A winning Forex trading plan should be the starting point for any journey to becoming a consistently profitable Forex trader. Yet unfortunately most traders don’t write one until they’ve blown a few accounts. Even then the task to write a trading plan often falls into the category of, “I’ll get to it when I have time”.
So why do most traders avoid taking the time to write one if it’s so important?
The answer is simple – we don’t like rules.
And this doesn’t apply to just traders. I use the term, “we” loosely to mean all humans.
Think about it, how many of you like being bossed around at work? How many of you got any kind of joy being called by your first and last name by your parents when you were younger? I don’t know about you, but that always meant I was in trouble. Why was I in trouble? Because I broke a rule.
Enter Forex, a limitless environment without many rules. Other than the rules set by your broker, you’re free to do whatever you wish. That’s a scary proposition for someone who has been bound by rules their entire life.
I attribute this one thing to the phenomena of why so many traders fail – they can’t handle having no rules to follow. Or rather, they didn’t take it upon themselves to set the rules.
In this lesson we’re going to take a look at what a Forex trading plan is, why it’s so important as well as some of the topics you should consider including in your trading plan.
A Forex trading plan is the blueprint of everything you do as a trader summed up in the most concise, yet descriptive, way possible. Your trading plan should consist of when and how you trade as well as what you do before and after a trade.
However writing your Forex trading plan is not the difficult part. The difficult part is writing the plan in as much detail as possible while keeping it as concise as possible, preferably to a single page.
After all, a trading plan that that is eight pages long and takes fifteen minutes to read isn’t likely to be referenced often – which is what you should be doing.
Lastly, a Forex trading plan needs to be revised as your trading skills improve. Please don’t make the mistake of thinking that your trading plan is set in stone and you simply have to make it work.
Be open to revisions as you move along in your trading career, just remember to always follow the most up to date version. Otherwise you will find yourself drifting through the market trying many different “things” without knowing what works well and what doesn’t work so well.
Simply stated, a Forex trading plan helps to keep you disciplined. Trading is a business and needs to be treated as such. Just as a business has standard operating procedure to keep things running smoothly, you have a trading plan to stay disciplined.
As previously mentioned, the Forex market is a limitless environment without many rules. Therefore your trading plan needs to serve as your rule book to help keep you out of trouble.
The trading plan is also a great way to test what works and what doesn’t. A successful experiment always involves one control and multiple variables by which the control can be tested against. Your Forex trading plan becomes the control by which you test variables (entry and exit methods, various price action patterns, etc.)
Now it’s time to start putting the pieces together. Below I’ve outlined what I feel are some of the most important topics to include in your trading plan along with some helpful tips to get you started.
This is by no means a complete list so feel free to add your own topics as you see fit.
Define Your Trading Strategy
Every winning Forex trading plan starts with a well-defined trading strategy, or strategies. Every topic below will reflect what you enter here in some way.
For me this topic includes the pin bar trading strategy as well as the inside bar trading strategy. It’s important to outline each strategy you will use and outline the market conditions necessary to validate a trade setup.
Does a market have to be trending or can it be range-bound? Does the pin bar have to occur at a support or resistance level or will you also consider trading continuation pin bars?
Define the Time Frames
This one is straight forward but also crucially important. You’ll want to define the time frames on which you will be trading.
The omission of this one simple rule has been the cause of a lot of headaches for many traders. I can’t speak for everyone, but when started trading back in 2007 I was constantly switching between time frames. One week I was on the one hour charts and then I’d get bored so I would move to the five minute charts the following week.
Not only that, but I had a habit of entering on the one hour chart and then switching between the 4 hour chart, daily chart, fifteen minute chart and even the five minute chart, just to see if they looked “okay”. I had no idea what I was looking for, but I was determined to make sure each time frame looked favorable.
Choose one or two time frames you’re most comfortable with and stick to it. Look for setups on these time frames, trade on these time frames and exit on these time frames. This is the only way to break yourself of the “time frame dance” that I think we’ve all experienced.
Define Your Watch List
As part of your Forex trading plan, you will want to define the currency pairs that you will trade. Much like your trading plan as a whole, your watch list will change over time. I usually recommend someone start with about 10 currency pairs to watch at any given time. This will give you plenty of setups each week even on the higher time frames.
As your trading skills improve and your confidence grows, you can expand this list to include other pairs and even some commodities. My watch list currently contains about 25 instruments that on average give me one or two solid trade setups each week.
No, you don’t have to meditate. Although I do highly recommend it!
Mental preparation is without a doubt the most commonly omitted topic in a trading plan. Perhaps it’s because traders get too caught up in defining their strategy. Or maybe it’s simply because people don’t like to talk about their feelings. Whatever the case may be, this one is a must!
How do you feel today? Did you get a good night’s rest? Are you feeling energetic, sluggish or somewhere in the middle? These are all questions that need to be asked as part of your trading plan.
We’ve all had “those” mornings. Whether it was a late night with friends, the stresses of life keeping you up at night or maybe you just woke up on the wrong side of the bed. These mornings happen to the best of us and they will continue to happen.
It’s your job is to assess the situation and figure out if you’re mentally prepared to face the markets. If not it may be best to sit this one out. The market will always be there tomorrow and trust me when I tell you that you’re far better off waiting to trade until you’re mentally prepared than to lose money because of a mistake that you wouldn’t have made otherwise.
Just remember, being flat (having no positions open) is a position and it’s the safest one you can have.
Establish Your Risk
As many of you know, I’m not a huge fan of establishing your risk in terms of a percentage. A much more effective approach is to define your level of risk as a monetary value. See my article Pips and Percentages Will Only Get You So Far for more information.
But let me stop you there. If defining risk as a monetary value is the preferred method, and establish a percentage has some value, wouldn’t it be best to use both?
Why yes it would!
Here is how I go about defining my risk as part of my trading plan. First off I want to determine what my risk threshold is in terms of a percentage. I recommend somewhere between 1% and 5% with 2% being the most common.
So now that I know I can only risk 2% per trade, it’s time to define my risk threshold for a monetary value.
But let’s put you in the hot seat to make this more relevant.
Let’s assume you have a $10,000 account and you’re comfortable using the 2% rule that I mentioned above. Using just this rule means you will risk $200 on any given trade.
But at what dollar amount risked do you start to feel a little anxious? In other words how much money are you prepared to lose on one trade? The reason this is an important question to ask is because it won’t always line up perfectly with the percentage you defined above. In fact most times it won’t line up perfectly.
Let’s say your threshold is $100. Anything over that and your emotions may start to get the best of you. But $100 is half of what your 2% rule is telling you to risk…
This is why it’s so important to define risk as both a percentage AND a monetary value. So which do you choose? Most traders go with the 2% rule simply because that’s what everyone says to use.
I say nonsense.
A percentage only has value once you assign it to another number. And that number, which in this case is money, is far more likely to get you in trouble if you aren’t careful than some arbitrary percentage.
Of course these numbers will change as your account grows. But just be sure to always define both money risked and percentage risked as part of your Forex trading plan.
Define Your R-Multiple
Your R-multiple is simply your risk to reward ratio stated as a single number. For example if you risk $50 on a trade and your potential profit is $100 (based on your target) then your risk to reward ratio is 1:2. In other words the risk is half the potential reward.
Stated as an R-multiple this becomes “2R”. Another example is $50 risked for a potential reward of $160. When we divide 160 by 50 we get 3.2R.
It’s important to set a minimum as part of your trading plan. I personally use 2R as a minimum so that I know my risk is never greater than half the potential reward. Of course the higher the R-multiple the better so no need to set a maximum value here.
Set Entry Rules
How will you enter the trading strategies that you previously defined in your trading plan? For example if one of your trading strategies is the pin bar, what entry method will you use? Will you enter at a break of the nose of the pin bar or perhaps you favor the 50% pin bar entry.
If you’re open to using both entry methods you should also define when to use each of them. What market conditions will justify using the 50% entry method? What market conditions need to be present to justify entering on a break of the nose of the pin bar?
Set Exit Rules
Ohh, where to begin? This is one of the more misunderstood rules when it comes to writing a trading plan Why? Because everyone is so obsessed with finding a trade setup that they completely forget to look for the exits before entering a trade.
Let me restate that by saying that most traders are excellent at finding one possible exit – the profit target. Everyone loves to see how much money they stand to make on any given trade. But without setting your exit rule in the event of a loss you won’t be able to properly define your R-multiple.
In this section of your trading plan you’ll want to define where your stop loss will be placed as well as how you define your targets. Speaking of targets, you’ll also want to describe in detail how you plan to exit a profitable trade. Will you exit the full position at the first target? Or will you exit half of your position and keep the other half on the table?
These are all questions that need to be answered in this section.
Establishing rules for how you manage risk is an essential part of every good trading plan. Although you have already established where you will place your initial stop loss, you will also want to outline how you plan to trail your stop loss, if at all.
For example in my own trading plan I use the highs and lows of previous days as a place to “hide” my stop loss. But I typically won’t move my stop until the market has had a chance to move well beyond my entry. Of course my plan defines what “well beyond” means, and you will want to do the same.
The topic of risk management is what makes or breaks a trader. As I’ve said before, it isn’t your win rate that makes you consistently profitable. It’s the amount of money made when you win vs the amount of money lost when you lose, averaged out over a series of trades. And the only way to tip the scale in your favor is with a solid plan for managing risk as well as a disciplined approach to executing the plan.
What you do after a trade is just as important, if not more so, than how you mentally prepare before a trade. Here is where I like to list rules to follow after both winning and losing trades.
Arguably the most important rule of them all is how much time will you take away from your trading desk before entering the next trade? This is extremely important!
After a losing trade you may feel tempted to take revenge on the market and make back what you lost. This is called revenge trading and is one of the larger contributors to why so many traders fail. The urge to immediately hop back in the market after a winning trade is just as strong. This urge is caused by two thoughts.
Use this section of your trading plan to define how you need to mentally prepare for the next trade. Everyone is different, but I haven’t met a trader yet who didn’t need some time away from the market after a winning or losing trade.
The hardest part about writing your Forex trading plan isn’t defining your rules. In fact once you start writing it you’ll find that the various rules fall into place quite easily. The hard part is including enough detail for it to be effective yet being concise enough so that you’ll actually use it.
Remember that the whole idea behind building a trading plan is for it to be read daily. This means keeping it to one page (two at the most) and hanging it somewhere that’s easily visible from your trading desk.
I hope this article has given you practical advice about how to write a winning Forex trading plan. My goal was to not only provide some of the more important topics, but to give you some ideas to help you get started.
Did I miss anything? Share your experience with writing or using a Forex trading plan in the comments section below.
I look forward to hearing from you.