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How To Start Trading

Introduction

Trading is an active style of participating in the financial markets that seeks to outperform traditional buy-and-hold investing. Rather than trying to profit from long-term uptrends in the markets, traders look for short-term price moves to profit in both rising and falling markets.

As a trader, one of the most important things you can do to improve your chances of success is to approach trading as a business. A successful trading business requires a strategic plan that covers your actual business and your actual trading. Your business plan will include things like short and long-term goals, the amount of capital you have available for the business and how you will set up your office. Your trading plan includes the details of trading: what you will trade and how you will trade it. Your plan should be so objective and concise that you could hand it over to another trader and they would be able to execute it exactly.

It’s important to understand that your trading plan is not simply a set of rules that you think will work, a list of set-ups that you are somehow fond of, or someone else’s plan. A good trading plan is one that you have researched, tested on historical data, tested in a live market and continue to evaluate at regular intervals.

Successful trading involves more than reading a few articles or books, and you should plan on devoting a substantial amount of time and effort before ever placing a trade in a live market. This can be difficult because most new traders are anxious to get in the market. While the research and time commitments may sound daunting, they're a realistic and integral part of becoming a profitable, independent trader.

This tutorial serves as an introduction to help you get started trading. For more information, be sure to check out part two of our series, which covers more advanced topics including charting, leverage, risk and strategy automation.

Trading Styles

Many people who become interested in trading are first introduced to the financial markets through investing.The purpose of investing is to build wealth slowly over time, and this is typically accomplished through a buy-and-hold approach: making investments – such as in a stock, ETF or mutual fund – and allowing price to fluctuate over time. Investors “ride out” the inevitable downtrends with the expectation that prices will eventually rebound and rise over the long-term.

After years or decades, the investment will, in many cases, increase in value and provide positive returns for the investor. Long-term returns can be further amplified by compounding through the reinvestment of profits and dividends. Investments are often viewed as a means of building wealth to provide stability and income during the retirement years.

Trading Time Frames

While investments are typically held for a period of years or even decades, traders buy and sell stocks, commodities, currency pairs and various other investment vehicles with the intention of generating returns that outperform a buy-and-hold strategy. Trading profits are viewed as income since profits are “taken off the table” on a regular basis (as opposed to investing, where positions are generally left alone for the long haul).

Trading profits are achieved through buying low and selling high – and selling high and buying (to cover) low, in the case of short selling – and all trades are entered and exited within a relatively short period of time. This time period can vary from a few seconds to months or even years, depending on the trader’s style. The following chart lists the four primary trading styles - position, swing, day and scalp – with the corresponding time frames and holding periods for each.

Position Trading

Position trading encompasses the longest trading time frame; trades generally span a period of months to years. Position traders may use a combination of technical and fundamental analysis to make trading decisions, and often refer to weekly and monthly price charts when evaluating the markets. Typically, short-term price fluctuations are ignored in favor of identifying and profiting from longer-term trends. This style of trading most closely resembles investing. However, while buy-and-hold investing typically involves long trades only (profiting from a rising market), position traders may utilize both long and short trading strategies.

Swing Trading

Swing trading refers to a style of trading in which positions are held for a period of days or weeks in an attempt to capture short-term market moves. In general, swing traders rely on technical analysis and price action to determine profitable trade entry and exit points, paying less attention to the fundamentals. Trades are exited when a previously established profit target is reached, when the trade is stopped out (moves a certain amount in the wrong direction) or after a set amount of time has elapsed. Because swing trading takes place over a period of days to weeks (with an average of one to four days), this trading style does not necessarily require constant monitoring. As such, traders who are unable to monitor their positions throughout each trading session often gravitate toward this popular trading style.

Day Trading

Day trading refers to a style of trading in which positions are entered and exited on the same day. Unlike position and swing traders, a day trader does not hold any positions overnight, and all trades are closed by the end of the trading session using a profit target, stop loss or time exit (such as an end-of-day exit). Day traders typically use technical analysis to find and exploit intraday price fluctuations, viewing intraday price charts with minute, tick and/or volume based charting intervals. Because trades are held for a period of minutes to hours, large price moves are uncommon, so day traders rely on frequent small gains to build profits. To leverage their buying power, day traders usually trade with margin. Day trading is a full-time job since positions have to be constantly monitored and traders need to be immediately aware of any interruptions to the technology chain (for example, a lost Internet connection or a trading platform issue).

Scalp Trading

Scalp trading is an extremely active form of day trading that involves frequent buying and selling throughout the trading session. Scalp traders target the smallest intraday price movements and rely on frequent and very small gains to build profits. Profit targets and stops are used to manage positions that are generally held for a period of seconds to minutes. Because gains are small on any one trade, scalpers may place dozens or even hundreds of trades each trading session; as a result, it's imperative that scalpers have access to low trading commissions. It should be noted that scalp trading is considered very risky because it relies on having a high percentage of winning trades. And because the average winning trade is generally many times smaller than the average losing trade, it can take just one or two losing trades to wipe out all of your profits profits. Precision is paramount with this style of trading, and scalping requires constant attention to the markets.

 High Frequency Trading

One other style of trading that we'll mention here is high-frequency trading (HFT). These traders use complex (and typically proprietary) algorithms to analyze multiple markets and execute orders based on market conditions. Because the traders who have the fastest execution speeds are the most profitable, independent traders trading from home simply cannot complete. As such, they stay away from this style of trading.

The book "Flash Boys: A Wall Street Revolt," written by Michael Lewis, focused on the rise of HFT in the U.S. equities market. The book highlighted high-frequency traders' need for speed and described a $300 million cable project to connect the financial markets of Chicago and New York that would shave 4 milliseconds off a trade. Today, just three years after Lewis's 2014 book, many HFT firms are struggling or have closed shop, citing as reasons a lack of volatility, stiffer competition and new trading rules – including the NYSE's "speed bump" designed to slow down HFT traders.

Which Style Are You?

As a trader, you must consider a variety of factors when determine the trading style that suits you best, including:

• ·         account size
• ·         amount of time that can be dedicated to trading
• ·         level of trading experience
• ·         personality
• ·         risk tolerance

In general, there is an inverse relationship between trading time frame and the amount of time you have to devote to the markets. For example, position traders may be able to spend a couple hours each week evaluating and managing trades. Scalp trading, on the other hand, is a full-time job and these traders spend every minute of every trading session actively managing trades.

Many market participants – whether investors or traders – do not fit neatly into any one category. For example, many traders are also long-term investors, while others may primarily day trade with a few swing trades mixed in. In general, it takes time and experience to figure out the style of trading that will work best for you.

Trading As A Business

The idea of trading for a living - or having your own trading business - is appealing to many people: you get to be your own boss, set your own schedule and work from home while enjoying virtually unlimited income potential. In addition to these factors, anyone with a computer, Internet connection and a small trading account can give it a try. Unlike many other jobs, no degrees, special training or experience is required.

Steep Learning Curve

Because trading is so easy to get into, new traders may not realize there's a very steep learning curve involved: being successful is difficult, and it takes a lot of time and effort. Here are some quick facts about trading:

• About 90% of day traders fail within the first year
• There is no way to completely eliminate risk in trading
• There is no trading system that wins 100% of the time
• You will always have losing trades, even if you are a rock star trader
• You need money to make money – it will take a long time to get rich with a small trading account
• Successful independent traders can earn a comfortable income, but most do not become millionaires

The ease with which you can start trading (just open a trading account and hit the “buy” button) in no way implies that becoming a successful and profitable trader is easy. Many of the 90% of traders who fail within the first year do so because they start trading without having developed any type of logical business or trading plan. Any business entered into with such a lack of planning is likely to fail. Another common reason for failure is that the trader is undercapitalized; meaning, they don't have enough money to take on the risk and absorb the inevitable losses.

No Easy Button

There is also a lot of deception associated with learning the business of trading. Late night infomercials and hundreds of websites would have you believe that trading is easy and that anyone can generate a huge and consistent income from the financial markets, with little or no effort. While there may be the rare case where a trader manages to make a huge amount of money in a short time, that's not the norm. For most people, trading involves a lot of hard work before becoming successful.

As a business, trading requires constant research, evaluation and discipline. There are no guarantees in the trading business, and you could work a 40-hour week and end up losing money. Anyone considering trading should make sure they have both the personality and financial means to take on this type of business activity.

You might ask yourself:

• Am I driven to succeed?
• How do I handle losing?
• Do I have time to dedicate to learning the business of trading?
• Can I stick to a plan?
• Do I have my family’s support?
• Do I have money that I can afford to lose?
• How do I deal with stress?
• Do I have realistic expectations?

If you want to become a part-time or full-time trader, it's important that you take the time to research and plan your trading business; these are essential steps in your overall success as a trader. This is not a profession at which you will become skilled overnight. Traders who start putting their money in the market too soon or without a well-researched trading plan often find themselves back at the beginning, but with a lot less trading capital. Traders who have realistic expectations and who treat trading as a business – and not as a hobby or a get-rich-quick scheme – are more likely to beat the odds and become part of the group of traders who succeed.

Trading Technology

Two keys to successful trading include taking a business-like approach (complete with a business and trading plan) and effectively using your available trading technology. The Trading Plan Development section of this tutorial introduces how to make a trading plan; in this section, we'll take a look at the various technology traders use.

Not That Long Ago …

Not long ago, you would have had to pick up the phone and call your broker to place an order. The broker would have called the order in to a floor trader who was physically at the exchange. The floor broker would find a match for the trade, and by the time your order was filled, the price could have changed dramatically. Not that you would have known…you probably wouldn't have had access to a live data feed.

Technology Today

Today, however, the technology that was once reserved for the exchanges and institutional traders is readily available to retail traders: faster computers, all-electronic markets and direct-access trading have all helped level the playing field for the independent retail trader. Additional advancements such as trade automation, innovative market research tools, sophisticated testing platforms and apps have given traders even more technology to work with. To get started trading, you'll need a computer, a reliable high-speed Internet connection and trading software.

Computers

A computer is your primary tool. This is where the action takes place and where you will research, test and trade your plan. In a perfect world, your trading computer would be used for one thing: trading. The reality, however, is that most computers have various applications running and are used for things like gaming and Internet surfing.

That said, if you must use your trading computer for pursuits beyond trading, be sure it is adequately protected with anti-virus software. Many companies offer free or trial versions of their virus protection software (keep in mind, though, that free versions don't always run scans automatically). Regardless of the software that you select, the key is to install it, update it often and perform regular scans to keep your computer healthy.

SpecOut | Graphiq

Your computer should have the fastest processor and the maximum amount of memory that you can reasonably afford (the shorter-term your style of trading, the more important this becomes). If at all possible, your computer should be capable of supporting multiple monitors. Trading with two (or more) monitors gives you the “real estate” you need to view multiple markets and trading charts, while having a dedicated order entry window. This can improve your situational awareness and allow for more precision in your trading.

SpecOut | Graphiq

You should also have a phone that works even if you lose power - such as a fully-charged cell phone. That way, you'll be able to call in an order to your broker if you've lost power. Keep your broker’s trading desk phone number in your contacts and have your account information handy.

It's also a good idea to have a back-up battery for your computer – an uninterruptible power supply (UPS). Think about how long you would need to keep your computer and other essential equipment running to properly manage and/or close out trades in the event of a power loss, and shop for a UPS based on that criteria, as well as the number of inputs you will need.

It's worth noting that, depending on the type of trading you're doing, you may be able to research, execute and manage trades from your mobile device or tablet. Most trading platforms today offer robust mobile interfaces, in addition to their web-based on downloadable software. Even if you don't make your mobile device your primary trading machine, it's a good idea to have your platform's mobile app loaded - just in case you need it while you're traveling or if your main computer crashes.

The TradeStation mobile platform has advanced charting and order entry capabilities.

Internet Connection

In fast-moving markets, it's definitely to your advantage to have a fast, reliable Internet connection so your trade orders are submitted and filled as quickly as possible. While most retail traders can't complete with institutional traders in terms of execution speed, a lag time of just one or two seconds can still mean the difference between a winning and losing trade. Depending on where you live, you may be able to pay a higher rate to your Internet Service Provider (ISP) to get faster speeds. In general, if you're doing anything faster than position trading, it's worth the added expense to have a faster connection.

Trading Software

Trading software serves three main purposes:

• Market analysis
• Testing
• Order execution

The market analysis component of trading software is what allows you to view and customize price charts and display price quotes. Depending on your style of trading, you'll need end-of-day market analysis (with delayed quotes) or real-time quotes that instantly update as market conditions change. Longer-term traders (position and some swing traders) may be able to use the EOD data; shorter-term traders (some swing, and all day and scalp traders) will need access to real-time data.

The next component is the software’s backtesting application. Not that many years ago, the ability to backtest at all was a fairly advanced feature of trading software. Today, however, traders can not only backtest, but also perform multivariable optimizations and walkforward optimizations/testing. These tools can greatly improve your ability to accurately test a trading system.

Lastly, your trading software will have at least one order entry interface. Some trading software offers very basic order entry, while others support advanced and even customizable interfaces. Many platforms support various levels of trade automation, from conditional orders to fully automated strategies.

Many trading platforms – the software that provides the market analysis, testing and trade entry capabilities – provide a simulated environment where you can practice taking trades and try out trading ideas. These “sim” accounts provide valuable experience for new traders, but it's important to remember that sim trading and live trading are different animals.

Sim trading, for example, often generates order fills that would never happen in live trading (giving you a false sense of profitability in many cases), and the emotions involved in sim trading can never be relied upon to represent how you will feel and act in live trading. That said, sim trading is an excellent way for traders to gain experience in the markets and with actual order entry placement.

While some trading software is sold as a complete package, most is leased on a monthly basis (from your broker, for example). In some cases, the monthly fee is waived if you trade a specific volume (e.g., 10 round-trip trades per month). It is important to note that in addition to any software/platform fees, you may also have to pay for certain data feeds, such as quotes from specific exchanges. These fees differ depending on your status as a trader: in general, the fees are relatively low for individual traders, but can be quite high if you are considered a “professional” trader.

Apps

Today, there are apps for everything, and trading is no exception - whether you're looking for market-moving news, real-time price charts or technical analysis. Apps let you stay on top of the market when you're not in front of your computer. Some broker/platforms, such as TradeStation, have libraries of apps from third-party vendors that integrate directly with the platform to enhance its capabilities. Most apps, however, can be downloaded directly to your smart phone or tablet. Some noteworthy apps include:

• MarketSmith - free technical and fundamental stock data, such as earnings and sales history, proprietary ratings and rankings, performance reports and charts
• Stocks Live - paid ($9.99) app that allows you to sync and trade your portfolios with major brokers, real-time quotes, global news coverage, watch lists, and scans
• Stocks Tracker - free streaming live quotes, pre-market/after-hour quotes, portfolio monitoring, market news, economic calendar and full-screen charts
• StockTwits - free market insights, updates, sentiment and analysis from thousands of real investors and traders

Brokers and Trading Accounts

Brokers are an essential partner in the trading business and allow you to interact with the markets. As a retail trader, you can't buy and sell directly at the exchanges, so you have to work with a broker, which acts as an intermediary. Choosing a broker requires a bit of time and research, and you may want to consider factors such as:

• Do they provide their own order execution software and is there a platform fee?
• Do they service markets that you want to trade (i.e., stocks, futures or forex)?
• Do they support simulated trading?
• How do they handle order execution?
• How efficient is their customer service?
• What are their commissions and fees, including “hidden charges?”
• What are their hold times when calling?
• What are their margin requirements?
• What type of data feed do they provide?

Once you have decided on a broker, you will be able to open and if desired, fund, a trading account.

Credio | Graphiq

Order Types

The order type you use to place a trade can have a big influence on the outcome of the trade. Trade orders are instructions that are sent to brokers to enter or exit positions. While it can be very simple to enter and exit a position – push the “buy” button to get in and press the “sell” button when it’s time to get out – trading in this manner is both inefficient and risky. If you trade just using the buy and sell buttons, you can sustain losses from slippage and from trading without a protective stop loss order.

Slippage is the difference between the price you expected and the price at which the trade is actually filled, and it can be considerable and costly in both fast-moving or thinly traded markets. Certain order types let you specify exact prices for trades, which can minimize or eliminate the risks associated with slippage.

Protective stop loss orders are exit orders that are used to limit trading losses by creating a “line in the sand” past which a trader will not risk any more money. A stop loss order automatically closes out a losing trade at a pre-determined price level. A protective stop loss order can be placed in the market as soon as a trade is entered. This can be especially important in fast-moving markets where a trader’s loss limit could be reached within seconds of getting filled on an order entry.

Because trading requires a great deal of precision, the types of orders that you use can have a profound effect on your trading strategy’s performance. In this section, we’ll look at the various types of orders you can use while trading.

Long and Short Trades

First of all, it’s important to understand the difference between long and short trades. A long trade, or long position, is entered if you expect to profit from rising prices. This is the “standard” trade direction, and losses from long trades are considered limited (although they can still be large) because price can only go as low as $0 if the trade moves in the wrong direction.

A short trade, or a short position, is entered with the expectation of profiting from a falling market. Using a margin account, you can enter a short position by borrowing a stock, futures contract or other instrument from your broker. Once price reaches the target level, you buy back the shares (or contracts), or buy to cover, to replace what you originally borrowed from your broker. Losses from short positions are considered unlimited because price could theoretically continue rising indefinitely.

Market Orders

A market order is the most basic type of trade order. It instructs the broker to buy (or sell) at the best price that is currently available. Order entry interfaces and many apps usually have “buy” and “sell” buttons to make these orders quick and easy. Typically, this type of order will be executed immediately. The primary advantage to using a market order is that you are guaranteed to get the trade filled.

If you absolutely need to get in or out of a trade, a market order is the way to go. The downside, however, is that market orders don't guarantee price and they don't allow any precision in order entry, which can lead to costly slippage. You can help limit losses from slippage if you use market orders only in markets with good liquidity.

Limit Orders

A limit order is an order to buy (or sell) at a specified price or better. A buy limit order (a limit order to buy) can only be executed at the specified limit price or lower. Conversely, a sell limit order (a limit order to sell) will be executed at the specified limit price or higher. Unlike a market order where you simply press “buy” and let the market select the price, you must specify a price when using a limit order.

While a limit orders prevents negative slippage, it does not guarantee a fill. A limit order will only be filled if price reaches the specified limit price, and a trading opportunity could be missed if price moves away from the limit price before it can be filled. Note: the market can move to the limit price and the order still may not get filled if there are not enough buyers or sellers at that particular price level.

Enter a limit order to buy at or below the current bid; enter a limit order to sell at or above the current ask price. Image created with TradeStation.

Stop Orders

A stop order to buy or sell becomes active only after a specified price level has been reached (the “stop level”). The placement of stop orders differs from that of limit orders: a buy stop order is placed above the market, and a sell stop order is placed below the market.

Once the stop level has been reached, the order is automatically converted to a market or limit order and, in this sense, a stop order acts as a trigger for the market or limit order. Consequently, stop orders are further defined as stop-market or stop-limit orders: a stop-market order sends a market order to the market once the stop level has been reached; a stop-limit order sends a limit order.

A buy stop order is placed above the market; a sell stop order is placed below the market. Image created with TradeStation.

Trailing Stop

A trailing stop is a dynamic stop order that follows price in order to lock in profits. A trailing stop incrementally rises in a long trade, following price as it climbs higher. In a short trade, a trailing stop falls as it follows price downward. You have to define the magnitude of the trailing stop, either as a percentage or a dollar amount, defining the distance between the current price and the trailing stop level. The tighter the trailing stop, the more closely it will follow price. Conversely, a wide trailing stop will give the trade more room since it will be further from price.

Stop Loss Orders

Perhaps the most common application for a stop order is to set a risk limit for a trade, or a stop loss. A stop loss order is set at the price level beyond which a trader would not be willing to risk any more money on the trade. For long positions, the initial stop loss is set below the trade entry, providing protection in the event that the market drops. For short positions, the initial stop loss is set above the trade entry in case the market rises.

Conditional Orders

Conditional orders are advanced trade orders that are automatically submitted or canceled if specified criteria are met. Conditional orders must be placed before the trade is entered and are considered the most basic form of trade automation. Two common conditional orders are the order cancels order (OCO) and the order sends order (OSO).

Examples of OCO applications. Image courtesy PowerZone Trading.

Order Duration

In addition to market, limit, stop and conditional orders, you can also specify how long an order will be in effect; that is, how long the order will remain in the market until it is canceled (assuming it's not filled). Order durations include:

• Day – automatically expires at the end of the regular trading session if it has not been executed.
• Good-Til-Canceled (GTC) – remains active until the trade is executed or you cancel the order. Brokers usually cancel GTC orders automatically if they have not been filled in 30-90 days.
• Good-Til-Date (GTD) – remains active until a specified date unless it has been filled or canceled.
• Immediate-Or-Cancel (IOC) - requires all or part of the order to be executed immediately; otherwise the order (or any unfilled parts of the order) will be canceled.
• Fill-Or-Kill (FOK) – must be filled immediately and in its entirety or it will be canceled.
• All-Or-None (AON) - Similar to an FOK, an AON order will be canceled if the order cannot be filled in its entirety by the end of the trading session.
• Minute – expires after a specified number of minutes have elapsed.

Trading Plan Development

Before starting your trading plan template, it's important to note the difference between discretionary and system traders. Traders typically fall into one of two broad categories: discretionary traders (or decision-based traders) who watch the markets and place manual trades in response to information that is available at that time, and system traders (or rules-based traders) who often use some level of trade automation to implement an objective set of trading rules.

Because it is often viewed as easier to jump into trading as a discretionary trader, that’s where most traders start, relying on a combination of knowledge and intuition to find high-probability trading opportunities. Even if a discretionary trader uses a specific trading plan, he or she still decides whether or not to actually place each trade. For example, a discretionary trader’s chart may show that all criteria have been met for a long trade, but they may skip the trade if the markets have been too choppy that trading session or they know a Fed report is coming up.

Systems traders, on the other hand, follow the trading system’s logic exactly. Because system trading is based on an absolute set of rules, this type of trading is well-suited to partial or full-trade automation. For example, a system can be coded using your trading platform’s proprietary language, and once the strategy is “turned on” the computer handles all the trading activity, including identifying trades, placing orders and managing exits.

While discretionary traders may mix some degree of intuition into their trading plans, system traders use an entirely objective trading plan that takes the guesswork out of trading and (ideally) provides consistency over time. In this section, we'll discuss how to develop a trading plan; the next section, Testing Your Trading Plan, introduces the various methods used for testing the viability of a trading plan.

Your trading plan is a written set of rules that defines how and when you will place trades. It includes the following components:

Market(s) That Will Be Traded

Traders aren't limited to stocks. You have a wide selection of instruments to choose from, including bonds, commodities, exchange traded funds (ETFs), forex (FX), futures, option and the popular e-mini futures contracts (such as the e-mini S&P 500 futures contract). Any instrument you choose for trading must trade under good liquidity and volatility so you'll have opportunities to profit.

Liquidity describes the ability to execute orders of any size quickly and efficiently without causing a significant change in price. In simple terms, liquidity refers to the ease with which shares (or contracts) can be bought and sold. Liquidity can be measured in terms of:

• Width – How tight is the bid/ask spread?
• Depth – How deep is the market (how many orders are resting beyond the best bid and best offer)?
• Immediacy – How quickly can a large market order be executed?
• Resiliency – How long does it take the market to bounce back after a large order is filled?

Markets with good liquidity tend to trade with tight bid/ask spreads and with enough market depth to fill orders quickly. Liquidity is important to traders because it helps ensure that orders will be:

• Filled
• Filled with minimal slippage
• Filled without substantially affecting price

Volatility, on the other hand, measures the amount and speed at which price moves up and down in a particular market. When a trading instrument experiences volatility, it provides opportunities for traders to profit from the change in price. Any change in price – whether rising or falling – creates an opportunity to profit. Keep in mind, it's impossible to make a profit if price stays the same.

It's important to note that a trading plan developed and tested for the e-minis, for example, will not necessarily perform well when applied to stocks. You may need a separate trading plan for each instrument or type of instrument that you trade (one trading plan, for example, may perform well on a variety of the e-minis). Many traders find it helpful to focus initially on one trading instrument and then add other instruments as their trading skills - and trading trading account - increase.

The Primary Chart Interval You'll Use to Make Trading Decisions

Chart intervals are often associated with a particular trading style. They can be based on time, volume or activity, and the one you choose ultimately comes down to personal preference and what makes the most sense to you. That said, it's common for longer-term traders to look at longer-period charts; conversely, short-term traders typically use intervals with smaller periods. For example, a swing trader may use a 60-minute chart while a scalper may prefer a 144-tick chart.

Keep in mind that price activity is the same no matter what chart you choose, and the various charting intervals simply provide different views of the markets. While you may choose to incorporate multiple charting intervals in your trading, your primary charting interval will be the one you use to define specific trade entry and exit rules.

Indicators and Settings You'll Apply to the Chart

Your trading plan must also define any indicators that will be applied to your chart(s). Technical indicators are mathematical calculations based on a trading instrument’s past and current price and/or volume activity. It should be noted that indicators alone don't provide buy and sell signals; you must interpret the signals to find trade entry and exit points that conform to your trading style. Various types of indicators can be used, including those that interpret trend, momentum, volatility and volume.

In addition to specifying technical indicators, your trading plan should also define the settings that will be used. If you plan on using a moving average, for example, your trading plan should specify a “20-day simple moving average” or a “50-day exponential moving average.”

Rules for Position Sizing

Position sizing refers to the dollar value of your trade, and can also be used to define the number of shares or contracts that you'll trade. It's very common, for example, for new traders to start with one e-mini contract. After time, and if the system proves successful, you might trade more than one contract at a time, thereby increasing your potential profits, but also maximizing potential losses. Some trading plans may call for additional contracts to be added only if a certain profit is achieved. Regardless of your position sizing strategy, the rules should be clearly stated in your trading plan.

Entry Rules

Many traders are either conservative or aggressive by nature, and this often becomes evident in their trade entry rules. Conservative traders may wait for too much confirmation before entering a trade, thereby missing out on valid trading opportunities. Overly aggressive traders, on the other hand, may be too quick to get in the market without much confirmation at all. Trade entry rules can be used by traders who are conservative, aggressive or somewhere in between to provide a consistent and decisive means of getting into the market.

Trade Filters and Triggers

Trade filters and triggers work together to create trade entry rules. Trade filters identify the setup conditions that must be met in order for a trade entry to occur. They can be thought of as the “safety” for the trade trigger; once conditions for the trade filter have been met, the safety is off and the trigger becomes active. A trade trigger is the line in the sand that defines when a trade will be entered. Trade triggers can be based on a number of conditions, from indicator values to the crossing of a price threshold. Here’s an example:

Trade filters:

• Time is between 9:30 AM and 3:00 PM EST
• A price bar on a 5-minute chart has closed above the 20-day simple moving average
• The 20-day simple moving average is above the 50-day simple moving average

Once these conditions have been met, we can look for the trade trigger:

• Enter a long position with a stop limit order set for one tick above the previous bar’s high

Note how the trigger specifies the order type that will be used to execute the trade. Because the order type determines how the trade is executed (and therefore filled), it is important to understand the proper use of each order type; the order type should be part of your trading plan. Review the Order Types section of this tutorial, or see Introduction to Order Types for more in-depth coverage.

Exit Rules

It's said that you can enter a trade at any price level and make a profit by exiting at the right time. While this seems overly simplistic, it's pretty accurate. Trade exits are a critical aspect of a trading plan since they ultimately define the success of a trade. As such, your exit rules require the same amount of research and testing as your entry rules. Exit rules define a variety of trade outcomes and can include:

• Profit targets
• Stop loss levels
• Trailing stop levels
• Stop and reverse strategies
• Time exits (such as EOD – end of day)

As with trade entry rules, the type of exit orders that you use should be clearly stated in your trading plan. For example:

• Profit target: Exit with a limit order set 20 ticks above the entry fill price
• Stop loss: Exit with a stop order set 10 ticks below the entry fill price​

Note: If you set this up as an bracket order (OCO order), once one order gets filled (either the profit target or the stop loss), the other order will automatically be canceled. If you place the orders manually, remember to cancel the remaining one to avoid an unwanted position.

Getting Ready for Testing

When developing your trading plan, remember to include all of the important elements:

• Trading instrument(s)
• Time frames
• Position sizing
• Entry conditions (including filters and triggers)
• Exit rules (including profit target, stop loss and money management)

Keep in mind, writing down your trading plan is only the first step in a lengthy process. At this stage, it's still just an idea - or a template for the final product. You'll have to thoroughly test your plan before putting it in the market. In the next section, we'll show you how.

Source : https://www.investopedia.com/university/how-start-trading/

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