Designing a Written Trading Plan
A written trading plan is a document that specifies exactly when you will enter trades, how much capital you will risk, and when you will exit. The plan exists to remove discretionary decision-making during market hours, when emotional responses can override rational analysis.
Studies of retail trading accounts consistently show that undisciplined traders underperform. FINRA notes that day traders in particular face steep odds, with studies suggesting 70-80% lose money over time. A written plan does not guarantee profits, but it establishes consistency and allows you to evaluate whether your strategy works.
Core Components of a Trading Plan
Every trading plan needs five elements: market selection, entry criteria, position sizing rules, exit criteria, and record-keeping requirements.
Market Selection
Define which securities you will trade. A plan might specify: "I trade S&P 500 stocks with average daily volume above 2 million shares and price above $20." This eliminates low-liquidity names where bid-ask spreads can exceed 0.5% and slippage becomes unpredictable.
Entry Criteria
Entry rules must be specific enough that two people reading them would reach the same conclusion. Vague criteria like "buy when the stock looks strong" fail this test.
A valid entry rule example: "Enter long when the 10-day moving average crosses above the 50-day moving average, RSI is between 40 and 70, and the stock is within 3% of a 52-week high."
Position Sizing Rules
Position sizing determines how much capital you allocate to each trade. The most common approach is fixed-percentage risk, where you risk a set percentage of your account on any single trade.
If you have a $50,000 account and risk 1% per trade, your maximum loss per position is $500. If your stop-loss is $2 below your entry price, you can purchase 250 shares ($500 ÷ $2 = 250).
Exit Criteria
Exit rules cover three scenarios: stop-loss exits, profit targets, and time-based exits.
Stop-loss example: "Exit if the position moves 2% against entry price."
Profit target example: "Exit 50% of position at 1.5:1 reward-to-risk ratio, remainder at 3:1."
Time-based example: "Exit any position not profitable within 5 trading days."
Record-Keeping
Document every trade with entry price, exit price, position size, and the specific rule that triggered entry. Without records, you cannot evaluate whether your strategy produces positive expectancy over time.
Worked Example: Building a Swing Trading Plan
Sarah has a $40,000 trading account and wants to swing trade large-cap stocks, holding positions for 2-10 days.
Account Parameters
- Starting capital: $40,000
- Maximum risk per trade: 1% ($400)
- Maximum positions: 5 concurrent
- Maximum portfolio risk: 5% ($2,000)
Entry Rules Sarah's plan specifies: "Enter long when price pulls back to the 20-day moving average after making a new 20-day high, volume on pullback is below average, and the S&P 500 is above its 50-day moving average."
Position Sizing Calculation Sarah identifies a trade in XYZ Corp, trading at $85. Her stop-loss is at $82, which is $3 below entry (the low of the pullback candle).
Maximum risk: $400 Stop distance: $3 Position size: $400 ÷ $3 = 133 shares Capital required: 133 × $85 = $11,305
This represents 28% of her account in one position. Her plan limits any single position to 30% of capital, so the trade qualifies.
Exit Rules
- Stop-loss: $82 (3.5% below entry)
- First target: $89 (sell 50% at 1.33:1 reward-to-risk)
- Second target: $94 (sell remaining 50% at 3:1 reward-to-risk)
- Time stop: Exit at market close on day 10 if neither target hit
Trade Outcome XYZ reaches $89 on day 4. Sarah sells 66 shares at $89, locking in $264 profit (66 × $4). She moves her stop-loss to $85 (breakeven) on the remaining 67 shares.
On day 7, XYZ reaches $94. Sarah exits the remaining 67 shares at $94, adding $603 profit (67 × $9).
Total profit: $867 Risk taken: $400 Reward-to-risk achieved: 2.17:1
Common Trading Plan Failures
Rules Too Vague
"Buy quality stocks at good prices" contains no actionable criteria. Every element must be measurable.
Position Sizing Ignored
Traders who size positions based on conviction rather than defined risk parameters often experience outsized losses. A single 10% loss on a concentrated position can erase months of smaller gains.
No Maximum Drawdown Rule
Plans should include a circuit breaker. Example: "Stop trading for 5 business days if account drawdown exceeds 6% in any calendar month." This prevents revenge trading during losing streaks.
Failure to Review
A plan requires periodic evaluation. If your strategy produces negative expectancy over 50+ trades with proper execution, the strategy needs modification. Review trades monthly, calculating win rate, average win, average loss, and expectancy.
Expectancy formula: (Win Rate × Average Win) - (Loss Rate × Average Loss)
If your win rate is 45%, average win is $600, and average loss is $350, expectancy = (0.45 × $600) - (0.55 × $350) = $270 - $192.50 = $77.50 per trade.
Regulatory Considerations
FINRA Rule 4210 governs margin requirements for positions held overnight. If you trade on margin, your plan must account for the 25% maintenance margin minimum, though most brokers require 30-40%.
Pattern day trader rules apply if you execute 4+ day trades within 5 business days in a margin account. This triggers a $25,000 minimum equity requirement. Your plan should specify whether you will operate under PDT restrictions or maintain the minimum balance.
Next Steps
- Write entry criteria specific enough that you could give them to another person and they would identify the same trade setups
- Calculate position sizes for your next three trade ideas using the fixed-percentage risk formula before entering any position
- Create a spreadsheet to log every trade with entry price, exit price, position size, and the rule that triggered entry
- Set a maximum daily or weekly loss limit that triggers a mandatory pause in trading activity
- Schedule a monthly review to calculate win rate, average win/loss, and expectancy across all trades