Like in any other business, planning is the golden key to become successful in Forex trading. A trading plan serves a detailed guideline on how to conduct your trading activities. Failing to create a plan or ignoring it might lead to irrational emotional behaviour. Just as we learned, and emotional decision-making is the most dangerous bane of Forex traders. -o-
“A peak performance trader is totally committed to being the best and doing whatever it takes to be the best. He feels totally responsible for whatever happens and thus can learn from mistakes. These people typically have a working business plan for trading because they treat trading as a business.” Van K. Tharp
Our Forex trading plan outlines the parameters and the limits of our trading process including:
- Trading Goals
- Assets to Trade
- Risk management strategies
- Trading strategies
We should create a plan in writing, and continuously refer to it as we trade. While we should stick to it as if our life depends on it, the plan can be subject to adaptations. Change is necessary as our awareness about markets and ourselves as a Forex trader increases. Here is a step-by-step guide on how to create a Forex trading plan.
Personal Facts, Finance & Availability
We must thoroughly understand why we want to trade before we start thinking about the rest. Write down your:
- Trading Motivation
- Why are you trading?
- What are you trying to achieve in the bigger picture?
- Trading Goals
- How much you want to earn?
- What is the average return percentage you want per week, month, and year?
- Goals should be SMART: specific, measurable, attainable, relevant, and time-bound.
- Financial Availability
- Do you have the financial means to trade?
- How much are you willing to risk in total?
- Trade only with funds you can afford to lose.
- Time Commitment
- How much time are you willing to dedicate to trading?
- Are you going to invest time to monitor your portfolio and the markets?
- Are you going to invest time to increase your knowledge and experience?
- Are you willing to commit?
- Strengths & Weaknesses
- What are your strengths and weaknesses about trading in the financial markets?
- Do you have strong knowledge about a specific asset or market?
- How much are you interested?
- How often do you act out of emotions?
- Do you think you might get greedy?
Entering the Markets
Once we understand ourselves, we can start thinking about what kind of a trader we want to be. Our goals, availabilities and commitments will determine our trading style and assets.
Choosing a Trading Style
Long-term, medium-term, and short-term trading styles could be utilised. However, trying to apply all of them is not beneficial. Forex traders usually prefer short-term scalping or day trading styles. Short-term trading styles involve small, same-day positions to accumulate smaller profits. Medium-term swing trading style is also common. Swing traders hold positions for several days to capitalise on the changes in the market trends.
Markets and Trading Hours
Each market has different characteristics in terms of volatility, liquidity and risk factors. Furthermore, their trading hours depend on the country and the exchanges they are related to. We should choose the markets that fit to our trading style and time zones we can attend to.
After we choose the markets, we should focus on a limited number of assets. The price characteristics of these assets should be fitting to our trading style. For example, scalping involves capitalising on the prices changes in seconds or minutes. So, if we are going to use scalping, we need assets which fluctuate in these timeframes.
Practising on a Demo
Entering the markets with a real trading account is tempting. However, we need to gather knowledge about our focal points before we trade them. Before we start for real, we should practice trading and risk management with demo accounts. We should continue using demo even when we start trading for real. It helps us to maintain our momentum, to gain trading discipline, and try new strategies. AvaTrade is a recommended broker for beginner traders, which offers both demo and live trading accounts.
General Trading & Risk Management Strategy
Every trader has a different trading plan depending on their means, needs, goals, and interests. Before starting to trade our markets and assets, we should set money and risk management rules.
Portfolio diversification is an important risk management technique. It can protect us against high risk exposure from a single risk factor. Thus, we should assign a specific percentage of our capital to each market and stick with it. If we have $100,000 capital and 3 markets, we can assign our capital as 40-40-20 or 35-35-30. The distribution of the capital would depend on our trading frequency in each of them. If we assigned 40% to a specific market, our capital to trade that market is $40,000. Accordingly, position sizing of the assets in that market should be based on $40,000 capital.
As we learned earlier in the risk management section, position sizing refers to our margin limits. We should determine:
- The position size limit in terms of the maximum margin amount per position
- Margin usage limit in terms of the maximum used margin across all positions
Risk/Return Ratio (RRR)
Risk/Return Ratio refers to the proportion between our profit target and risk tolerance. We should determine a global RRR to apply across the entire portfolio. RRR can be market-specific and asset-specific, too. However, expanding the RRR specifications would significantly complicate the trading process. Therefore, it’s preferable to keep RRR adaptations to minimum.
Specialising the Portfolio
So far, we wrote who we are as a trader, what we trade and how do we manage our money. In this step, we expand our trading plan with specialised rules, analytics and strategies per asset.
Fundamental and Technical Analysis
Each market and each asset is influenced by different factors and market events. Thus, they all require following different fundamental events, timeframes, and indicators. Specifying the assets in our portfolio limits the scope of the analysis and improves its quality.
Position Sizing and Pip Value
A global position sizing and pip value rule would significantly reduce the effort required. Still, each asset varies individually and may require different pip values to achieve profit targets.
Entry and Exit Points
Having a personal description of a trading opportunity helps eliminating the market noise. We should specify the market conditions which would serve us as entry and exit points. The conditions to enter and exit positions are set with fundamental and technical analysis. For entry points, we should specify the market events and price patterns which must be present. For exit points, we should use technical analysis to specify the price targets for TP and SL orders. Our detailed risk management course goes through different types of strategies that will help you reduce your risk when trading on leverage.
There is a fine line between emotional reactions and rational responses. As a Forex trader, our trading psychology determines which side of the line we will be on. That’s why we create a Forex trading plan: to avoid emotional decision-making when trading. We should continuously monitor our emotions and feelings about the markets and our trades. Feeling emotional, like confident or fearful, is a strong signal to pause immediately.
Sticking to the Plan
We create the trading plan for a reason; however, creating a plan is not enough. We must abide to it under all circumstances, regardless of a perceived risk or opportunity.
Whether you’re a confident person in your daily life or not is quite irrelevant to Forex trading. The markets usually appear in a rush, which can make you anxious. In order to remain confident in all situations, we should first fully internalise our trading plan. Then, we should identify potential pitfalls and seek training and resources to gain knowledge. Starting with small trades, we can observe the efficiency of our plan, skills, and knowledge.
Pitfalls to Avoid
There are very common behaviours which both new and professional traders find hard to avoid:
- Panic trading to recover losses: Increasing position size or frequency of trading.
- Confusing opportunities: Not every price action is an opportunity, stick to the plan.
- Not using price targets: All successful traders use TP and SL – invariably!
- Ignoring your emotions: Any emotion affects trading, regardless of the source.
Trading Diary & Self-Assessment
Stick to your Forex trading plan as if your life depends on it – financially, it does! However, we should also understand that it may require changes and modifications. As we progress, we will gain insights about the markets and our trading style and strategies. Our survival will depend on our flexibility to adapt our habits to the changing conditions.
Keep a Trading Diary
A trading diary is the record of your past trades with details including:
- Entry and exit times and prices
- The level of fluctuations
- Notes on the market conditions
- Your personal experiences
Qualitative details will give us insights to refine our scenarios and predictions. Quantitative details will allow us to analyse our performance and see the patterns of losing.
Adapting the Trading Plan
Our trading diary will allow us to understand the efficiency of our trading plan. Perhaps we chose a tough market, or perhaps our global RRR isn’t useful for a specific asset. Once we can understand these patterns, we can confidently adapt our trading plan.