You think you are already ready to start trading. Do you have a trading plan? No? To work without a plan means to rely only on a luck. In the heat of the moment, it is difficult to make objective decisions. The trading plan helps you avoid the momentary transactions dictated by emotions.
Trading plan on the Forex market is the basis of successful work. It answers the questions “what to do”, “why”, “when” and “how”. The plan should be clear and understandable as well as reflects trader's personality, his expectations, overall goals, describes both risk and money management rules. Forex trading plan is based on a comprehensive market analysis both fundamental and technical and should be drawn up before starting trading.
Drawing up the trading plan
The trading plan is a complete guide. It is a written description of what trader will do in the markets. What does this guide consist of?
1. Trading style
Are you a scalper, a day, a swing, or a position trader? Define what type of the trader you are:
- Scalpers execute a big amount of trades during a short period and fix profit in several pips. The recommended timeframe is M1 or M5. Scalpers mainly use technical analysis. This style of trading is very tense and requires maximum concentration.
- Day traders (intraday) execute trades within one trading day. All opened transactions are closed at the end of the day. Traders define key levels on older timeframes (M30-H1). The entry points are M5-M15.
- Swing traders hold trades from several days to week. The recommended timeframe for analysis is H1-H4.
- Position traders use long-term trading strategies and work on the charts with large timeframes. They are interested in the main trend itself and aimed at making the profit in the long-term.
2. Financial instruments that will be traded
Traders have a wide choice of instruments to choose from, including currency pairs, metals, commodities, ETFs, CFDs, futures etc. Each of the instruments has their own characteristics and trading conditions. Seasoned traders recommend starting with currency pairs. If you are a beginner, it's better to concentrate on one or two major currency pairs.
The major currency pairs, so-called majors, EUR/USD, USD/JPY, GBP/USD, USD/CHF, AUD/USD, USD/CAD, NZD/USD refer to the most traded ones in the Forex market. They are the most volatile and liquid, there is always a demand for these currencies.
3. Signals to enter the market
Define what situation in the market is a signal for you to open the position to buy/sell. You can use technical analysis and enter the market focusing on the MACD histogram or Stochastic Oscillator, chart and Price Action patterns etc. But anyway it is important to be sure that the signal is highly accurate.
Don't use a lot of tools at once. Indicators will cross, overlay, cluttering the price chart. Two or three tools is quite enough. Choose those that are convenient and which are fully understood for you. Be sure to consider the news factor. Analyze the fundamental data and assess their impact on the currency movement.
4. Trading goals
Write what you want to achieve. For example, the average daily number of transactions, weekly and monthly targets. Set clear, achievable and realistic goals. Your trading plan should be based on truth, not dreams. Do not expect to earn millions of dollars overnight.
5. Stop Loss
In order to avoid the possibility of losing everything, use Stop Loss. It limits the possible losses if the market goes against the position and keeps you safe when you are offline. In fact, the size of Stop Loss is the amount a trader is willing to risk. The recommended risk level should be 2-3% of the trading capital for each transaction.
When you put Stop Loss, you control the risk, as you determine the amount you can afford to lose. Stop Loss which is placed too close to the price may lead to the early responses and multiple small losses.
6. Take Profit
If Stop Loss limits losses, Take Profit is used to fix profit. The standard loss/profit ratio is 1:3. The potential profit should exceed the risk in several times. When opening an order to sell, Take Profit is put below the current price, whereas Stop Loss must be above it. When opening an order to buy, Take Profit is above put the current price, whereas Stop Loss is set at a level below the current price.
7. Signals to exit the market
Before opening any trade, you must clearly identify when you will close the position. It is necessary to adopt signals that will signify the closing of the position.
8. Analysis of transactions and mistakes correction
Keep records of all your transactions, so you can track the patterns and make mistakes correction, and improve your trading strategy. After you closed the transaction, you need to analyze it: whether the entry and exit were correct, the result obtained. It is also necessary to note and record all the thoughts arising during trading, identify the positive and negative aspects of the trading process, that need to be worked.
An example of the trading plan
We have covered 8 tips of the trading plan. Let's write a sample of the trading plan.
- Market. The financial instrument I will trade is the EUR/USD currency pair. My trading style is day trading with all trades taking place during the European and American trading sessions. I will close all opened positions by the end of the day.
- Preparation. Every day before starting the trading I will check out the economic calendar. Choose the fundamental data that could affect EUR/USD. I won't trade half an hour before and half an hour after the news release. I will also look at the chart and analyze the market: whether it consolidates or is in a trend? Determine the key daily support and resistance levels, and plot them on the chart.
- Timeframes. I will focus on M30 and H1 charts.
- Strategy. If the forex market is in a sideways trend, I will stay out of the market. I will not trade until a trend will be formed. I will use resistance/support, MACD histogram and Stochastic Oscillator signals to open long/short positions.
- Stop Loss. The Stop Loss level for each transaction is 20 points.
- Take Profit. The profit ratio for each transaction is 1:3, Take Profit will be 50-60 points.
Every trader needs to have a profitable strategy and the trading plan to succeed on Forex. But it is not enough to draw the plan, you should adhere to its rules. The properly made plan will allow you to avoid unnecessary losses.