Forex Trading Plan Example and Definition
Trading has several levels of complexity, starting from the easiest, like buying and selling random assets, to a more comprehensive one, with deliberate risk management, timing, and objectives. Combined, they are a must for every successful trader, so we decided to explain everything you need to know about the rules you should follow to trade well.
What is a trading plan
A trading plan is a set of rules a trader should follow to achieve their objectives. It includes timing, risk tolerance, the size of an order, and entry/exit points. Also, a trading plan often outlines how a trader will manage open positions, what securities they can trade, and many other rules that may be useful.
Some may think they don’t need a trading plan to perform well. In some lucky cases, these people even manage to be profitable for a while. However, a lack of a trading plan usually leads to severe losses because a trader has difficulty controlling emotions during extreme volatility in the market or after a series of wins/losses.
More to say, trading experts recommend trading on a demo account until a trading plan is made. This way, you’ll be able to gather enough data about trading without a plan to understand its importance.
Understanding the trading plan
The trading plan combines trading rules and creates an algorithm you will follow. Thus, the fundamental goal of a plan is to help you to achieve your personal goals in trading. Let’s say that your №1 goal is to prevent severe losses. Then, your trading plan should contain a part where you stop trading and take a break after a series of bad trades. You can even change your trading strategy in case of a prolonged losing streak, and it is also a part of the trading plan.
Trading plans can be quite lengthy and contain a ton of different specs. However, a simple trading plan isn’t always a bad one. If you make a long-time investment, you can confine to the amount of money you’re willing to invest monthly, your yield expectations, and your actions in case of prolonged losses. This plan will work perfectly, especially in the global stock market, which tends to grow over time. Still, this trading plan doesn’t have a time limit, which means there’s a possibility of holding assets for years or even decades before seeing any profits.
On the other hand, swing and day traders have lengthy plans that include various specs of a trading routine. With a plan, a trader can easily define whether a trade is worth it, perform an action and control the result to the maximum degree. Even if a trade goes in another direction, with a trading plan, you can minimize risks.
Examples of a trading plan
The figure below is an example of a trend-based trading plan. Notice that this plan doesn’t include many essential parts like timing, risk management, exit points, timeframe, and type of asset. However, this example is a good place to start from.
A trading plan should be an all-in-one place. We suggest including as much detail in your plan as possible because your results will depend on it. If you are in a shaky situation, your trading plan should always have an instruction you will follow.
Here’re units of a well-prepared and comprehensive trading plan:
- Premarket routine. What do you do before trading starts? Maybe you read all the fresh news and decide what asset you will choose today? Or do you look through every asset you trade and mark support and resistance lines? In both cases, the premarket routine helps you to concentrate on trading and discard everything that may distract you. Develop a routine that you follow to build discipline and consistency, and outline it in your trading plan. Then, follow this routine every day.
- Timeframe. Trading on bigger timeframes is different from short-term scalping or day trading. Some trading strategies, like Gap and Go, tend to work better on small M5-M15, while others, like trend trading, work better on H4-MN (one month). It doesn’t mean you will lose your money trying to catch a trend on an M5 timeframe, but it’s way harder, especially on the Forex market, where sideways movement is the most often seen. Notice that some traders use every timeframe and don’t see a difference between trading on M5 and H4. If you are among them, you can skip this step and move to the next one.
- Risk management. Frankly, it’s an essential part because proper risk management will prevent you from losing all your money in one bad day and take your trading strategy to a new level.
- To improve your risk management, you need to set a daily drawdown – a potential loss after which you stop trading and begin to analyze your mistakes. Usually, traders set a 5-10% daily drawdown, after which they stop opening trades for the rest of the day.
- Also, a trader should define how much money he is allowed to lose in a single trade. For me, it’s 3% of capital per trade, but more conservative traders often stick to 1% of capital per trade. It means you need to have 100 bad trades in a row to blow up your account, and you will never have 100 losses if your trading strategy is profitable.
- Finally, it would be best if you had a decent risk-to-reward ratio. The R/R ratio measures expected income and losses in investments and trades. I suggest having at least a 1:1.5 R/R ratio. This way, your potential Loss in every trade is X, and your profit is 1.5X. However, traders who don’t set a Stop Loss and Take Profit levels beforehand may skip this part if their trading plan allows it.
- Define whether you will trade a trend or a range. There is a vast difference between them. Trend traders may hold an open position for longer because trends tend to continue. Thus, these traders may have bigger profits with fewer risks. On the other hand, range traders benefit more from sideways movements and consolidations.
- Market type. A stock market is open only for specific hours, and you must be in front of your trading platform on time every weekday. The cryptocurrency market is trading 24/7, and you shouldn’t leave your order without a Stop Loss due to its high volatility. The Forex market is open 24/5 (without weekends), but the volatility is lower. And that’s not to mention different macroeconomic events that influence these markets. Choose whatever you like the most: it’s way easier to trade an asset you are interested in.
- You need to look for the same movements on the market and enter the trade only if it has been written in your trading plan. There are several options for an entry point:
- A pullback is a perfect place to buy in case of an uptrend.
- A real breakout suits those who want more certain confirmation of a movement. However, a false breakout is a thing to be aware of.
- If you use technical indicators in your trading, like MACD, you can enter the trade on a crossover of indicator lines.
- You can create your own entry signal. For example, it could be a divergence on the RSI oscillator, a touch of a Fibonacci retracement level, or a candlestick pattern. Still, it’s better to have several reasons to enter the trade and don’t rely only on one pattern or a technical indicator.
- Stop Loss. Every trader must have a plan if things get bad. You can set a Stop Loss before entering the trade and forget about the chart while the order is open. Conversely, you can monitor your trade and decide where and when you want to exit it. This approach is way riskier as you can make emotionally-driven decisions and lose money in a potentially profitable trade.
- Take Profit. If you have a risk-to-reward ratio, your take profit is further than your Stop Loss. However, you can close part of your position at the first target and then move your Stop Loss to breakeven. This way, your trade becomes risk-free, and you can hold it for much longer, potentially increasing your profits.
The figure below will help you on the way of creating a trading plan.
Tactical or Active trading plans
Many investors use automated investing to invest a specific amount of money each month into mutual funds or other assets. Such trading plans are called automatic. While the process runs on its own, it still needs to be written down as a plan.
If a trading plan marks a condition where you will look for entries, such plans are called tactical or active. Unlike automatic investing, where the investor buys securities at regular intervals, a tactical trader typically looks to enter and exit positions at certain price levels or only when particular requirements are met. Because of this, active trading plans are much more detailed.
A tactical trader needs to see a set of triggers to enter the trade. Some but not all are technical indicator signals, statistical bias, or economic releases. Thus, the chapter “Examples of a trading plan” is about tactical plans because they suit traders better.
Altering a trading plan
A good trading plan doesn’t need to be changed for a long time. Usually, it covers all circumstances you may face while working with the market. Therefore, you shouldn’t change your trading plan when you have a losing streak or a bad day because your trading plan contains information about how to act in a situation like this.
However, as traders, we must improve and strive to develop our skills and knowledge. Hence, if you grow out of your old trading plan, it’s wise to develop it or create a new one that reflects a fresh market view. Notice that you should stay away from trades until the new trading plan is ready.
Trading restrictions
The main rule of a trading plan is to follow it. You need to describe every step you make to be profitable. Moreover, if your trading plan is based on technical indicators, you can make it an algorithmic trading strategy. For example, you can create a robot that follows every step of your plan, opens and close trades, and even stops trading when there’s a losing streak.
The risk management section of your trading plan should include actions you take in case of significant losses. After a series of unsuccessful trades, it would be best if you stopped trading and had a rest from the market. The best you can do in this case is to analyze what happened. If you made mistakes that led to losses, write them in your trading journal and try to avoid them in the future. If you didn’t make any mistakes and the market acted less predictably, then just have a cup of tea or coffee and relax.
The difference between a trading plan and a trading system
A trading system is a set of rules that formulate buy and sell signals without any subjective elements. In a nutshell, a trading system defines how exactly you enter the trade. How do you split your order, and do you split it at all? Will you buy now or wait a little bit? The trading system knows the answer.
Therefore, a trading plan is more than just a system telling you when to enter and exit a trade. It’s a recipe book for all your trading needs and situations you may meet in your journey.
Conclusion
A trading plan defines more than just entry and exit points. It’s a comprehensive set of rules that gives you the answer to every part of your trading routine. There are no successful traders without a proper trading plan; it would be best if you create your own using this article.
FAQ
Why is a trading plan important?
A trading plan gives you the answer about your actions under different circumstances. Without it, your chances of winning in financial markets are much lower.
What should a trading plan consist of?
A trading plan should include a premarket routine, timeframe, risk management, trading conditions, market type, entry points, Stop Loss, and Take Profit levels.
What is a trading plan in Forex?
A trading plan is a set of rules a trader should follow to achieve their objectives. It includes timing, risk tolerance, the size of an order, and entry/exit points. Also, a trading plan often outlines how traders should manage positions, what securities they can trade, and many other rules.
What is the golden rule of trading?
You can earn a lot of money if you are consistent, learn from your mistakes, and follow risk management techniques. Don’t forget about them and you will be rewarded.