One of the common mistakes new traders make is to trade without having a trading plan. However, entering a trade without a plan is an action similar to gambling and every time you do so, you risk losing your money. Trading plans can help you to manage risk and increase your profits if you follow them.
With that said, here are some tips you could follow to develop your trading plan:
1. Trading style.
Deciding on your trading style is the first step of constructing a trading plan. There is a significant number or trading styles and approaches in Forex, however, most of them can be grouped in three categories:
A) Short-term, high frequency trading. Short- term trading in other markets such as stocks, means holding a position for a day or several days. In Forex, due to the liquidity of the market, prices fluctuate constantly in small increments. For that reason, short-term trading in Forex involves holding a position only for a few seconds or minutes. Traders who open short-term positions are looking to benefit by gaining few pips each time. An extreme form of short-term trading is called scalping. Scalpers are interested to capture only few pips per trade and have to be among the fastest and most disciplined among the traders. Scalpers don't really take into consideration fundamental data when trading but rather develop an intuitive feel for the market. If you are interested in short-term trading, you should trade during times of peak liquidity since a fluid market is essential for succeeding with this trading style. Also, it would be best to choose a broker that offers click-and deal trading so you are not subject to execution delays.
B) Medium term directional trading. Medium term positions are held from minutes to a few hours but usually not more than a day. In medium term trading, traders seek to benefit from more significant moves by getting the trend right. Medium term trading requires well defined entry and exit strategies, analytical skills and a lot patience and discipline. To determine what direction a currency pair will follow, traders either study fundamental data or technical data or both. Traders also often follow events or data releases. However, event traders usually open the positions far in advance and close them when the outcome is known. The Forex market is trending one third of the time. The rest time they are trading sideways or ranging. Medium term traders realise that a trending market is not the rule and instead of buying and holding in the case of the uptrend, they are looking to capitalise on the 50 to 150 price increase that makes the overall uptrend.
C) Long term macroeconomic trading. Long term trading in currencies is usually for hedge funds and other organisations since it requires a substantial amount of investment capital. Long term trading can involve holding positions for weeks, months or years. The risk of holding positions for that long is short-term volatility that can overwhelm margin trading accounts.
2. Trading System.
After determining your trading style, you should develop a trading system. This will be the heart of your trading plan. Your trading system should include: Time frames, position sizes, criteria to decide on entry and exit points, which currency pairs you trade, stop loss and take profit points.
Include all the necessary information about your system such as: time frames you use, criteria for entries and exits, how much you risk during each trade, which currency pair(s) you trade and how many lots you trade.
Example: I am a medium term trader and I trade off 1 hour and 4 hour charts. I use the moving average crossover with the rest of my indicators which must also point to the same direction and I use the 34 EMA on High, Low and Close to confirm the Market Cycle.. Most often I trade the GBP/USD and EUR/USD and I never risk more than 3% of my capital on each trade. I trade 1 lot per time. My stop loss is 30 pips and take profit 70 pips per trade.
3. Mind management
In Forex, you will often hear people talking about the importance of managing emotions and your own mind when trading. In order to successfully manage your mind in Forex. The three dominant emotions to be aware of are FEAR, GREED & UNCERTAINTY where one emotion may lead to another.
A) Focus on the pips rather than the money lost or won. Focusing on the money will conjure emotions that are triggered by memories or past experiences and possibly influence your judgement. Focus on prices and how they are behaving and stick to your trading plan as Price Action could be a worthwhile focus expecially in Forex Trading.
B) Accept you are going to lose in some trades. There is no one who will only take profit all the time. If you have a solid risk management plan, you will be able to keep your losses to a minimum.
C) The market is not against you. Don't take it personally. The market is going to do what it's doing either you trade or not, so, if you are losing, remember it's not your bad luck. Review your trading plan carefully and make necessary changes if needed.
4. Know Thy Self.
Know yourself and your weaknesses. We all have weakness but don't find it pleasant talking about them. However, there is no way to improve in life if we don't admit what we need to work on Ask yourself: How will I become a better trader?
Example:
• I tend to overtrade. Whenever I lose on a position, I get upset and immediately try to get "revenge" on the market.
• I often exit early on trades out of fear that I am going to lose more money.
• I don't stick to the rules of my system. I need to change this and be disciplined.
