A proper trading plan has five essential elements, all of which will guide a trader to profitability. In thinking about how you structure your trading plan, these five parcels should make the cut.
- Specific Goals – The point of a trading plan is to induce logic into your trading strategy whenever your emotions take control. Your goals should be properly outlined. “Make money” is not a goal. “Earning 20 pips per day” is a goal.
- Risk Allocation – A trading plan should also highlight your willingness to take on risk. For example, a long-term trader might find that they can risk more of their account balance because they make fewer trades, and each pip is worth less in the long haul. Thus, a long term trader might risk 5% of their account balance on each trade, with a goal of earning 500 pips and losing only 250.
- Trading Times – You cannot trade 24 hours per day 7 days per week—even if the market is open 24/7. With that in mind, a trading plan should keep you focused on when you can make the most pips in the most comfortable way. A trader in the US who works a 9-5 job might agree to trade only in the Asian session from 8PM-10PM. A professional day trader in the UK may decide to trade only for a few hours each day when the London and New York trading sessions overlap.
- Scoping the Market – New traders go bust because they don’t stick to their trading plan. Typically this is due to “information paralysis,” a made up condition that results when a trader takes in too much information and cannot make a decision, or when a trader diverges from their plan because they find new information elsewhere. You should have a dedicated plan on how you will keep up to date on the foreign exchange market. Decide which information sources to read—the Wall Street Journal, Financial Times, the Economist magazine—and stick to it!
- Trade Criteria – Including your trading criteria to your trading plan is a great way to ensure that you stick to the plan. Just as people who want to lose weight will remind themselves of what they can or cannot eat, a successful trader has to remind themselves of their strategy. Will you trade only with technical analysis and seek to avoid the fundamentals? Do you want to trade the news, and make money by predicting market reactions to news releases? Are you going to trade long-term by focusing only on opportunities with 1000 pips or more in profit?
Consider how each of the above elements make for large profits, and how you can work each into your trading plan guidelines. In the next article, we’ll discuss a trading journal, which will keep you accountable to your plan, and show you what does and doesn’t work.