Market Insights: How to Develop a Trading Plan that Wins [Part 1]

Chris Burgess here, and I am back with another Market Insights blog! It’s been a while, and it feels good to be back. Today I wanted to start a discussion about trading plans and designing your own trading plan.

The subject of trading plans is a very vast topic, and it’s one that is difficult to cover in a typical training course due to its breadth and depth. With that being said, I will do my best to address the topic in detail over a series of entries, today marking the first entry. My goal with this series is not necessarily to cover every aspect and fine detail of trading plans but rather to give you some insights into how to think about them and begin developing your own.

Keep in mind that I will be sharing my own thoughts and my own approach to the subject, and it may be different from information you have read or heard about from other sources. And that’s fine as trading is not the type of subject where there’s a one-size-fits-all approach. There are many different ways to trade, and therefore many different trading plans. Ultimately you have to learn a lot and do what suits you best.

In this initial entry to the discussion, I want to begin by giving a broad overview of the topic and its major components, and in subsequent entries, I can go in-depth on each of the sub-topics. So first off, what is a trading plan?

A trading plan is a systematic way of approaching the markets that gives you a desired outcome. So when it comes to trading, there are generally two goals that most people have: cash flow or account growth. Therefore, the first thing we need to decide when creating a trading plan is the ultimate goal. Please note, throughout this series; I will address trading and investing together as just “trading” -- I’ll leave it to you to interpret the term as it best suits you. Let’s take two different hypothetical traders as examples:

Anna is an engineer who is nearing retirement. She has saved up a sizable nest egg in her retirement account, and she wants to use that money to create income that she can live off of in retirement, ideally without drawing down her principle each year. For Anna, it’s clear that her goal is to use her accumulated funds to create cash flow.

On the other hand, Josh is a young professional fresh out of grad school. He has a promising career, but he wants to use the stock market to actively grow his wealth beyond what he could get at a savings account or his company’s 401(k). He’s starting with a small amount of after-tax money that he has set aside through savings, and he’s looking to turn his small cash pile into a much bigger cash pile by the time he retires much later down the road. Therefore, Josh clearly has a goal of account growth.

Of course, you will have many different considerations and complications in your own life. These over-simplified examples are just that--examples that we can use to illustrate the differences in approach to a trading plan.

Anna and Josh are both looking to use the stock market as a means to reach their ends, but their different goals will require different approaches, and therefore different trading plans. The first difference is one of perspective and how they view/treat their trading plan. Those of you who have read Rich Dad Poor Dad should be familiar with the basics of personal financial statements. In short, your income statement tracks your income and expenses every month, while your balance sheet weighs your assets vs. your liabilities.

No matter what your own goals are, a trading account is an asset that sits on your balance sheet in the “assets” column. Your goal may decide how you perceive that account and how you use it. For example, Anna will view and use her trading account in a different way from Josh.

Anna’s goal is to use her trading account in order to generate income that flows from her asset column to her income statement every month, and she intends to use that income to pay for her expenses in retirement.

On the other hand, Josh also finds his account in the asset column of his personal balance sheet. However, Josh wants to grow that asset into an even bigger asset over time. So his goal is to increase his balance sheet by growing his assets. Josh knows that if he wants to grow his trading account as quickly and efficiently as possible, he can’t afford to take money out of his account and use it to pay bills. Any dollar he takes out of his trading account is another setback to reaching his goal. Instead, Josh will use his salary from his job to fund his expenses, and he’ll keep any gains in his trading account to fund more trades and grow the account further. As Josh makes more money at his job, he can funnel excess income into his trading account to grow it even faster.

As you begin to develop your own trading plan, think about your goals and how your trading account fits into the picture. Decide how the money will flow between your personal balance sheet and your income statement.

You may realize that your plan will have to change and evolve over time, and that’s perfectly fine. For example, your ultimate goal may be to create enough monthly cash flow to live off your trading account. But maybe your trading account barely has one month’s worth of expenses in it now. So your first goal may be to grow the account first, then later convert to a cash flow plan where your trading account funds your monthly expenses.

Lastly, keep in mind that you don’t have to limit yourself to a single trading account. Personally, I find it helpful to have different accounts for different goals. I have several different trading accounts, each with a different goal in mind: one is for account growth, one is for cash flow, one is for teaching, another is for testing different strategies, etc. I find that this keeps my mind more organized rather than having a single account with many unrelated trades in it. If you’re just getting started and have limited funds, you may not have much of a choice. But as your wealth grows, you can expand your accounts.

So your next step is to decide your trading goals because that will be an essential factor in the direction of your trading plan. Ultimately, your trading plan exists as a means to achieve your financial goals.

And that’s it for this week! Next week, we’ll begin exploring the steps to determining your time horizon and trading style and how those decisions impact your trading plan. Until next ​time! Happy trading!