Creating a Trading Plan - Perpetual Protocol 🥨

In this article, we’ll discuss what a trading plan is and why it’s important to have one.

What is a Trading Plan?

A trading plan is a compilation of rules that provides a trader with discipline and structure, helping you to protect your capital and prevent you from making impulsive decisions. Beginners and more experienced market participants should create a framework of how they want to approach the markets and progress as a trader.

Spending enough time making a plan pays off over the long run, as in the heat of the moment, you can refer back to it and see what you initially planned with a cool head. In this way, a trading plan is like a recipe that will tell you what you need to be seeing from the markets to enter a position.

A very basic trading plan should (at the very least) answer the following questions:

How do you get into a position?
How much risk are you taking on per trade?
How do you get out of a position in events of losses/profits?

A solid plan incorporates factors other than your trading strategy, such as the goals you want to achieve, what markets you’ll trade, risk management, backtesting, and how you plan on tracking and improving your performance over time.

While this is not an exhaustive list of elements you can include in your trading plan, it should give you an idea of where to start. In the following sections, we’ll discuss the various elements of a trading plan you should consider. But at the end of the day, your trading plan is unique to you, your personality and trading style, so it’s entirely up to you how to formulate it. In addition to this framework, you may also want to create an execution checklist to refer to when trading and check off your entry conditions.

Elements of a Trading Plan

In the following sections, we’ll look at the individual components of a good trading plan, which includes:

Goal setting, to give you direction, motivation, and something to work towards
Deciding which markets to trade, and when
Trading strategies, which outline the things you’re looking for to enter a position
Risk management, informing how much risk per trade you’ll take and how you’ll exit a position in two cases: the ideal scenario where a trade is profitable and the not so ideal scenario of a position that’s at a loss.
Backtesting, to help refine and improve your strategies, execution, and risk management.
Further education: a big part of trading is learning new techniques. Even experienced traders have more to learn, so pursuing further education about the markets and trading in general is an important part of a plan.
Trade journaling: as with backtesting, journaling your trades and thoughts as you go and reflecting on them from time to time will help to improve your performance.

Setting Goals

Trading goals help you stay motivated to implement your trading plan and outline where it is you want to be in the next year, two years or three years’ time. As well as setting certain outcomes as goals, you should also think about the process towards achieving these goals, and focus on their quality. These goals can be monetary or educational, or both. For example, one goal for your plan could be to average a certain amount of profit every day, such as “I want to make a profit of $100 per day.”

Now $100 may not sound like a lot compared to the traders on CT who boast about thousands, hundreds of thousands or millions in profits, but everyone starts somewhere and small wins compound over time. Setting a target of $100 per day works out to be $36,500 per year! Or even if you can average $50 per day, that’s still a respectable side hustle, amounting to $18,250 per year.

Keep in mind though that beginners should focus on retaining their capital rather than growing it, as you’ll need to build experience over time to become consistently profitable, so an alternative could be to set a goal such as, “I want to, at the very least, retain 100% of my capital while I gain more experience in the markets.”

Mastery of a strategy and honing your skills are important for long-term success. There are many ways to trade cryptocurrencies: some people do it using technicals, some people use quantitative methods and trading bots, while others can simply trade off sentiment. Choose a style that fits your personality and lifestyle, then set a goal to learn as much as possible about these techniques so that using these strategies becomes like second nature to you, and you don’t even have to think about it.

What Markets to Trade? And When?

After deciding your goals, you’ll then want to make sure you’re trading the right markets at the right times to achieve these goals.

So the next step is to come up with a way to decide what markets you’re going to trade and when. To decide on the markets you’re going to focus on, you can screen assets in various ways.

Price-based scanning: let’s say you have $10,000 in capital. The dollar cost per unit of BTC may be out of your budget, since you’d only be able to get exposure to 2 or 3 BTC using sensible levels of leverage. However, the dollar cost per unit of ETH is much lower, so you can take on sensible levels of leverage and get exposure to 20 to 30 ETH instead.
Volatility-based scanning: you’d want to avoid trading assets that are too volatile, unless you have a lot of experience in the markets already. For example, the chart below shows the 30-day volatility for various assets listed on Perp v2. Beginners would want to stick with the least volatile assets, which are BTC and ETH, and avoid the most volatile assets. With less volatile assets, you’re less likely to experience unpleasant shocks when a move takes place. By working with lower volatility assets, you can increase confidence in your trading plan and gain experience without unnecessarily losing money on volatile assets.

Source: CoinMetrics

Correlation-based scanning: find assets that are less correlated with BTC and ETH to identify opportunities. It’s also worth deciding under what conditions you’ll trade two assets that are highly correlated with each other and will likely move in the same direction. If the trade idea turns out to be wrong, then you’ll face losses on both trades.

After deciding what markets you’ll trade, another important factor is when you’re going to trade these markets.

When you’re going to be trading can be informed by market characteristics such as important events related to cryptocurrency, seasonality trends, and heatmaps showing time-of-the-day effects for price and volume so you only trade when there’s greater volatility or more activity happening. Do some research for this part of the plan and take note of when the price fluctuates more, how long trends last, and when market participants are more active.

Traditional markets are driven by trading sessions (Asian, European and American) and this also can have a bearing on cryptocurrency markets. Depending on your location and lifestyle, dedicate your trading activities to a particular session. For example, if you're an early bird based in Europe or a night owl based in Asia, then you might want to strictly trade the European sessions (between the hours of 07:00 UTC to 15:00 UTC).

Source: Investopedia

As well as market-based factors, your personality style and mood can affect your trading, so you’ll want to decide when is the best time for you to trade based on these. Are you dedicating yourself full time to trading or just part time. If part time, when are you going to be most active?

As well as knowing when to trade, you can also set some rules for when you will not touch the markets.

These considerations can be based on:

The market itself: avoid trading when volumes are low or the markets are ranging, and
Your own individual needs: for example, if you’re not feeling great, you’ve not gotten enough sleep or are not emotionally or psychologically ready to take a trade.

If these requirements are not met, then it’s probably best to take a break from the markets. Opportunities will always present themselves, you just have to be patient and figure out when to trade, and when it’s best to take a break.

Trading Strategy

The trading strategy part of the plan describes how you’ll enter trades, manage them and on what conditions you’ll exit a trade. These need to be formulated in advance so that you don’t have to do it after opening a trade to give you more time to monitor the trade. By setting predefined levels before getting into a trade, you remove emotions such as fear or greed from the process.

A big part of your trading strategy may rely on technical analysis, which is the use of charts for timing and entries. It doesn’t have to be advanced, and can include a few indicators such as support and resistance, volume, trends, and so on. Having a system in place ensures that no decision is made, and no position is entered if there’s no trade there according to your plan. Keep it simple.

Technical analysis can also help prevent you from jumping into a trend too early. Remember, getting in at the absolute high or low is worse than getting in at the right time when buying or selling pressure comes in. Tools, such as the volume delta, cumulative volume delta and on balance volume, can identify buying or selling pressure.

https://perpprotocol.mirror.xyz/9NbHFOYibV6-efcT1cVWwLMoBFL67Jh4VmpOPydOSfE

As well as technicals, fundamentals are an important consideration for your strategies. One example of a fundamental is the news flow around a particular crypto-asset. If there’s a sustained period of negative news flow, then it is likely the asset will not perform well, whereas a string of positive news flow can help support an asset’s price.

https://perpprotocol.mirror.xyz/Dyif1_fZdM0TA9uAjdxZ8JhvN4_q2qlGCwbvxT_GdSE

Knowing when to pull the trigger is important and is defined by the elements we’ve already discussed so far, but as well as knowing how to analyze the markets you’ve chosen and decide where you’re getting in, another important thing is where you’re going to get out of a trade. This brings us to the next element of a trading plan: risk management.

Risk Management

Risk management rules can be even more important than your strategy, and this element of a trading plan should, at the very least, answer the three following questions:

How much capital are you working with?
How much are you willing to risk per trade?
What are the triggers for cutting losses or banking profits?

Let’s say you’re working with $5,000 in capital. Your plan should specify how you’re going to allocate this capital. Are you going to take a maximum of 10 positions with $500 as margin for each, or smaller positions but greater in number, say 20 positions with $250 as margin for each?

Position sizing is basically setting how much risk you’re going to take and will depend on your trading style and tolerance for risk. As a rule of thumb, this should be somewhere between 1% to 5% of your trading capital, so if you lose that amount at any point in the day, week or month, you get out of the market and live to fight another day.

https://blog.perp.fi/how-to-determine-position-size-and-leverage-56262b7b8c7c

Profits are only banked when you get out of a position and as the saying goes, no one ever went broke taking profits. So it’s important to set realistic goals for exiting at a profit. One of the main reasons to build a trading plan is to replace any emotional decision making with analytical decision making.

Without a plan, you may easily fall victim to greed and because of this, it prevents you from taking profit at an appropriate time. As the price moves in your favor, you can mistakenly think the move will continue and as your P&L increases, it can be tempting to let the trade ride.

On the flip side, if you’re in a losing position, an internal conversation in your head might go something like, “it’ll come back, I’ll just hold on a few more days”, but it could continue to eat into your capital. So the plan should specify when you should cut your losses to help you avoid falling into the trap of thinking, “it’ll come back”.

For example, where to get out in a profit can be determined by price ranges or a particular percentage. You might want to close a winning trade when you’ve made at least 20% return on investment.

By setting rules beforehand, you can combat greed and manage expectations that the asset can make more profit for you than it can deliver. Otherwise, you might be tempted to think that it can deliver more gains than the trading range can offer and end up missing out on taking profit. Now if the market price slides back to your entry, then you’re stuck or trapped in a position but could’ve taken profits.

As boxing legend Mike Tyson has said, “Everyone has a plan, until they get punched in the face”, and this applies to trading too. Imagine the market will punch you in the face every time you open a trade and plan accordingly. So the important questions are:

Where to get out at a loss? And what happens if our analysis is wrong?

This is where stop losses come into play, which is a level that you set before you get into the trade, and if it hits that level, you’ll get out of the trade to prevent further losses and protect your capital. So as soon as the position is filled, set a stop loss according to your plan.

https://perpprotocol.mirror.xyz/_5L7XdEIBWfLQU97qVl0oT8CWYyacLUlNS3vLPh2XP0

Backtesting

This involves what you want to test, and how you’re going to do it. You should regularly backtest and make improvements to your strategy. Then ask yourself before you start trading with significant capital: Do you have confidence it will work in a live environment? Can you follow signals without hesitation?

Backtesting helps to inform other elements of your plan. For example, only trade certain times of the day if backtesting has shown that your strategy is more effective in these periods. Or maybe your stops are too narrow or your strategy is more effective for a certain cryptocurrency.

There are various ways to backtest your strategy, where you can use spreadsheets, websites like TradingView, or by using programming languages such as Python and R.

Here are some useful guides to help you start backtesting trading strategies:

Further Education

Set a roadmap for your learning, including aspects of trading you want to learn more about, books about trading you want to read, or simply observing other traders to see what you can learn from them. You’ll want to scour the internet for different resources (such as articles, podcasts, YouTube channels) and find the knowledge you can apply to your strategies to hone them.

The aim of the game is to improve over time, which comes with more live experience in the markets as well as more knowledge. Trading is a multi-disciplinary exercise where there’s always more to learn, whether that be in the field of technical analysis, how to code to run backtests or set up an automated trading bot, mastering your own psychology or gaining expertise in different risk management techniques.

Trading Journal

The final part of your plan should include journaling, which will help you organize your thoughts, identify problems with your performance and assess how well you have implemented the rules of your strategy. In the same way that keeping a diary can benefit us with more mindfulness, improved memory and self-discipline, the same thing applies to a trading journal.

A trade journal should record your trades over time, with stats such as position size, entry price, time of entry, average time your position is open, and the P&L of each trade. As well as information about each trade, journaling should also include your thoughts and feelings so you can reflect on your trading activities and see if there are any bad habits that affect your trading.

The whole point of this element of the trading plan is to identify areas for improvement, so that you can avoid mistakes made in the past and augment other elements of the trading plan. There’s no point forgetting bad trades and writing what you did, where you think it went wrong, your feelings and thoughts will help to reflect on why it went wrong and what you can do next time to avoid making the same mistake. The learnings from journaling should feed back into the trading plan, so it’s best to think of your plan as a continuously evolving document.

Review the trades you have taken frequently over time to track your progress towards meeting the goals you’ve set for yourself. Depending on what you prefer, use a notebook to write down your journal entries or use the trading journal templates listed below:

Summary

It’s better to have a plan than to trade the market blindly and become a victim of your own emotions. As the foundation of your trading endeavors, a plan sets the stage for becoming a successful trader.

The ideas presented in this article should give you a good starting point for creating your own plan, but remember that you can include anything else that you think will help, after all your plan should be unique to you, your goals, trading style and lifestyle.

Remember, once a trading plan has been created, it can be re-evaluated and tweaked over time as you gain more insights from your performance as well as changing market conditions. As with anything in life, the more work you put into making and refining a plan, the more disciplined you’ll become and the more you’ll get out of it in the long run.