6 essential steps for a successful trading plan

Having a detailed and written trading plan with defined rules is fundamental if you are serious about trading Forex as a professional. Among all the steps you will have to include, depending on your particular system or strategy, there are five elements which I consider are essential to your success as a Forex trader.

Step 1: Before you Trade

Preparing yourself mentally and physically is a must. Make sure that you are really ready to start trading, test your system thoroughly before you apply it on a live account, and review your rules to be able to follow your trading plan with confidence and leaving emotions out of the way. Your workspace should be free of distractions, your mind clear and focused, feeling energetic and psychologically stable. If you are not ready and focused, if your emotions or physical well-being are less than optimum, you should not attempt to open positions that day, as the risk of making bad decisions and losing will be much higher.

Step 2: Pick just One Time Frame, One Market and One Trade

Although there are a few strategies that involve trading a basket composed of several currencies, it is more difficult to focus on the task at hand if your attention is split among different pairs, each of them having its own pace and personality, and especially if you are still in the process of acquiring experience in this profession.

The same can be said about time frames: even if you use longer-term charts to spot the main trend, and then drop down to faster ones to pinpoint your entries, there has to be only one time span on which you will be calculating your targets and stops and checking the validity of your signals.

Finally, monitoring a single trade will be less stressful than having several trades open for the same currency pair. Most platforms allow partial closing if your strategy involves scaling out of the trade and a single position will be much easier to manage.

Step 3: Time, Money and Risk management

Time and Money are your main resources. Your strategy and trading plan has to be devised first of all based on how much time do you effectively have available and what amount of money are you willing to assign to your trading account. For example, an intra-day strategy will not be suitable if you have a full-time job, and being under-capitalized will hinder your chances of success because of the higher risks you would incur. Calculate how much capital do you need to implement your system with success. The costs will also diminish as you increase your base amount.

The next step is to decide what percentage of your assets will be invested in each trade. This will depend on the overall risk per trade that you are able to allow. An ideal scene is to commit no more than 2% of your capital to eventual losses, and always calculate the stops needed prior to entering each and every trade. Also, be sure to evaluate this point accurately in regard to the specific time frame to be used: while a 20 pip stop-loss can be wide enough on very short scales, it wouldn’t be appropriate and would lead to continued losses on a 4-hour or daily scope.

A daily limit should also be defined according to your risk tolerance: how much are you willing to risk before you stop trading for that day. Avoiding over-trading and “revenge trading” is the goal here. After a series of losses, emotions can take over and your ability to make sensible decisions could be impaired.

Another important point is the setting of realistic targets and risk/reward expectations, and avoid taking trades that do not offer a potential of at least a 1.5 to 1 profit/loss probability. Establishing daily goals in percentage can also be a good practice if you allow some flexibility and only use this as a general guide.

Step 4: How to Enter, When to Exit, Where to Stop

Entries should be taken when the risk is much lower than the potential reward. Your strategy will help you establish the rules which have to be followed with discipline. There is always another trade coming along, be patient and do not try to force things just to be “in the market”.

If you have followed step 3, the initial exit points will already be in place. Now, there are other steps to take into account: when is it safe to set the stop at break-even, will you be taking partial profits along the way or implement a trailing stop method in order to protect the profits already made.

Finally, you’ll have to decide which kind of orders to use either to enter or exit the trades. Limit orders are much better for entries, in my opinion, to gauge the proportional risk and reward in advance, and also help taking the emotional part out of the picture. On the other hand, exiting a trade with a target profit isn’t always the best move, although it should be in place in case you aren’t able to monitor the trade all the way. A market order will allow you to exit immediately if the initial conditions have changed, taking away the risk of missing the target exit point.

Step 5: Follow-up your trades

Keep a trading journal. A daily analysis of all your trades, including details as personal emotions or surroundings, were you able to follow your trading plan or on the contrary were those impulsive trades, etc., will help you learn from your mistakes and evaluate how well are you performing as to your discipline and goals. Make it an end-of-day routine and include all the pertinent details of the trade itself, entry and exit prices, original stops and targets, supports and resistances of that day along with the daily range, time of the day, and time spent in the trade, with comments on every position taken, why did you enter the trade and why did you exit, and finally a summary to record what were the lessons learned through the outcome of that particular position. This will help you avoid repeating similar mistakes, and give you a good database to use in the future if you need to evaluate a particular system or strategy in regard to profit/loss ratio, potential draw-downs and trade efficiency. Know why and how and save the records as a reference, which you will read again before starting the next trading day.

Step 6: Back-up solutions

What are the possible unpredictable events and how will you prepare in case those occur?

Prepare yourself for any eventuality. The markets can change and reverse direction in a few seconds even if the trend was apparently well in place. Your ISP connection can fail. A power outage can occur. Your broker’s platform could be out of reach momentarily at peak market moments. Your computer might crash.

Having a back-up solution for each one of these eventualities will accrue your confidence and eliminate fear from your trading. The unpredictability of the markets is well managed through the appropriate setting of stops, trailings and a quick exit reaction when monitoring the trades. Alternate modes of connection, as for example cell phone or wireless, setting up an additional computer, getting an UPS and having the phone number of your broker’s trading desk at hand will most often take care of the rest. Above all, being able to adapt easily and fast to any changes is key to your trading confidence and effectiveness.

Having a well-structured plan and following it to the letter will help you trade without being influenced by emotions, which account for the biggest mistakes and bad decisions. If after a while you discover that your actual plan doesn’t match your expectations, you can always do a revision and change it, but never get into a trade by impulse. Trading has to be treated as a business and following your plan is crucial for consistency and success on the long term.