frictions, and a loss of money can be the outcome.

Time Management & Allocation

Does your choice about the style of trading reflect the time you have to devote to the markets? It is crucial to know how much time will you have to trade. Not much time available? Then adopting a short-term trading style is highly unlikely to work for you. Include in your plan if trading is going to be a part- or full-time venture for you by explaining the amount of time you are going to dedicate to your trading. Indicate also at what times throughout the day are you going to spend actually trading, analyzing charts, or learning about the market.

Allow a certain level of comfort and do not over estimate how much time you have: it is unrealistic to trade every minute of every day of every year in a calm state as a trader. And the shorter the timeframe you use, the truer this is. The smaller the timeframe, the easier it is to miss opportunities which triggers frustration and anger. In turn, higher timeframes allow more time to prepare the trades.

If you have the tendency to deeply analyze your positions, think that the very short-term trader can't afford to over think trades. Instead, that trader needs to react very fast to short-term trading patterns, and this requires mental agility. In turn, if you feel you can not exploit your analytical skills with intraday trading, you might try to adopt a swing style on higher time frames. All styles can be combined into the same plan, they do not exclude one another.

Have you tested at which times you (or your method) are most profitable? Is it at the first hours of the London session, or do you prefer to trade after news  is released in the US There is really no one time that is better than any other - it all depends on your personality and the style you adopt.

Make sure you are awake when your strategy produces the best trade results. Consider this aspect carefully since it makes no sense to turn your lifestyle upside down because of trading.

List your office hours and the holidays you plan on taking. This part of the plan will help you treat your trading more like a business and not a hobby. Despite being self-employed, traders must have discipline. Don Dawson offers the following advice:

Identify your daily time allocation to your trading task. Trading is a very isolated business. Therefore, we need to have some structure of how we will spend our trading day. I like to identify the times of day I will do pre-market, post-market analysis and hours I will spend trading. Also, consider your lunch breaks and hours you will spend in the office each day. Trust me, without this, you can literally spend your life in the trading office. Make time for yourself so you do not get burned out by working in the office too much.


After deciding which type of trader you are, and how you will be managing your time by allocating different tasks, the timeframe aspect will be an easy one. As a intraday trader, it will be usually 60 minutes or less as a timeframe whereas swing and position traders will use 240 minute, daily, weekly and monthly price data.

Perhaps the most important point is to distinguish what timeframes will be used to analyze the big picture and what timeframes will be for tactical trading decisions. Write them down in your plan and stick with them. One of the mistakes new traders commit is entering a trade based on the analysis of one timeframe and then manage that position in a different one. Unless this tactic follows explicit system rules, the traders ends up sabotaging his or her very own plan.


Choose the set-ups you are most interested in. Do you prefer technical set-ups, like for example, price gaps? If so, how will you identify them and then how will you capitalize on them? But if you are going to use predominantly fundamental analysis, what economical figures are of most interest to you? Is it growth, interest rates, or employment? Describe how will you use that information.

Once you have done that, then start a detailed development of the strategy by determining if the set-ups are truly profitable. You can also look for existing strategies which exploit your set-up and customize them to your profile.

What is a set-up? A set-up is the set of characteristics that enables you to identify a high probability trade prior to your entry trigger being hit. A set-up can be, for example, a price gap ocurring at the opening of the market on Sunday/Monday. A set-up is usually a simple and easy-to-spot market condition which carriers a certain potential. It is imperative that the set-ups are very clearly defined in your Trading Plan. Be sure to thoroughly test them prior to live trading in order to determine their probability of success.

Strategies & Systems

How can it be that so many traders lack confidence in their trading decisions if there are so many proven strategies and systems out there? The answer has to be found in the fact that only few people realize that adopting a trading system involves three main tasks: skill assessment, research and detailed development.

Once an accurate, honest skill assessment is correctly done, the trader is ready to start researching. Research process consists in looking at what is out there in terms of strategies and systems, how other traders are working today, which pairs or instruments have more potential, etc.

There are lots of strategies to choose from in books or forums all over the Internet. But you can start here at the Learning Center Testing where Chapters C01, C04 and D02 show plenty of examples. Explore the section Trading Strategies as well.

The next step is the development of the system. The process goes from market observation, through theorizing hypothesis, to finally formulate the rules and conditions which generate signals to open, close and manage positions. All these details were covered ni detail in Chapter C01 and should be part of your Trading Plan. However, it is important during the development process that no indicator, set-up, or trading system becomes the central piece of your Trading Plan.

Set-ups and trading strategies are essential elements in a Trading Plan. But the purpose of the Trading Plan is to shift our attention to what we might feel inclined to do as traders, namely, search for entry opportunities, and help us stay out of trades. If you just follow a system but not a plan, you will obviously surrender to over-trading since the system is designed to generate buy and sell signals, while under the protective umbrella of a Trading Plan, you can be much more selective as to what trade opportunities meet all your criteria and ultimately lead you to the achievement of your goals.

As a trader gains more experience, skills are developed to new levels and the strategies evolve. But from the very start the rules need to be set and adhered to. As opposed to emotion, defined rules will guide you through the execution stage. By referring back to them, you can maintain  discipline and trade consistently based on your plan. These rules are formulated by asking questions like:

  • Which technical indicators will I use?
  • How will I go about protecting my capital?
  • What type of orders will I use?
  • Which signals or conditions will bring me to exit a trade partially or completely?
  • Will I exit before my stop is hit?
  • Where and when will I take profits?
  • Where will the stop loss orders be placed and what type of stops?
  • Etc., etc.

As part of your plan, describe an objectively definable method, one that is thought out in its entirety to the extent that if someone asks you how you make your trading decisions, you can explain it briefly. A method can always be altered and improved, but it should always follow the three mentioned tasks.

Money Management & Risk Control

Money management is the most often overlooked component of a Trading Plan. Thus it is no wonder most who try their hand at trading go broke. They simply fail in laying out money management rules early on. The importance of these rules relies in the fact that they will help keep your capital protected while you improve as a trader. Even though your primary motivation is to make money, and you have certain monetary goals, protecting your trading capital is even more important. Only later on, the objective of money management becomes more centered in maximizing profits.

Failing to understand these basic rules will add you to the losing statistics in this business. Van Tharp, in an article taken from the Trader's Journal, writes:

Thoroughly understand your objectives and develop a position sizing strategy to meet those objectives. Probably less than 10% of all traders and investors understand how important position sizing is to trading performance and even fewer understand that it is through position sizing that you meet your objectives. Thus, the fourth step is to develop position-sizing strategies for each system that will help meet your objectives.

The money management model will contain the rules on what the optimal  trade size and leverage used by the trader should be. The point here is to know what you will need to risk in order to reach your proposed goals. To do that, you have to chose the adequate technique. Remember that each trading style and strategy requires a different technique concerning risk and position sizing.

We suggest you read Chapter C03 carefully  where the most important money management techniques are outlined. Examples include the Fixed Fractional method and its multiples variations, as well as the Fixed Ratio, the Cost Effective and many other money management models.

In this part of the Trading Plan you will consider under what conditions you may start with a Fixed Lot model and change to a Fixed Ratio one; change time parameters in the Periodical Fixed Fractional; or even change the Delta factor in the Fixed Ratio if a new Drawdown has been registered. As you see, there are lots of creative combinations you can choose from.

The trade size influences our objectivity as traders, and most people react differently when they're under pressure from being over-leveraged. They tend to be more emotional or reactive and their judgment becomes impaired.
Especially once you begin to trade well, you will be tempted to increase your position sizes. We suggest to be very careful here because this is the point where many traders lose sight of their long term goals. Avoid the sole temptation to make money during the first year of your trading career and focus instead of developing your skills and strengthening healthy habits. Greed will creep in if you lose sight of your realistic goals and start risking too much. If the habits are still not ingrained, there is a higher probability that the new trader makes stupid mistakes- so be aware of that and protect yourself, especially during the first year. If the swinging of the equity in a $5,000  account causes you emotional stress, imagine a $500,000 account later on.


Decide before you start how you are going to “collect your pay” for your work and how often. A percentage of the gains can do yourself a service here since you never know how much you are going to achieve in a certain time period. Don Dawson suggests:

Have a plan for your profits and replenishing your trading account. List here your plans for taking a monthly draw of your profits and how much you intend to keep in your account. Try not to keep too much excess cash in your account. What tends to happen is you will get more careless and not as selective with the trades you take. Keep the extra money in another interest bearing account where you can get immediate access, if needed. Have a plan on how much you will replenish your account with if it drops below a set minimum you have established.


Keep in mind as traders we do have to pay taxes on our gains. Either have an accountant estimating and calculating taxes for you or do the calculations yourself. Identify in your Trading Plan how and when you will do these tasks and calculate the amounts in the overall gain figures.


The act of documenting your trading activity for reference, besides adding an element of discipline, will also help you analyze which parts of your Trading Plan that are working and those which need to be adjusted.

This component is absolutely crucial to your success and an entire section is devoted to it in Chapter D04.

A trading journal can help the trader in many different ways. For example, it can assist a trader in finding the degree of emotional involvement permissible in trading, strengthening the beneficial emotions and weakening the destructive ones.

A Trading Plan also provides critical data on where money is being lost or made. This is easily detected on the equity curve or in many of the statistical figures commonly used. This trackrecord also allows to test different money management techniques and see which ones work and which ones do not. This part of the Trading Plan, if followed, will allow the trader to quickly see where weaknesses are and correct them.


With regards to websites and managing the information flow, it is important to identify what information you need and where you will source it. With RSS feeds, blogs and twitters, there is a wealth of specialized information organized in user-friendly ways and delivered directly to your desktop. Be careful in the selection though, taking only those sources you really need to trade or that are of your interest, while never interfering with your decision making.

These are some of the most important components and requisites of a trading plan. Our goal here is to give you a foundation for creating your personal plan and then allow you to add your own personal touches.

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