Creating a Trading Plan

 

Video Transcription:

Hey, traders. Welcome to Video 14 of the Forex Beginners Course. This is
Cory Mitchell. In this video, we are looking at creating a trading plan,
brought to you by Investoo.com.

Trading requires a plan; if you try to wing it, you are going to fail.
Without a plan, you don’t know what works and what doesn’t. You need to do
the same thing all the time to know if it works or not. So, if you step
into your trading environment, you open your platform, you look at a few
charts, and you just decide, “Yeah, I’m going to go long this one, I’m
going to go short this one,” and there’s no real plan there, you have no
concept later on of what works and what doesn’t. You may, even, when that
trade ends, you may look at that trade and think, “What was I doing? Why
did I take that trade?”

With a plan, you at least know why you took that trade, how you’re going to
manage it, how you’re going to get out. That way, when you look back on
your trades, you can see how you can improve. If you don’t follow that
plan, you have no idea why you took those trades, why you got out of them,
how you managed them. It becomes very hard to improve as a trader when
you’re just winging it. Until you have a plan and you follow it, you’re not
going to know how to improve.

Trading with a plan also relieves a lot of stress. It takes a lot of the
emotion out of trading. As I said before, if you just open your platform
and start making trades, it can be extremely stressful. You have no concept
as how to manage those positions, whereas if you’ve set out a plan, you
say, “I’m entering here, I’ve set a target here, and I’ve set a stop here,
and now I just have to let it hit that stop or target.” Let’s say that’s
your strategy. That’s it. You have nothing else to worry about.

You may want to watch it, but you can also just turn your computer off and
walk away. That trade is technically done. Your work is done. The price is
either going to hit your target or it’s going to hit your stop. That is a
planned out trade. When that plan isn’t in place, it becomes much more
stressful.

A trading plan consists of four primary sections. The first one we’ll
simply call restrictions. It’s just some general guidelines for what you’re
actually going to be doing. This covers which market you’re going to trade,
so forex, or if you’re going to trade another market as well. This may
cover forex and futures, let’s say, if you’re going to trade futures as
well. For the sake of this, let’s just say that you’re trading forex. It
covers the forex market and what pairs you are going to trade and when.

You want to create some guidelines for yourself. Maybe there are some pairs
you need to avoid simply because you don’t know much about them, let’s say
the US dollar and the South African dollar, or the Danish, or any other
currency pair that you don’t know a ton about, maybe the Chinese currency.

You just don’t know a lot about them, so you’ve decided, “I’m going to
restrict those. I’m not going to trade them. I can trade all the common
pairs that we discussed near the start of this video series: the US dollar,
the Australian dollar, the British pound-US dollar.” Write down the pairs
that you’re going to trade and the ones that you have to avoid. This
creates a guideline for you so that, let’s say you do happen to hear
somebody mention, “Oh, the Chinese currency is flying off the chart,” and
you decide, “Okay, I’m going to step in and do that,” but you don’t really
know anything about that currency, so avoid trading it.

Follow your trading plan. Listen to it. Restrict currencies that you don’t
want to trade either because of spread or something like that, and just
stick to the ones that you know. There are lots of opportunities in pairs
that are actively traded and that you know something about.

Are you going to day trade? Are you going to swing trade? Are you going to
do both? Are you going to be a position trader, where you’re taking
positions for potentially weeks or months? Define how you’re going to
trade. You don’t want to be jumping back and forth. I do both; I like to
day trade and I like to swing trade, so I will take swing trade positions
and day trade positions in different pairs.

You’re also going to want to define here if you have a day trade out, say
in the Euro-USD, can you take a swing trade in that same pair? There are no
hard and fast rules here. It’s just what you decide. You have to define
these things for yourself. How are you going to classify yourself as a
trader and what rules are you going to set for yourself?

The next major section of our plan is the entry rules. What criteria is
required to enter a trade? What is your trade trigger going to be? What has
to materialize for you to actually take a position? So, you want to go long
the Euro-USD, what conditions are present for that to occur?

The trade trigger is what actually triggers the trade. You may say, “Yes, I
want to get long in the Euro-USD,” but what is actually going to trigger
the action? You need to have something that initiates the trade, whether
it’s the price hitting a new high or an indicator crossing over another
indicator, something like that. You need something that tells you to get
in. You want to be very specific with your entry rules. For example, you
may say, “I’m only going to trade with the trend,” but how do you define
the trend?

You need to be very specific, because looking at a five minute chart, the
trend may look, all of a sudden, very different than on a 15 minute chart
or an hourly chart. How are you going to define that trend? Be very
specific. Why are you going to enter and how are you going to enter?

If there is any ambiguity about whether you should or shouldn’t be taking a
trade, your plan isn’t specific enough. If you see a potential trade and
then you start second guessing yourself, you haven’t defined it well enough
in your plan. You want to go back and make sure there’s no real ambiguity
there so that when the time comes to pull the trigger, you are going to
pull the trigger on that trade.

You’re also going to want to have exit rules. You’ve got into a position,
but how are you going to get out of it? We have two options. We have the
stop loss, which controls losing trades, and then we also have to get out
of our winners. We can’t just let our winners run infinitely, because they
will eventually turn back into losses. What criteria is required to exit a
trade? Are you going to use a stop loss order, are you going to use a
trailing stop loss order, or are you just going to manually exit the
position?

If you’re going to manually exit the position, how are you going to do that
and why are you going to do that? It is true. Let’s say the price is
running in your favor. There’s an uptrend. All of a sudden, you notice a
lower low, a lower high, so that potentially indicates that that uptrend is
in trouble and a downtrend is beginning. That would be a point where you
could look for a manual exit. The reason you’re in the trade is the
uptrend, but since that’s no longer there, you want to get out. How are you
going to get out of that position? What is your trigger for getting out?

Profit targets, as well. In a winning trade, are you going to use a profit
target to establish when you get out? Profit targets make it easy. If you
have a stop loss and a profit target, you can just wait for the price to
hit one of those and you’re set. That’s all you have to do.

You can also implement a trailing stop, so you just keep moving the stop up
as the price moves up, and that will lock in some profit as the price moves
in your favor, and eventually it will stop out the position when the price
pulls back far enough.

You can also look to manually exit. Again, we discussed that before, but
you want to know why you’re going to do that manual exit and how you’re
going to do that manual exit. Again, be specific. If you say in your rules,
“I’m going to place a stop behind a major high or low,” how do you define
major? Is that major on your timeframe, if you’re trading on a one minute
chart? Is that major on an hourly chart? How do you define major? Again, if
there’s ambiguity about where you should be placing a stop or how you will
exit a position, your plan isn’t specific enough.

We’re going to go through what your process is. You create this plan, then
you start going into a demo account and trading. What you’re going to find
is that there is going to be some ambiguity in your plan, and you’re going
to have to keep revisiting it and filling in some blanks that you may not
have thought of before. The more experience you get, the more you’re going
to be able to fill in those holes in your plan, so it eventually becomes a
very good, solid plan.

Money management is the fourth section of our plan. One of the main things
that we want to focus on here is the maximum risk. You want to define your
maximum risk. I’ve said before mine is 1%. I don’t risk more than 1% of my
account on a trade, 2% absolute maximum if you have a very small account
and you’re just starting out. Ideally, you want to be risking less than 1%
of your account, but 2% is the absolute maximum.

You also want to establish a maximum risk for all positions. If you’re
risking 1% on a trade, can you take 100 trades? It’s unlikely that all
those would lose; if they did, you’ve lost all your capital. Is there a
maximum risk on all your positions? Maybe you want to cap your trades at 15
or something like that. That would mean that if you’re risking 1%, 15% of
your capital is technically a risk at any time if you have a maximum of 15
positions out.

You also want to look at can you trade correlated positions? We looked at
correlations and volatility in a prior video. If the Euro-USD and the
British pound-USD are highly correlated and moving together, can you have a
long position in both? There’s no right or wrong; it’s just can you do it?
As we discussed in that video, even if they’re highly correlated, they’re
going to have slightly different tendencies, so it is okay to take
positions in both.

I do take positions in correlated pairs. Simply, I’m normally risking less
than 1% on my account on each trade, so if I have a couple correlated
positions, my risk is still pretty small even if those positions do tend to
move together, so if I lose on one, I’ll probably lose on both. That’s
okay, because my risk is small. I’m okay with that.

It will be up to you to decide. Can you take correlated positions? If so,
how many can you take? If you take one or two highly correlated positions,
that might be okay. Can you take 10 correlated positions? That would be
something you’d have to consider for yourself. I would probably recommend
not. I’d probably cap it at about five. That way, 5% of your account,
that’s still quite a bit, but since they move a bit differently, you may be
able to manage that.

This is something you’ll have to decide for yourself if you’re going to do
this or not, or, if you decide not to, if you have a potential trade in the
British pound-USD and a potential trade in the Euro-USD, you’re just going
to have to decide which one you want to take and take one of them.

The more work you put into your trading plan, the less stressful trading is
going to be. Test out your plan for profitability in a demo account and
don’t trade live until you are profitable. If you aren’t profitable in a
demo account, there’s no reason to think that you’d be profitable in live
trade. Live trading is even more difficult. There is more of a
psychological demand on you because it’s real money. If you can’t make
money in a demo account, do not make the switch to live trading.

Whether it’s in a demo account or live, once you’re profitable, make sure
you have tested out for at least a month. Even if you lose money in the
demo account, it will develop your discipline in sticking to the plan. A
lot of traders will create a plan, go to the demo account, they lose money
on their first day, and they decide that plan’s crap and they chuck it out,
start a new one, go into a demo account, try it, it works for a day or two
and it loses money, then they get rid of it, create a new plan. This is the
cycle. They’re always looking for something new. You develop no discipline
that way, and you’re actually developing a very bad habit.

Instead, even if you’re losing money, once you’ve created that plan, stick
to it for a month. This is going to build your discipline. You’re going to
force yourself to follow that plan. The goal as a new trader is to simply
follow your plan. If you follow that plan, eventually the money’s going to
come, because you’re going to work out what’s wrong with that plan. When
you do, you’re going to have the discipline to start following it and make
money off the good plan.

If it’s unprofitable after a month, revisit the plan and try to improve it.
Then again, you’re going to try it out in the demo account for a month
again, and this process continues until you have a profitable system. Once
you’ve made a profit for the month, you have a good system. You can still
look to refine it a little bit. Go back in the demo. Maybe your results
will improve. Until you’re profitable for a couple months in a demo
account, don’t switch to live trading. Once you are profitable for a couple
months, and then make the switch to live trading. Do exactly what you were
doing before. Continue to follow your plan exactly, and keep risk below 1%
per trade.

That’s how you build your creating plan. Make sure it’s thorough. You’re
going to create it, step into the demo account, and try it out. Stick to it
for at least a month. Make any refinements. Go back. Trade it for another
month. This is how you become a successful, disciplined trader, because
you’re going to find out what works and what doesn’t.

Until next time, happy trading.

Comments are closed.