Forex Trading Plan

Of all the four letter words in the English language, none conjures up more powerful feelings of dread, than the word ‘plan’. It’s a task to be avoided at all costs. Planning is boring, it requires thought and effort. It’s tedious and time consuming and there are far more interesting things to do than plan. Planning involves thinking ahead, which is hard. Planning involves analysis and research which is boring. Planning involves the ‘what if’ scenario which is difficult. So to plan is hard, boring and difficult.

Little wonder then that virtually every forex trader ignores the tedious business or writing a plan, preferring to rush headlong into the exciting world of currency trading, as the thrill of losing money trumps the tedium of planning, every time.

Assume for a moment that you have three major events in your life. First, your son is getting married. Second you are starting a new business, and third you are moving to a new home.

An unplanned wedding would be an interesting event, and one assumes that the only attendees would be your immediate family, since no one else would have been invited. Transport would no doubt be the family car, but since nothing had been planned, the vicar would be unaware of your imminent arrival, forcing you instead to consider the local registry office at short notice. This unexciting event would then be followed by a celebration at the local take away, followed by an evening of dancing by close family members in the newly weds house.

Following the success of your son’s wedding, you decide to start your own business, again with no planning. With no funds, no business plan, and no funds, the venture promptly fails in record time.

Undetered, you blunder on, this time moving house, and whilst your new home is ready for your imminent arrival, with no removal company on site, you now have to consider sharing your house with the new owners until your furniture can be moved from the pavement, where it will no doubt be either stolen by the locals, or removed by the council in due course.

Success is following the plan

To succeed in the world of forex requires planning and to trade using a plan which you follow, time and time again, and the only analogy that seems to come close, is that used by the army to train their troops.

When a new recruit joins the army, they are trained in a formulaic and prescribed way, where discipline, attention to detail, and an unquestioning response to commands are the order of the day. New recruits are drilled and trained by numbers, so that responses become automatic and mechanical, and are based on decades of experience in the front line. Teaching someone how to react to a situation when they are under fire is not the way to succeed. Instead, training is conducted using blank rounds, and repeated time and time again, until the drill becomes second nature, and the reasons are very simple to understand.

In battle conditions, emotions need to be kept under control so that calm rational thought can be applied to each and every decision, and the only way this can be achieved is to have a prepared drill which is then executed without hesitation. Why?  Because on the battlefield, as in the world of trading, we have to deal with fear, and all the damaging effects this can have on our decisions, blurring logic, as our decisions are reduced to emotional responses triggered by the flight or fight switches deep in our DNA.

So, why do so few traders ever have a plan, which in one simple step would elevate them from the also rans, to those trading elite who make consistent profits week in and week out. Surely one of the great unanswered questions of our time!

Keep it simple

Writing a trading plan can be simple or complex, it makes little difference other than as a trader you are more likely to follow a simple plan which has just a handful of rules, rather than one which has many rules which are then simply broken or ignored. So the principle with any trading plan is the KISS principle, or the Keep it Simple and Stupid. A simple clear well structured plan is the key to success. So how do you write a trading plan and what should be included?

Any trading plan should have three simple components.

The first is a statement explaining what you are planning to achieve from your trading, and here you need to think about the amount of time you have available, and how you propose to approach your trading based on your personal circumstances.   For example, will you be trading full time, or is this something that you are proposing to fit in while continuing to work full time. This will have an impact in several ways. First it will define the hours that you trade, which markets may be open or closed when you have free time available, and it may also dictate the best strategy to suit. Whilst the forex markets trade twenty four hours a day during the week, there are of course times when the market has its deepest liquidity, and times when the markets are likely to trade sideways with thin volumes and a lack of direction. Which markets are suitable for you will depend on where you are in the world, and the hours you have available to analyse the markets and also prepare and plan your trades accordingly.

In preparing and writing the opening statement of your trading plan, you should also start to think closely about your own attitudes to risk and money, and how you will handle both losing and winning trades. This is a key part of your plan, and to begin to develop your strategy you need to have a deeper understanding of your own attitudes and beliefs, and outlook on life, which have been built up over years, starting as a child and no doubt influenced by your parents, teachers, mentors and peers. Some forex traders are aggressive, whilst others prefer a more conservative approach. Some forex traders prefer to take a longer term approach to their trading, preferring to hold positions for days or weeks and take advantage of the longer term trends. Others, prefer to trade many times a day, taking small positions across a variety of currency pairs, using tick charts or short time frames such as the 5, 10 and 15 minute charts.

The key point to note, is that there is no right or wrong way to trade, but the important thing to realize is that your trading strategy has to fit you own temperament and attitude to risk. If it doesn’t then you are trading using the wrong plan for you, and it needs to be changed. So the opening statement in your plan should define your trading approach in simple terms, along with when you plan to trade based on your own personal commitments and circumstances. Finally your opening statement should also include some simple targets, so that you have something by which to measure your progress. Naturally this can be difficult when you are first starting, so try to be both realistic and conservative. It is far better to conservative and over achieve, rather than optimistic and under achieve. The key here is not to focus on the monetary values but to try to achieve consistency, so the best targets to aim for are pip related, so for example you may decide that your initial weekly target may be 20 pips – this may not sound much, but look at it this way.

Suppose you are achieving your target every week and taking 20 pips from the market, consistently. This is a total of over 1,000 pips during the year. As a novice trader you start with micro lots, where each pip is worth 10 cents, so in the year you have earnt $100 – not much, BUT, you have done this by consistent trading, something few forex traders ever achieve. Now suppose you increase you lot size to a mini lot at $1 per pip, suddenly you’ve earnt $1,000, and from there it’s a small step to a full size lot at $10 per pip and an annual income of $10,000. I’m sure you get the picture! So within your opening statement, include a simple pip related target, and it can be as small as you like, in fact the smaller the better as it will then give you the confidence you need as you begin to build your experience and knowledge, based on sound principles and simple targets.

The second stage of your trading plan is where we begin to define the trading rules which are part of our trading strategy and approach, and which are followed without hesitation on each and every trade, and there are two golden rules here. First, keep them simple, and second keep them to as few as possible. Keeping them simple will ensure you follow them to the letter. Keep them short, and uncomplicated so that you know exactly what to do and when in each situation. This is how the army recruits are taught, so that when you are under fire in the markets, you have a plan which you follow without thinking, just like an army drill, removing emotion and helping you to manage all your trades either to maximize your profits or to minimize any losses.

Always keep your trading rules to just a few. Imagine if you had twenty rules in your plan – you would spend half you time finding each rule and reading it, before taking action, by which time it may be too late and the market’s moved on. As a rule of thumb, try to keep the number of rules to a minimum and somewhere between five to eight. Naturally the number you finally end up with will be dictated by your trading strategy and approach to the market, so this is just a rough guide to get you started. It is also important to realise that almost all of your trading decisions will be discretionary ones. In other words, not rule based. And the reason for this is simple. The markets are different every day, and therefore your decision making will also vary, from day to day. It has to. A rule based trading plan for entry and exit would be a black box approach, and all of these fail ultimately simply because markets change. An approach that works for a trending market will fail in a congested market, and vice versa.

The third and final component of your trading plan, is where you define your money management and risk rules, along with how you propose to keep your trading records. Here of course you need to specify how much trading capital you are proposing to use as your initial investment, which in turn will then define all of your money management and position sizing rules which are so vital to your longer term success. Most forex traders fail, not because they have limited capital available, but because they are over leveraged, trading lot sizes that are too large in relation to the margin in their accounts. After all, if you only have $1000 available as your starting capital, a move against you in a full lot size contract of $100,000 would wipe out your account with just a 100 pip move against you, something most currencies move on a daily basis.

So understanding leverage and margin, and the implications in terms of position sizing are crucial, and should be clearly defined in this section of your plan. In this section, you should also include details of how you propose to keep a record of your trading, of which a trading diary should be an integral part.

Finally, you should always consider a trading plan to be a living document. It can and will change over time as your skills and knowledge increase. This does not mean you change the rules every day – it does not. However, your plan can be modified and adjusted as you gain more experience, and indeed if you personal circumstances change, where perhaps you have more time to devote to your trading, then this would require your plan to be amended or modified accordingly, with a possible change in strategy.

Your trading plan is the cornerstone of your trading success on which every other element is built. It is your business plan, rule book, and financial planner rolled into one. Without one you will be an also ran – with one, you will be elevated to the top 1% of forex trading professionals, so start writing one NOW.