Thursday, May 13, 2010

How to make a Forex trading plan

I got a few emails over the month asking what was in my trading plan and how to make one. So I thought it might be a good idea to devote an article about what I think how to make one and what should be in it. Perhaps lifting a little piece of the curtain revealing some of the aspects in my 'holy grail' trading plan, ahum.
A forex trading plan can be any way you want it to be. The bottom line is, you have to have one. The reason why you should make one shouldn't just be 'because you want to make a lot of money', sure it helps you get to that part, but ultimately there is much more to a trading plan then just that. Forex trading is a business and as with any business it requires a trading strategy, the one that's in your plan.
If your trade goes wrong or right, you have to be able to look back and analyze what you did wrong so you can fix it and do it better next time, or if your trade went well, repeat the same thing next time.
There are certain elements in a trading plan that I think should be standard, other than that it can be however you want it.
By the way, a forex trading plan is different then a stock trading plan. Stock trading is in a sense much different then currency trading because for one you just can't buy and hold on to a currency like you can with a stock. A stock can be worth a couple of pennies for months if not years right after you bought it for a double digit price and bounce back up to a higher price that you originally paid for resulting in a profit. You can't do that with in foreign exchange trading unless you have plenty of capital to maintain your losing position (margin)  for months which is possible but makes no sense since you would have no money to trade with for that of time period and can be very frustrating and nerve wracking.

Now what's in a Forex trading plan? First of all you would have to ask yourself a couple of questions before you can begin to write anything down.

The first question should be, besides how much extra capital am I going to trade with (that should be obvious before you even start trading) 'what kind of trader am I?'
This depends on your own personality. Are you a market scalper, day trader, intra-day trader, swing trader, mid term or long term trader? Answering this question pretty much lays the foundation of your trading plan. You need to know what in time frame your trades are going to be made. A 5 minute chart can look completely different then a 15 minute chart etc. What may look like a great entry point for a buy or sell position on one chart can look like not such a good idea on another.
The second question you may want to ask yourself is what trading platform (system) am I going to use? Which is essentially which broker do I want to go with. Try a few out, use their demo account to familiarize yourself with their trading system for a few months until you are pretty comfortable with their layout and on to step three you go.

Third, when can you trade? Did you give up your day job so you can you trade full time? If that's the case, what time zone are you in? I wrote an article about the best days and times to trade forex which you can read here. Can only trade on weekends? Great! But the markets are likely closed in your time zone or are so unpredictable due to low liquidity and direction you might as well go to a casino and have a better chance to make money. A few hours after work? Again, researching which time frame of the day works best for you is part of your trading plan.

Which currency pair or pairs are you going to focus on? The foreign exchange market is by far the largest market in the world meaning you would also have to follow the news on a macro scale. Breaking news about a bus crash in a country that you hold currency in, as tragic as it sounds is irrelevant to the forex markets. Greece's debt crisis on the other hand has a significant impact on the Euro currency thus the world economy.
So follow the financial news and regular news frequently that is relevant to your trades, even if you trade once a month. There are plenty of reliable news sources out there that give an unbiased opinion on happenings around the globe. In your trading plan of course you don't have to write 'watch CNBC every night', but make it routine to keep up with analyzing news regarding your trade(s).

Trading psychology. This you can link back to your trading personality. Another thing that has to be in your trading plan. Are you going to be upset after a losing trade and jump right back in another trade to get 'revenge' on the market hoping to cover your previous losses and get rid of that awful feeling of losing? If you are biased towards one currency over another you are likely going to lose. Many trading and investing books I read regarding this believe that you just have to turn this off and trade like a robot to make successful trades. I found this always a weird statement. We're all humans with feelings, intuitions and instincts and it's hard to 'turn off the switch' and just see only numbers. The question is, can you handle being a trader at this point? If this sounds to risky and are not sure how to handle your emotions trading may not be for you.
No trading plan is perfect, a perfect plan just doesn't exist. Although many claim to have (almost) found the holy grail of plans or systems, they're simply are trying to sell it to you. Think about it, if their trading plan was indeed so superior why would they be selling it, don't they make enough money with their ultimate trading system?
The markets are the boss, not you. The markets do what the markets want, it's up to a trader/investor to make some sense out of it. Await your opportunity, sometimes that takes a lot of patience. Sometimes I don't trade for days because I can't see any patterns that would make a profitable trade and other days I put twenty orders in during the day because there's so much opportunity out there. Don't trade because you have to trade. Would you rather have one huge profitable trade in a week then a hundred little ones with little return and racked up trading fees?
About my trading plan
To be honest, overall I switch trading plans quite frequently because it all depends what market I am trading in at that moment, but lately it has been pretty consistent since I found that the plan I'm using now brings consistent returns. And like every other trader, I'm still pursuing the ultimate trading system.
The setup:
If I want to trade the EUR/USD for example, I use four different screens at once all showing the same currency pair but with different time frames. On one the 30 minute, 15 minute, 5 minute and 1 minute time frame and I trade of the 5 minute chart since I am a intra day, day trader.
My 5 minute screen looks something like this; just took this snapshot at this time of writing;

(click on the image for full size)

I say something because I intend to switch indicators and oscillators once in awhile but this is pretty much an accurate picture of my trading strategy. As you can see I use a few things besides the main chart. Those are the RSI 14 (real strength index), and the AO (Awesome Oscillator) an oscillator I found recentl
y that I found pretty helpful determining entry and exit points. This is basically my main screen that I prefer not to have to cluttered, just the basics. On the other screens I check if the trade I'm about to put in makes any sense, especially the 1 minute chart since I trade on such a short time frame, a good entry point is important to me. The two white lines are my entry (short) positions determined by the MA 7 (moving average) crossing below the MA 14, the AO crossing south territory (sell) and the RSI dipping below 50. I do the reverse when the opposite happens. So a few things have to happen in order for me to confirm if there is an opportunity to buy or sell. That is pretty much already a trading plan on a technical basis. There are many many different variations and combinations and indicators/oscillators on this. You can use mine or make your own. You can make it as basic or complex as you want, in the end we all try to make money with it.
Some of the things that I have written down in my plan is:
If MA 7 crosses below MA 14 , the AO heads south and the RSI 14 dipped below 50 sell order of 5 mini lots risking not more then 5% of my account.
The trick is to do this consistently making consistent returns which is not easy. It can scare a lot of people away, and it has. But think about it, there are millions of traders out there trading and making money, if at this point you still believe trading is for you and you have capital you can afford to lose, you can give it a shot as well.
Now I have a plan, now what?
Stick to it. Make it a routine of every trade you do to check with your trading plan first. Check the news, check blogs, forums, anything really that is relevant to your pair and make a decision based on technical, fundamental analysis together with some common sense, along with your trading plan you will become more experienced and better trader.

Disclaimer:

All opinions expressed, trade recommendations/advice on this website are solely of John van der Munnik and are not affiliated with any investment firm or any other organization. You should not make an investment only based using this website VDM Trading for your trading needs without seeking help from your own financial advisor.