The Importance of Having a Forex Trading Plan
Updated: April 10, 2013 at 8:50 AM
When approaching a field like forex trading where personal decisions translate into profits or losses, having a well-outlined and easy-to-follow plan can make the difference between success and failure.
Having a plan to be successful in any field of endeavor is highly recommended, but trading the forex or any other financial market without a plan is almost a sure recipe for failure. Having goals set in advance and knowing when to get out of a trade make up an important part of successful forex trading. Remember, a trade must be liquidated in order for a profit to be realized. Virtually every successful trader in the markets depends on some sort of plan or guidelines for their success. Here we'll go through the basics of a trading plan, the advantages with one and the importance of keeping it.
Advantages of Forex Trade Plans
Having a trading plan before starting to trade is much like having a map before starting to travel. Would you take a trip without knowing how to get where you are going? Trading in the forex without a trading plan, even if you have experience trading in a demo account, can be a challenging experience once real money is on the line.
Basically, having a trading plan helps traders treat trading forex more like a business. Most people interested in forex trading already know that anyone running a business generally requires a business plan in order to have an organized basis from which to achieve greater success.
Furthermore, the objectivity and clarity that a good trading plan provides can be a real boon when needing to make quick trading decisions to take advantage of opportunities that may arise in the often fast moving forex market.
However, the main advantage of having an objective and well thought out trading plan stems from the fact that it gives the trader an opportunity to trade objectively and therefore with greater confidence and less emotional involvement. When engaging in a risky endeavor such as forex trading, having enough confidence to return to the market after taking an emotionally-draining loss can ultimately be the determining factor between success and failure. Read more on self confidence and forex trading here.
Emotions Can Create Havoc When Trading Forex
Rules in the trade plan help traders keep trading psychology and emotional responses to trades at a minimum. One sign of a successful trader consists of an undaunted attitude regardless of market direction or lack of it. The savvy trader seems to be composed no matter what the market circumstances.
Common human emotions like greed, fear and hope can cause serious trouble when trading, so having a good way to manage them when they inevitably arise can help you overcome many common forex trading pitfalls. Read more on trading psychology here.
Many traders have lost their entire account because of the lack of discipline to follow their trading plan. Once discipline is lost when trading, the trader will then be much more likely to trade emotionally and can potentially incur devastating losses as a result. We'll come back to this later in this article.
Accordingly, for the best chances of success when trading, remember to prepare yourself before you begin to trade by planning your trades objectively and then proceeding to trade your plan as strictly and calmly as possible.
Both successful Forex and Futures Traders Use Trade Plans
How successful traders behave becomes most readily apparent on the floors of the major futures exchanges where thousands of people trade a multitude of different financial instruments, currencies and commodities in a central location or trading pit. Traders of all types find themselves on these exchange floors - day traders, scalpers, spreaders, option traders, as well as brokers executing orders for clients.
The frenetic activity, which appears chaotic, in reality occurs in quite an orderly fashion in the transacting of trades. The wild gesticulating actually arises from traders and clerks using hand signals to communicate with each other and to service the off-floor traders on the phone or out of earshot.
Yet very few, if any of the successful traders on those floors trade without a trading plan. The plan helps them make sense and order out of the apparent chaos.
Not only does this fact generally hold for exchange floor traders, but it applies to off floor traders too. Basically, the market does not play favorites and can be equally unforgiving to all participants, so those who have a proven trade plan tend to survive, while those without one do not.
Overall, a good trading plan will help you
Identify your goals
Organize your market research and trading activities
Decide when to take a position and in what direction
Manage your emotions and trading risk once you enter a position.
The Trading Plan
A trading plan to a trader is much like a road map to a traveler. The road map shows a traveler where they are and how to get to where they are going and it gives them an overall trade strategy to follow.
While some trading plans seem complex, developing a trading plan does not have to be difficult, and the complexity can be decided by the developer. A basic plan which is easy to follow and incorporates clear technical trading signals is what most traders attempt to achieve when developing a plan.
Elements to Incorporate Into a Trading Plan
Most trading plans typically contain certain important elements. These might include such things as:
How to determine the size of positions
How to manage positions once taken
Objective criteria that the trader will use for selecting, entering and exiting trades
Also, the trading plan should provide for an adjustment in trading strategy depending on the type of market conditions observed.
Using Technical Indicators in your Trading Plan
Technical analysis involves the study of prices and volume of a currency pair, commodity or stock as well as indices. Technical analysis also consists of different indicators based on the price and volume information that generate buy and sell signals in the market. Many traders use relatively simple technical analysis techniques and indicators that provide objective signals that they can incorporate into their trading plan. When they observe such a signal, perhaps in combination with other conditions, then this will trigger an entry into a trading position.
As an example of an indicator that might be included in a trading plan, two moving averages of different time-frames crossing over could constitute a trading signal. Let's assume the 30-day moving average has "crossed over" the 10-day MA, meaning that the 30-day has gone above the 10-day.
In an upward moving market, the indication would be bullish and would constitute a buy signal for the trader. The trader may then initiate a trade, buying the currency pair or commodity.
The above was just an example of how a trader might incorporate a technical indicator to a trading plan to initiate a trade. Other elements tend to be added to the plan as well, including a risk-management component.
Avoid Circumventing Your Trading Plan
The aforementioned benefits to having an objective and proven trading plan can more than compensate over the long run for the time it takes to develop, test and then implement a decent forex trading plan.
Nevertheless, even armed with this understanding and a good plan for trading, some forex traders find themselves short circuiting their own potential trading success by circumventing the decision making process laid out in their plan.
Such a failure on the part of a forex trader to follow their own trading plan can easily be a cause for the eventual demise of their trading account.
Circumventing the protections placed into your trading plan might arise from the emotion of greed, especially in the case of failing to take profits appropriately. Alternatively, it can be influenced by hope in the case of failing to cut losses when the plan advises that the right time to do so has arrived.
Since your trading plan was developed to protect you from losses in the process of maximizing your potential profits, failing to implement your trading plan faithfully can cost you a considerable amount of money - perhaps even your whole trading account.
Stick to Your Trading Plan For Optimal Success
In essence, if you went to all of the time and trouble of developing a decent trading plan in the first place, the least you can do is follow it when trading.
Not following your own trading plan that is intended to protect both you and your trading account would tend to beg the question of "why are you trading to begin with?"
Losses of trading discipline may also be a sign that you are not yet consciously or unconsciously psychologically prepared for trading forex. Basically, forex traders generally require considerable personal discipline for the best chances of success in the long run.
Accordingly, for the best chances of success when trading, remember to prepare yourself before you begin to trade by planning your trades and then proceeding to trade your plan.
Keeping a Trading Journal
In addition to the trading plan, a daily journal of trades makes up another extremely useful tool for a forex trader to help them further hone their talents.
Keeping a journal of all of their trading activities allows the trader to look back at both winning and losing trades to determine what went right with the winners and hence should be repeated, as well as what went wrong with the losers and hence should be avoided.
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.