Why is a Trading Plan Important?

Are you sticking to your trading plan, if not, why not?

Dec 9 • Forex Trading Articles • 1041 Views • Comments Off on Are you sticking to your trading plan, if not, why not?

Novice FX traders are naturally very eager to trade the markets, and this impatience often causes them to overlook the importance of creating a trading plan as soon as possible.

In some ways, this oversight is understandable because it’s a chicken and egg situation with forex; you can’t make a trading plan until you know what’s involved. You need to know what to put in your trading programme and what you hope to get out of it. That initial knowledge can only come from the experience of trading FX markets.

However, it’s still noticeable that many novice traders who are perhaps into their second quarter of trading markets, don’t create a plan. If they’ve lost money, they don’t apply this simple remedy. If they make a profit, they discount the worth of a trading plan.

If we ask a cohort of experienced and successful traders to describe in one word why a trading plan is essential, many will reply with the word “discipline”. The concepts of discipline and successful trading are inextricably linked.

Consider traders at investment banks, do we think they have a free license to chase a prime alpha mandate, by pleasing themselves? No, they have a strict set of rules and trading parameters constructed by their bosses, and if they violate those rules, they won’t last long.

So, what would a trader at a Tier 1 bank have in their trading plan, and what should we, as humble retail traders at the bottom of the food chain, take from their blueprints?

Now the parameters at banks will be created by code, and they won’t have to input the rules manually. Moreover, the rules are attached to algorithmic code that makes many of the trading decisions. But bear with us as we suggest that the trading code might contain these five essential elements.

  • What to trade
  • When to trade
  • What risk to take on each trade
  • What maximum exposure to apply
  • What circuit breaker to use  

The bank traders can’t trade outside of this framework, whatever trading platform they operate the computer will say no. If the trader tries to risk 1% on a single trade, but the code says no more than 0.1% the transaction won’t get executed. If they try to trade cryptos but it’s outside of the firm’s remit, the orders won’t get executed. Let’s adopt these five rules into our initial trading plan.

What to trade

It would be best if you decided what you’ll trade. Will you trade FX, if so, how many pairs will you regularly buy and sell and why? Let’s not lose sight of the fact that some very successful FX traders (retail or institutional) might only trade one or two major currency pairs. If you intend only to buy and sell EUR/USD and USD/CHF because the spreads are usually tight, the fills are generally good, and the correlations work most of the time then stick to that decision.

When to trade

It would help if you decided what style of trading you’ll employ, your method. Scalping, day-trading, swing-trading or position-trading? This decision will underpin many of your other choices and what you ultimately embed in your plan.

Will you trade only during the day, looking for daily trends but never holdover your trades and avoid incurring swap charges? Then you’re probably a day trader who might zone in on either the London or New York trading session.

When to trade also covers the obvious; you only make a market order when all your trading strategy parameters chime. You don’t break this rule, ever.

What risk to use on each trade

This decision forms part of your trading strategy but is so critical you need to apply it before you even decide what core elements will be in the strategy. You must decide what tolerance to risk you have. If you choose only to risk 0.5% account size per trade, then stick to it. Breaking this rule will lead to chaos and freehand trading, which will, in turn, compromise the distribution of losses and gains.

What maximum exposure to apply

The risk per trade needs to work hand in hand with the overall market risk you have at any one time. If you risk only 0.5% per transaction, then you might decide not to have more than 2% at risk at any one time. So, you’ll never take more than four trades, or only take the fifth if some are already in profit and the gains are locked in, perhaps by way of trailing stops.

Circuit breaker

There are times when your method and strategy are simply out of step with market behaviour. It’s not you; it’s not the market; it’s just how it is.

If there’s a limit on your daily losses of 2% and you hit it, that’s it. You lock yourself out of the market. You close your platform and do something else with your day. You don’t try to win back your daily losses; you don’t revenge trade you accept the losses as the price of doing business in this risky industry.

If you haven’t created a plan, now is the time to do it. As illustrated, it doesn’t have to be complicated, because, when you break it down, it’s just a simple basic form of rules. We all live our lives by our code, discipline and set of rules, and trading is no different.

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