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The huge foreign exchange market has only recently become widely available to retail traders after the introduction of online forex brokers. These days just about anyone with a modest cash deposit, a relatively modern computer and an Internet connection can get involved in trading currencies.
Many of the newer forex traders entering the market have had little or even no professional training in how to trade financial markets. Like many gamblers entering casinos, they are often attracted by the questionable appearance of easy profits that can be made with only a modest capital investment.
Unfortunately, just like most gamblers, many of these untrained forex newbies end up wiping out their trading accounts by making common beginners’ mistakes that could have been readily avoided. By getting some basic training in market analysis and trading techniques — and also taking the time to practice and do some advance planning — these unsuccessful traders could have turned their trading activities into more of a business than a gamble.
Many novice traders overlook or simply ignore one of the key maxims followed by most successful traders, which is to “plan your trade and trade your plan”. This article is aimed at introducing the newbie forex trader to the various concepts related to building and following a forex trading plan. And in doing so, to help them transform their interest in currency speculation into a more fruitful long term business.
Introduction to Forex Planning
Just about anyone seriously intending to invest their own funds or attract other investors’ funds into a start-up business would first create a business plan. This common planning process gets the prospective businessperson to take the time to strategize and organize their thoughts in writing about such things as: why the business makes sense for them, how they intend to operate it, what their competition is likely to be, and what sort of return they would expect to make on their investors’ money.
Engaging in this sort of preliminary forex planning process — rather than just jumping into taking positions in the forex market without a plan — helps differentiate the forex trading business person from the gambler who is just wildly speculating in the currency market without proper analysis or planning.
Risks of Trading Without a Plan
Although currency speculators can certainly have winning trades, their disorganized behavior significantly reduces their chances of long term success at forex trading in comparison to those traders who have learned to plan and trade currencies strategically in a highly disciplined manner.
As a result of having no real trading plan to help them manage their emotions, money and risks appropriately, the level of risk such speculators take on may be substantially higher than what a more strategic trader would allow in their better organized trade planning process.
Since taking higher risks can often mean suffering greater losses, speculators’ trading accounts typically pay a heavy toll for their lack of foresight and planning. This helps explain why so many novice forex traders eventually find their trading capital has dwindled down to almost nothing after entering into a series of currency trades while being focused primarily on the potential profits without due concern for the financial risks involved.
Some additional risks of trading forex without a plan that can result in a novice forex trader failing to become successful at their new business may include the following:
- Using excessive leverage. Although some countries like the United States have reduced the leverage legally available to retail forex traders, any sensible trader needs to remain cognizant of the magnified risks they are taking by using leverage when trading forex. Always keep in mind that using leverage to take greater risk in pursuit of higher profits can also result in bigger losses.
- Allowing losses to run. Most experienced traders have learned to avoid the pitfall of thinking they are right and the market is wrong. They therefore cut their losses short on unsuccessful trades to save their account instead of potentially having to take much larger losses down the road that could put them out of business.
- Failing to take profits in timely manner. One of the old trading maxims is to “never let a winning trade turn into a losing trade”. Many novice traders hope for even more profits when they have a winning trade, so they end up being disappointed when the market subsequently retraces and wipes out most or all of their gains. Planning in advance how profits will be taken can help alleviate this problem.
- Not adapting to changing market conditions. Trading strategies that seem to work well in trending markets often fail to produce profits in corrective or ranging markets. Traders need to assess market conditions and plan ahead to change their trading strategy accordingly or refrain from trading in unsuitable conditions altogether.
- Allowing emotions to dominate trading decisions. One of the best things about having a good trading plan is that it helps you objectively deal with situations that can arise when trading so that you do not fall into the common pitfall of getting carried away with your emotions while trading.
- Experimenting rather than using strategy. Experimentation and practice may be helpful ways for a novice trader to learn about trading currencies and develop a profitable trading strategy using a demo account. Nevertheless, once you are trading with real money, you will really want to allow your pre-planned trading strategy to rule your trading activities rather than allowing trial and error to seep in.
- Being unrealistic. Although exceptions certainly exist, the market for a particular currency pair typically only moves so much over any given time frame. A good trading plan should help make sure that your market objectives are realistic for any trade contemplated or taken. Taking a currency pair’s historical and implied volatility into account can be one way of doing this.
Due to the significant risks involved in trading currencies without a suitable plan discussed above, those new to forex trading would be very well advised to take some time learning about trading, practicing in a demo account, and forming a sound forex business plan to organize their trading activities.
Benefits of Having a Currency Trading Business Plan
Most experienced travelers like having a detailed map to guide them before they start out on a trip to a new location to avoid losing their way.
Like that map, organizing your forex trading business using a well-defined written trade plan has many benefits and can really help you from getting lost while trading and potentially losing your trading capital in the process.
Most of the benefits associated with having a sound forex trading plan and treating your trading activities as an organized business involve avoiding the numerous pitfalls mentioned in the previous section. Having a trading plan and maintaining the required discipline to stick to it really helps prevent the emotions that naturally arise when trading and can reduce excessive psychological stress — not to mention havoc in your trading account!
Being more businesslike about your forex trading activities also allows you to get less caught up in the gambling aspects of trading and instead use sound money management techniques that will considerably improve your long term prospects for survival as a currency trader. As a businessperson engaged in forex trading, you will probably also be more likely to invest time and money in your education as a trader and into developing a profitable trading system.
Furthermore, having a trading plan helps objectify your trading activities and can assist you in trading with greater confidence — even when recovering from a substantial loss that can be emotionally devastating to some people. Also, knowing in advance how you intend to deal with certain situations that can arise when trading helps you make faster decisions about what to do. That benefit alone can really make the difference between taking a minor loss and taking a much more devastating loss if the market is moving quickly against your positions.
Having a solid forex trade plan can help you quickly take advantage of trading opportunities that arise, instead of missing potentially profitable trades while you are figuring out what to do. Being prepared also helps to reduce trader paralysis that can come from engaging in excessive analysis.
Forex Trading Plan Basics
Some of the basic objectives to be fulfilled when creating a trading plan for forex trading should include the following:
- Goal identification. A trader should aim to clearly articulate what their goals in trading are and lay out how they intend to achieve them by trading currencies. They should also determine in advance what conditions would indicate these goals are not being met and make necessary adjustments.
- Market Research. Creating a trading plan is a great opportunity for an aspiring forex trader to get organized about their trading activities. This means laying out how market research and analysis will be performed and exactly how such analysis will influence trading activities.
- Position taking. A good trading plan will allow the trader to objectively decide when to take a position, in what direction and in what amount. It will also contain guidelines about when to take losses and profits.
- Trade Management. Having a trading plan should allow a trader to better manage their trade positions, their trading risks and their emotional responses that might arise when trading.
Covering each of those forex trading plan basics should provide a currency trader with a better understanding of why they are trading and when to pull the trigger on a trade or get out of it.
The Importance of Keeping a Trading Journal
Many experienced traders maintain a daily journal of the trades they take and their rationale for doing. This practice can also be exceptionally useful for novice traders since it can help them identify trading errors, improve their trading skills, and help them to revise their trading plans as necessary.
Basically, being able to look back over a journal describing their trading activities lets traders better identify what went right in their winning trades and what went wrong in the losing trades.
They can then resolve to do more things right and less things wrong in the future to further enhance their chances of trading successfully. If deemed necessary, they can also modify their trading plan by taking this very useful feedback information into account.
Essential Components of a Trading Plan
Since every trader is different, every trading plan should be tailored to fit the personal objectives, psychology and trading style of the individual forex trader creating it. Nevertheless, some basic elements are usually incorporated into most good trading plans, and these include the following:
- Trading goals.
- Time, funds and educational commitment.
- Broker partnership.
- Risk identification.
- Market analysis.
- Market condition adjustments.
- Objective trade entry and exit criteria.
- Position sizing.
- Position and money management.
- Trading journal entries.
Although the above elements are typically included in each trading plan, just about any decent trading plan will ultimately prove worthless if the trader lacks the discipline or ability to stick to it. Accordingly, having a strong commitment to maintaining trading discipline in the face of whatever the market throws at you could be considered one of the most essential elements to a trader’s success.
A Sample Trading Plan
Each forex trading plan will be different to reflect the personal goals, preferences, risk tolerance of the trader creating it. As long as they contain the basic components laid out in the previous section, trading plans do not have to be complex. Some of the best trading plans can seem relatively simple but can yield impressive returns.
For example, a rather simple trading plan for a retail forex trader based on a popular technical analysis trading system might look as follows:
SAMPLE FOREX TRADING PLAN
My Goals, Commitments and Partnerships:
Goals: To improve my lifestyle by making an extra $1,000 per month from forex trading.
Time commitment: I commit to spending an additional 5 hours per week on my forex trading business.
Funds commitment: I currently have $5,000 in risk capital that I require for no other purpose and that is available immediately to use as my trading account deposit for margin purposes.
Educational commitment: I am presently taking a forex trading course and commit to broadening my knowledge of forex trading practices as required.
Broker partnership: I have researched the reputation and tested the trading platform of XYZ Broker and found them both to be adequate. I therefore feel comfortable using XYZ Broker as my online forex trading partner for the execution of forex transactions based on a margin account to be held with them.
Risk and Money Management:
Legal: Forex trading is presently legal for individuals in my residential jurisdiction and is expected to remain so for the foreseeable future.
Market movement risks and position sizing: These will be regularly assessed based on the average of one month historical and implied volatility levels for each currency pair. Those risk parameters will used to inversely weight the sizes of positions taken, to result in larger positions being taken in quieter markets with lower volatility and smaller positions taken in fast markets with high volatility.
Account risks and position sizing: Using a Fixed Fractional Position sizing method, each trading position will put at risk no more than two percent of funds remaining in my trading account to reduce risks as funds dwindle and increase risks as funds increase.
Since technical analysis often breaks down during sharp market moves driven by the release of fresh fundamental information, I will refrain from trading forex during the hour before and after medium and high priority economic data, policymaker speeches and news releases relevant to either currency in a currency pair.
Technical Indicators Used:
- A 60 minute RSI(4) with its upper line at 90 and its lower line at 10.
- A Daily SMA(50) and a 240 minute SMA(20).
Market condition adjustments:
This technical trading system will not be followed in fast markets.
Trade Entry and Exit Criteria:
Trade Entry Rules:
- Buy a currency pair at the market when it trades above its Daily SMA and under its 240 minute SMA, with an RSI reading below 10.
- Sell a currency pair at the market when it trades below its Daily SMA and above its 240 minute SMA, with an RSI reading above 90.
Trade Exit Rules:
- If buying, exit the trade when the exchange rate moves above the 240 minute SMA.
- If selling, exit the trade when the exchange rate moves below the 240 minute SMA.
Trading Journal Contents and Review:
I will keep a trading journal in Microsoft Excel, and an entry will be made in this journal for each trade taken. Each entry will list the currency pair, amount and net profit or loss seen on the trade, and it will describe the reason(s) for entering into and exiting the trade. At the end of each month, I will review my trading journal to determine whether any modifications to my trading plan seem warranted by the results it obtained over the preceding three months.
You may have heard the saying “Luck Favors those who are Prepared “. And I am sure this is true in the world of trading. Too many new traders enter the forex market with visions of grandeur and begin trading with very little knowledge and no trading plan whatsoever. These traders will likely fall victim to the well-known statistic that – over 90% of traders fail. I say this not to scare you, but to prepare you. Preparation requires forethought and planning, and without that, you’re going to be spinning your wheels without getting anywhere.
So as we have now made clear, it is imperative that all new traders begin as soon as possible to start putting together a personal trading plan to help guide them during live trading. Trading is difficult to begin with, but many of the negative emotions that arise from trading related activities can be reduced if the trader is prepared and follows a predetermined course of action.