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What is a trading plan?

Key takeaways

  • Investing and trading plans are your guides to buying and selling investments.
  • Trading plans may help you make informed decisions when markets fluctuate.
  • You shouldn't take changing your investing and trading plans lightly. If you do switch things up, make sure your new plans fit your goals.

A trading plan creates a path that can help you make decisions through the market's highs and lows. Here's what you need to know to craft yours.

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What is a trading plan?

A trading plan is your strategy for tactically buying and selling assets like stocks, bonds, exchange-traded funds (ETFs), and other investments. It can be a lifeline when markets are down and your investments are in the red.

But it's also an important guide when prices are up as it keeps you from cashing out at times that holding onto your investments may be better for your longer-term strategy. In short, trading plans help remove some of the emotion and guesswork from your trading decision-making. This may keep you more on track to accomplish your financial goals.

Because they set the ground rules for buying and selling investments, you may have trading plans to address short-term and long-term goals. This may seem unintuitive for those familiar with the terms investing and trading, but in this case, "trading" refers simply to the act of buying and selling investments, rather than the amount of time you plan to hold them. That means short-term traders who buy and sell investments for quicker potential profits and long-term investors who plan to hold assets until retirement—as well as everyone in between—may have trading plans.

What's in a trading plan?

Trading plans can help direct your buying and selling of securities and help provide you with peace of mind.

Trading objectives Trading objectives give your money a mission statement. Why are you buying or selling securities? To diversify your entire portfolio? Other reasons? Figuring out your "why" is a critical first step. Depending on your goals, seeking professional financial guidance, like coaching sessions or a financial advisor, may be appropriate.

Risk tolerance Just as important to understanding why you are buying or selling assets is knowing if you are comfortable with these trades. Your risk tolerance is an assessment of how comfortable you are with the idea of losing money and your financial ability to accept losses.

Though the stock market has historically gone up over the years and decades, it can and has experienced prolonged periods of declines. Of course, past performance is no guarantee of future results, but history shows that dips are normal. If you choose to actively trade the market, you have to understand that you may lose some (or even all) of what you trade with. Knowing your willingness and ability to take on risk will help guide how you craft your trading plan. And keep in mind that your risk tolerance may not be the same for all of your financial goals or accounts.

Time horizon For how long are you planning to trade? Generally, the longer your timeline, the more time your money may have to grow and potentially recover from tumbles in the market. For instance, you may be willing to risk less money if you are seeking to turn a profit in a day, instead of a month or year.

Tax situation The most important thing to keep in mind when selling securities is that there are higher tax rates when securities are sold that have been held for one year or less in a taxable account. In addition to capital gains taxes, keep in mind that interest and dividends can also be taxed if those investments are held in a taxable account. It's a smart idea to plan and set money aside for your taxes, so you're not stuck in a sticky situation when it comes time to foot the bill for the IRS. Normal taxable brokerage accounts may let you claim losses on your tax returns through a process called tax-loss harvesting, which can decrease what you owe each year.

Depending on your financial goals and time horizon, you may be able to benefit from tax-advantaged accounts that help you reach your goals more efficiently. Retirement savings plans, like 401(k)s, 403(b)s, or IRAs, offer specific tax advantages that may lead to higher after-tax returns. Keep in mind though, we do not recommend actively trading retirement assets. And never trade more than you can afford to lose.

It may help to meet with a tax pro to understand the tax implications of your trading plan and whether there are certain accounts or strategies that may work best for you. 

Asset type preferences It can help to research your asset options to see what best aligns with your goals, risk tolerance, time horizon, tax considerations, and overall preferences. Assets can range from relatively conservative (like government bonds) to more risky (like individual company stocks). You may want to learn about mutual funds and exchange-traded funds (ETFs) as investment options for long-term financial goals, which may help lower your risk by widening your exposure across many different securities at once. You'll also want to determine what percentage of your investable funds will be devoted to each asset type.

Entry and exit plans Once you've finalized what investments you want to buy, you have to decide when to buy and sell. In trading terms, these are known as your entry and exit strategies.

It's important to determine this process before you start investing so you aren't making spur-of-the-moment choices based on temporary market peaks or valleys later. You don't want to find yourself, for instance, seeing prices climb high and jumping to invest so much money that your risk level exceeds the amount you intended to take on. Conversely, you want to lay the ground rules for when you'll cut your losses vs. when you'll hold tight if the market stumbles and falls. For entries and exits, you may aim to target a certain price, a percentage gain or loss, or another indicator related to the particular asset.

To help you manage your entries and exits, you'll likely want to take advantage of features like price alerts or one of many different order types that can help you achieve a purchase price you're comfortable with while potentially reducing your maximum loss.

Revising your trading plan

You may wish to change your trading plan over time. Market conditions, your financial situation, and your financial goals change, and you may want to amend your trading plan to reflect that.

Keep 2 things in mind: You shouldn't alter a trading plan as a knee-jerk reaction to temporary market events, like when stock prices take a dive. (That's a big reason why you came up with a trading plan in the first place.) And even if you decide to alter your original plan, make sure you devise a replacement to guide your trading.

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This information is intended to be educational and is not tailored to the investment needs of any specific investor.

Diversification does not ensure a profit or guarantee against loss.

Past performance is no guarantee of future results.

Investing involves risk, including risk of loss.

Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risks, including the loss of principal.

Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.

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