Watching business news and reading stock pages can give the impression that investing is too complex for beginners. The unfamiliar terminology and rows of numbers are incomprehensible when you don’t understand the context. That’s unfortunate because investing in stocks is often the most effective way to build wealth over time.
The good news is that a variety of online brokerage services have made it their mission to “democratize investing.” In other words, they want to make the stock market accessible to everyone – not just the elite and ultra-rich.
Some beginners hear about a promising stock and jump right in with the purchase of as many shares as they can afford. Occasionally, they get lucky, but it is more common to experience losses without a carefully developed trading plan. Here’s how to build a trading plan for beginners so that you can boost your confidence with some early wins.
What Is A Trading Plan?
At the most basic level, a trading plan outlines your investing strategy. It covers how you will structure your portfolio and includes the types of stocks that interest you, how you will minimize your risk, and how you will determine when it is time to buy or sell a particular security.
Before you begin this process, there are some important questions to consider. How you answer will determine which trading strategy and what sort of trading plan is most compatible with your personal investing style and your financial goals.
Points to cover as you prepare to create a trading plan include:
What is your motivation for exploring the stock market?
How much money do you have to invest?
How much can you afford to lose?
Realistically, how comfortable are you with putting your capital at risk?
How much time will you spend managing your portfolio?
What are your financial goals?
Do you have the discipline to navigate through market ups and downs without selling in panic or buying the meme stock of the day?
Do you have the patience to let your portfolio grow long-term?
As you examine various trading strategies, the answers to these questions will guide you toward the method that best meets your needs.
Which Trading Strategy Is Best For Beginners?
There is a seemingly endless collection of get-rich-quick schemes online, and many of them target beginning investors. They generally promise exceptional results if you purchase a costly (often non-refundable) membership that gives you access to the facilitator’s special insights and winning stock tips.
Take a hard pass on any education program or investing club you have to pay for. The best trading strategy for beginners is available at no charge from the world’s most successful investors. People like Warren Buffett and Brian Feroldi have been involved in the stock market for decades. They are familiar with how the market behaves through economic cycles and which investing methods work long-term.
Buffett. Lynch. Munger. Fischer.
All of these legendary investors use checklists.
I spent hours researching their criteria.
Here’s the ultimate list of questions for creating an investing checklist (all yours for free):
— Brian Feroldi (🧠,📈) (@BrianFeroldi) November 6, 2022
While Buffett and Feroldi’s investment strategies aren’t identical, they do share common principles. The most important is to buy high–quality companies and hold onto them regardless of short-term market conditions.
Other key principles to guide your trading plan include:
Don’t invest more than you can afford to lose – and never borrow money to fund your trades. One of the most-often repeated Warren Buffett quotes is “If you’re smart, you don’t need leverage. If you’re not smart, you shouldn’t use it.”
Maximizing compounded returns is the most powerful method of growing your wealth. Essentially, you get interest on your interest and accrue returns on your returns. That means your primary goal is to create a portfolio that will hold up over time – not one that may (or may not) deliver short-term results.
Individual stocks – and the market as a whole – are unpredictable, and there are no sure things. Even if you are absolutely certain a stock will go up, make sure your trading plan includes risk mitigation measures, just in case.
Many investors who are just starting out watch the stock’s performance rather than the behavior and performance of the underlying business. That’s a mistake. Short-term stock prices rarely reflect a company’s long-term potential, so make your decisions with business fundamentals in mind.
Don’t base your trades on emotion. Stick with your trading plan. If you start to question the wisdom of this crucial principle, remember Warren Buffett’s most famous quote: “Be fearful when others are greedy, and greedy when others are fearful.” He knows what he’s talking about. He has been trading stocks for 80+ years, and Warren Buffett’s net worth is nearly $100 billion.
In the stock market, as in life, focus on what you can control and forget the rest. Will another pandemic tank the economy? Maybe. Will the Fed raise interest rates again? Perhaps. There isn’t anything you can do about that. Instead, create a portfolio that can withstand market ups and downs by choosing quality stocks from a diverse mix of companies.
Many new investors are embarrassed by their errors, so they stay in poorly chosen positions much longer than they should. Don’t fall victim to that mentality. Even the most experienced traders make mistakes. If you change your mind about a trade, reverse it and move on.
With these principles in mind, you are ready to develop a trading plan that is aligned with your specific circumstances and unique financial goals. When it comes to the nuts and bolts of a trading plan, what should be included?
What Should Be Included In A Trading Plan?
Every investor’s trading plan is a little different, but the most successful investors in the world have tested certain core tactics and proven their effectiveness. This is what they found:
The ideal portfolio contains between 30 and 50 stocks that are carefully diversified to manage risk. Diversification can mean different things to different investors. Common examples include varying sectors, industries, market caps, and geographies.
Plan to hold stocks for seven or more years – the length of a typical economic cycle. Barring any unusual events that put the company’s future in doubt, holding for this amount of time allows you to realize the full potential of a stock.
Most people don’t have millions to invest when they first begin trading. That’s okay. Start with whatever you have, then build your portfolio over time. The most effective method of doing this is to make regular contributions regardless of market conditions, which ensures your average per-share cost is evenly distributed through highs and lows in price.
No matter how volatile the market becomes, don’t allow yourself to be frightened into deviating from your trading plan. Volatility passes, and historically, the market has always recovered and achieved new heights. If you sell in a panic, you won’t enjoy the benefits of that recovery.
Ensure your trading plan sets specific thresholds for buying and selling. Ride winners until they hit the price you set to collect your profits, and cut losers when they decline past the point where you can no longer tolerate losses. Remember that you set those buy and sell thresholds when you were in an objective frame of mind, so don’t give into in-the-moment temptation to hang on a little longer.
Short-term gains are elusive. The real returns accrue long-term. However, you can only benefit from long-term returns if you keep your portfolio in good order along the way. Focus on longevity rather than investing with gains in mind. It’s a tried-and-true way for beginners to build wealth.
Once your trading plan is complete and you are ready to go, keep two final tips in mind. First, most people think they will remember the details of their research and trading decisions, but that is almost never true. Keep complete records of the data you collect, the trades you make, and why. These often become critically important at a future decision point.
Second, analyze your results. Without this information, it’s impossible to know what techniques are working to increase your wealth. A cursory glance can give you the impression that specific trades are or will be successful, but a deeper dive into the data may show that, in fact, there are losses on the horizon.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.