How to Create a Forex Trading Plan

We all know how important it is to have a solid forex trading plan.

But how do you get started?

To help ease that uncertainty, we’ve created this guide that will show you, step by step, how to create a forex trading plan that leaves no stone unturned.

Even if your plan is already up and running, it never hurts to revise it – to make sure it’s as good as it could be.

So, if you’re having trouble creating your forex trading plan, or if you want to tweak your existing plan, read on.

How to Create a Forex Trading Plan

There are two options:

The first option is that you simply take a piece of paper and start to note everything you find important.

Needless to say, this is not the best approach.

To make sure you don’t leave out any essential parts, it’s better to follow a systematic process.

That’s why we created this guide.

For our tutorial, we’ll be building on the strategic management process.

The strategic management process is a six-step process that encompasses strategy planning, implementation, and evaluation. This is the same process that companies like Apple use to define organizational objectives.

Here’s what it looks like:

Strategic Management Process

Source: Stephen P. Robbins, Mary Coulter – Management, 11th Edition (2011, Prentice Hall)

It’s a great concept, but because it is developed for organizations, we made some modifications to make it relevant for traders.

Following the seven steps we’re about to show you, you can create your forex trading plan.

Are you curious?

Great! Then, let’s get started.

(To get the most benefit from this guide, make sure to read all the steps carefully and in order.)

Step 1: Set Your Goal

In the first step, you will have to form a clear understanding of what you’re trying to accomplish.

Setting goals is a skill in itself, but don’t worry—there’s a shortcut.

Some of you have probably already heard of the SMART goals formula. It’s a simple framework for goal-setting, widely used in the field of project management, and performance development.

If you’re new to this, here’s a short explanation from MindTools:

In a nutshell, you have to make sure that your goal is:

  • Specific
  • Measurable
  • Attainable
  • Relevant
  • Time-bound

Let’s look at an example:

  • Specific: I want to supplement my income with $500 per month trading forex.
  • Measurable: I will build a trading strategy that produces an average return of $500 per month when backtested on five years of historical market data.
  • Attainable: I have a trading capital of $20,000. This means I need to produce an average monthly return of 2.5%. Many traders have proven that this is possible without taking excessive risks. Therefore, I’m convinced that my goal is realistic.
  • Relevant: I have been studying forex trading for over a year. I have always been interested in the financial markets and have read several books on the topic. Consequently, I feel that I am capable of reaching this goal.
  • Time-bound: I assume that during the first three months of trading, I’m going to lose money. Then, as I became better at live trading, I expect to recoup my losses and get into break-even half a year after I started. From then on, I can gradually proceed toward my goal. I expect that after one year of trading, I can consistently make an average of $500 per month.

See how different this is from just saying that you want to make money?

It forces you to map out the process and support your ideas with facts. This is why irrational goals fall apart when they’re plugged into the SMART goal formula.

You can save yourself a lot of time, money, and energy by making sure that what you’re pursuing is realistic.

If you’re done creating your SMART trading goal, you can proceed to step 2.

Step 2: Perform a SWOT Analysis to Determine Your Ideal Trading Style

One of the key features of a successful forex strategy (we’ll get to that in a minute) is that it suits your personality and circumstances.

You don’t want to trade one-minute charts if you get nervous watching your account fluctuating. Similarly, you don’t want to have a day trading strategy if your job requires you to run around all day.

Simply put: There are internal and external factors that you need to consider when developing a trading strategy.

That’s where we can borrow yet another tool from the realm of management: the SWOT analysis.

In case you’re wondering, SWOT stands for Strengths, Weaknesses, Opportunities, and Threats. Companies use this type of analysis to assess the organization’s current position before deciding on a new strategy.

SWOT Analysis

Source: The Coaching Tools Company

As you can see, it’s a combination of internal and external analyses. Let’s investigate how forex traders can use it.

Read:  Easiest Way to Trade Forex App

Internal Analysis

Did you know that, above all, trading is a psychological game?

The major reason why people fail usually boils down to trading psychology. Fear, greed, and regret can prompt people to do all kinds of crazy stuff. We don’t have to give you examples.

Now, you can’t eliminate your emotions from trading just like that, but you can take some time to identify your psychological strengths and weaknesses. That’s what we call an internal analysis.

An internal analysis will allow you to create an environment – both mental and physical – that capitalizes on your strengths and minimizes the situations that expose your weaknesses. It’s also a great opportunity to highlight where you can develop yourself as a person.

Self analysis

So, the next stage would be to fill out the strengths and weaknesses part of the SWOT diagram.

You want to be honest with yourself, but there’s some room for flexibility. For example, if you’re short-term-oriented, it’s up to your personal experiences as to whether or not you consider this a weakness. Try to be as factual as you can get. After all, you’re doing this for yourself.

Here are some general personality traits that can add to your chances of success:

  • Discipline
  • Enthusiasm
  • Determination
  • Dedication
  • Trustworthiness

And some that might hold you back:

  • Laziness
  • Inflexibility
  • Irresponsibility
  • Disorganization

These are just to get you started. Of course, the more specific you are, the better.

If you’re done, let’s move on to:

External Analysis

Besides discovering your psychological traits, you need to consider factors that lie outside of you. Your resources and circumstances are both very important determinants of the trading strategy you’re going to develop.

Circumstances

Sure enough, these are vague terms, but you don’t have to think of anything complicated.

For example, you might be a millionaire with a degree in economics and hours of uninterrupted time for trading. In this case, your opportunities include money, relevant professional knowledge, and time.

On the other hand, you might live in a place where the internet connection is hit or miss. Also, for whatever reason, you can’t trade between 2PM and 5PM. Those are threats. Some of your trades might not go through, and you are missing out on the most active market period.

Similarly, come up with some external factors that pose opportunities and some that are rather threatening to your trading career.

Once the SWOT analysis is ready, you can choose the most relevant trading style.

Choose Your Trading Style

A trading style is a particular manner of trading, typically determined by the length, timing, and frequency of your trades.

There are four different trading styles:

  • Day trading
  • Position trading
  • Swing trading
  • Scalping

It would be a large detour to talk about them here, but we have an entire guide on trading styles that will help you out.

The point is that your trading style gives the basis for your trading strategy.

Think about it as choosing a shoe. It’s possible to go running in a hiking shoe, but you’re going to struggle. Similarly, it’s important to pick the trading style that makes the most sense for your situation.

Step 3: Set Money Management Rules

Before you start putting together a trading strategy, you need to lay down some solid money management rules.

Money management

What does that mean?

Money management can be broken down into three parts:

  1. Deciding how much you risk per trade.
  2. Deciding what your maximum aggregate risk can be.
  3. Deciding how much and how frequently you cash out.

Let’s start with the first one.

Addressing the risk Issue – How much to risk?

Do not risk thy whole wad – as the old adage goes.

When your trading career depends on available trading capital, protecting your account becomes an important factor. In other words, you must avoid risks that can put you out of business.

Now, risking the whole wad will certainly lead to failure, but so will risking much lower amounts, like 20% or 10%.

Failed forex trader

The disadvantage of betting too much on a single trade is two-fold:

First, the market is a very uncertain environment. You simply can’t achieve a big enough edge that would justify excessive risks.

Read:  Applieing for a Forex Trading Licence in South Africa

Second, losing a larger amount is psychologically distressing and you’re more likely to fall into revenge trading (i.e., risking even more to recoup your losses and eventually blowing your account).

So, what’s optimal?

According to BabyPips, you should never risk over 2% per trade.

This is pretty solid advice and we tend to say the same. While the actual number will be slightly different for everybody, for most people risking between 1 and 2% is indeed optimal.

Setting the limit for aggregate risk

When we talk about aggregate risk, we refer to the risk your account is exposed to considering all open trades.

If you use the same risk percentage on each position, your aggregate risk will be the number of open trades. In other words, if you’re risking 1% per trade and have five open trades at the same time, your aggregate risk is 5%.

This should make sense.

If you used different risk levels, for example, 2% on position A but only 1% on position B, you would need to summarize the risks. In this example, we would add 1% and 2% to get an aggregate risk of 3%.

While it’s not rocket science, you do need to set some limits for yourself, especially because of psychology.

If you trade multiple currency pairs, it makes sense to go even further and set rules regarding aggregate risk per currency. For example, if you have a long position on EUR/USD, and a long on EUR/GBP, and a long on EUR/JPY, your overall euro exposure might be too high.

You’re basically purchasing the same euro, just with different currencies. Even one bit of bad news can send the euro into a freefall against major currencies, leaving your account badly damaged.

Deciding how much and how frequently you cash out

This is from the nicer issues.

Because you’re aspiring to be a successful forex trader, it’s a good idea to think about what you’re going to do with the money you make.

Cash out rules

What’s fortunate is that there’s no right or wrong answer here.

After all, the profits are yours and you can do whatever you want with them. That said, you want to approach everything as strategically as possible.

Basically, there are two common scenarios:

You either cash out all your profits at the end of the month, or you cash out a fixed percentage and let the rest grow in your account.

We don’t recommend the first scenario because if you have a bad month, you’ll fall below your deposit, which you probably don’t want to do.

The second option is better because even if your goal is to live off your profits, you can take out something like 90% of your gains and still have the benefit of compounding.

Naturally, the more your goal is building wealth as opposed to making income, the more you must leave in your account. That way, you can benefit from compounding to a much larger extent.

(If you’re wondering how long it would take to reach 1,000,000 dollars, or any other amount, check out our forex compounding calculator.)

Step 4: Formulate Your Trading Strategy

A trading strategy is a collection of rules that determine how you enter and exit your trades.

forex strategy

Many people confuse trading strategies and trading plans. However, if you have read this far, you should see that a strategy is just one piece of the puzzle. That said, it’s a very important piece, so you need to have one.

Essentially, a strategy can be built in five steps:

  1. Choose a time frame.
  2. Pick your currencies.
  3. Choose an entry signal.
  4. Choose an exit signal.
  5. Choose a risk-to-reward ratio.

In our guide to building a forex trading strategy, we go into detail on each of these steps, so here we’ll cut it short.

The key is to understand that building a strategy is a process and takes time. It doesn’t end with you walking through the above steps. In fact, completing the steps is just the beginning that allows you to move on to backtesting.

Step 5: Backtest Your Trading Plan

Backtesting is the process of applying your trading approach to historical market data to see how it would have performed. If the result is not optimal, you make a change and backtest again. Rinse and repeat until everything is great.

The key is to make one change at a time so that you clearly see the effect.

Read:  Forex How Long to Stay in a Trade

Notice that we used the words trading approach.

When it comes to backtesting, almost everybody talks about it as if it were relevant only for trading strategies.

So, let’s get this clear:

While backtesting is indeed centered around the strategy, once you have a trading plan, you must also backtest the plan at the same time.

At a minimum, you must observe your money management rules. For example, if you decided to risk a maximum of 1% of your capital, stick to that while backtesting.

Since we’re talking about testing, it’s a good idea to experiment with different risk parameters to see how they affect your performance. But, again, make one change at a time.

If you bumped up your risk level, keep everything else intact for that testing round. That way, you’ll see whether there’s a benefit to taking a higher risk.

Step 6: Implement Your Trading Plan and Keep a Trading Journal

If you’ve gotten to this part, pat yourself on the back. You’re ready to execute your trading plan on the live market.

It’s as simple as it sounds, but there’s one more twist we want you to know about:

Whenever you open a trade, journalize it immediately into an Excel file.

A trading journal serves two distinct purposes.

First, it serves as instant feedback about your ability to follow the plan.

Second, it provides the data that you can use to analyze yourself.

You might be thinking:
Okay, but what details go into the journal?

Just take a look at the following picture:

Trading journal template

To begin, note the general parameters of each trade. In MetaTrader, you can access this information by looking at the open position window or clicking the account history tab for already closed trades.

Next, add two screenshots of the trade. Ideally, you will take a photo right after you open the position, and another photo right after you close it. Feel free to write notes on the photos if needed.

The following step is to explain the signal that made you open the trade. The signal is defined in the strategy; you just name it here. The same goes for the exit signal.

Finally, add some comments. How did you feel before opening the trade, while the trade was open, and after the trade was closed? Answer these questions and add any other information you find important.

Step 7: Evaluate Your Trading Journal Periodically

The thing is, no matter how hard you try, you’ll make mistakes.

By reviewing your trading journal every week or month (depending on how frequently you trade), you can spot recurring blunders and take the necessary steps to correct them.

In addition, it is a great opportunity to monitor your trading plan. If you generally do everything correctly, but your results start to significantly diverge from those of the backtesting data, it might be time to revise your plan.

Markets change all the time and you have to keep up.

This doesn’t mean you should throw away the plan and create a new one. However, you must think smart and make adjustments.

For example, if you’ve had a stable win/loss ratio for a year, and then it suddenly starts to deteriorate, you will need to look into your trading journal to determine the root of the problem.

It might reveal that most losses happen because a price swing takes you out of the market. In that case, you can keep wider stops.

Or it might reveal that one specific technique is producing the bad trades. Then, you can either eliminate it or try to make some optimizations.

The point is, when market circumstances change, you usually don’t have to create a new plan from scratch.

Conclusion

Even if you’re completely new to forex trading…

Even if you’ve never been profitable…

Even if you’re not a finance expert…

You can create a forex trading plan that allows you to reach your goals.

This guide lays out an exact process that you can follow step by step. It is based on a model that has already been proven to generate results for billion-dollar companies.

There will be moments when the process gets grueling. However, when you’re consistently profitable and live life on your own terms, you will be redeemed a thousand times over.

How to Create a Forex Trading Plan

Source: https://forexspringboard.com/forex-trading-plan-guide/

Posted by: derivbinary.com