Designing Forex Trading Plans and Rules
Updated: May 16, 2013 at 10:06 AM
Just about every consistently profitable forex trader uses a trade plan and follows it in a disciplined way. Read more on this here. Accordingly, this successful trading mindset represents a key forex trading guide post that you will want to emulate as you grow as a forex trader.
In essence, a trading plan gives a forex trader all the information they need to initiate a trade, liquidate the trade for a profit or take a small loss if the trader was in error.
Many profitable traders use relatively simple technical analysis techniques and rules that they incorporate into their trading plan. Perhaps they might observe classic chart patterns in the process of forming, or they might look for trading signals on various technical indicators.
Initial Trading Plan Preparation
Novice forex traders will probably want to either obtain some mentoring or a trading system from a more experienced trader to get a sense for how such trading plans should operate in practice.
They might also benefit from studying technical analysis and how it can help you generate trading signals and set take profit and stop loss levels. Some traders also perform a fundamental analysis review or have a plan for trading the volatility that commonly occurs over major news releases or at the market opening.
Once you understand the basics of how the forex market works and how to generate trading signals, coming up with a forex trading plan can actually be quite a simple initial process.
You can also later refine your plan after developing some more experience with operating under a trading plan and have the opportunity to see where problems might arise.
The main characteristic that you will want to achieve with your trade plan will be an objective way to trade the forex market that will help you remove the emotional element from your trading activities.
Elements of a Basic Forex Trading Plan
You will first want to set up a number of clear and objective rules in your trading plan that you intend to operate under when trading. Ideally, these rules should tell you:
(1) What observables to watch for trading signals.
(2) When to get into the market.
(3) When to exit the market at either a profit or a loss.
(4) How large your trading positions should be.
The plan does not have to be complex, and you may find it considerably easier to maintain discipline and execute the trading plan if it has relatively simple rules.
Of course, you will want to write down each one of your trading plan rules in detail to provide you with something to refer to when you are trading. Many traders use a decision tree schematic diagram incorporating their trading plan's rules to assist them in making prompt decisions.
Another viable option consists of following someone else's trading plan, saving the time and effort to develop your own; you would be able to test the plan immediately. If the plan fit your trading style, and you were able to stick to the parameters outlined by the plan, it would really not matter who developed the plan as long as the plan produced positive results.
Time is Money When Trading Forex
Time really is money when it comes to trading forex, so you will need to be fully prepared to understand your trading plan's signals and execute them quickly when they arise.
Since the forex market often moves quickly, the importance of being able to make decisions rapidly cannot be overemphasized. You will basically need to be able to pull the trigger on any trade that your system signals as soon as possible in order to avoid missing valuable trading opportunities.
Many traders use a decision tree schematic diagram incorporating their trading plan's rules to assist them in making prompt trading decisions.
Money Management Considerations
Certainly, developing clear and objective trading signals is going to be an important part of your trading plan.
Nevertheless, another key part of your trading plan will need to involve having an appropriate position-sizing methodology and a sound risk-management strategy to keep losses at a minimum so that you can survive a losing trade to trade another day. The risk management component would include clear instructions for position sizing in relation to the size of the account. This allows a trader a greater degree of control over their risk exposure.
Once positions are initiated, a savvy trader will use "stop-loss" orders, in other words, if a trader initiates a position by buying EUR/USD at 1.35, they can immediately enter an order to sell the position if the pair drops to 1.34, taking a loss on the trade, but limiting the loss nevertheless.
These important money management considerations need to form a part of just about any trading plan for it to have the potential for creating long term profitability for your trading portfolio.
Testing the Trading Plan
Once the trader has developed or acquired a trading plan, the time for testing the plan has arrived. The easiest way to test a trading plan is to open a demo account with a forex broker and download their trading platform. Open a trading demo account here. Conversely, you can just open a Metatrader 4 account to back-test your trading plan. Some trading platforms will even allow you to automate your trading plan with their proprietary programming language.
After setting yourself up for virtual or paper trading, it is strongly recommended that you trade in the demo account for at least a three month period, primarily to get used to watching the market and find out if you are comfortable trading the market.
Remember, virtual trading is not the same as when you have real money on the line. Your emotional responses will be invariably different when you have nothing to lose. Read more on the differences between demo and real money trading here.
Nevertheless, the experience will give you a good idea whether trading forex is for you.
Putting Your Education to a Live Test
Once you have determined that trading is a viable way for you to use your money to make profits, you are able to go live and start trading in a funded account. This makes up the most important part, where following your trading rules will translate into hard cash profits.
The reason that professional traders remain successful involves the following of their trading plan rigorously and not losing discipline in the face of losses. Many traders plans allow for a certain amount of losing trades in a row. When faced with a string of consecutive losses, many traders fold unless they have made provisions for just this eventuality in their trading plan.
Trading in any market, let alone the forex market is not for everyone, be sure to do the research and take the time to trade in a demo account before deciding to jump in with both feet. Who knows, you might be the next George Soros.
Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.