You got a cup of coffee set up on your table for today’s hangout? Maybe a bite to it? I’m doing mine without a bite. Because coffee is best taken without an accompaniment, in solitude, or at least that’s my way. But you’re right, we are not here today to talk about coffee rules, but to cover one of the most imperative aspects of any trader approaching Forex as a business.
A trading plan is the ‘business plan’ for us, traders. The most cognizant definition of a trading plan is ‘a well written guide that is prepared when the market is closed to inform your actions when the market is open.’ That kicks the beginning of the real talk! Any trader without a properly documented trading plan that guides all their trading actions when the market is open is doomed to fail. It is the surest tool that keeps us disciplined while trading the forex markets. We dwell in a business where we are constantly influenced by greed and fear, both emotions that are hard to battle without strict discipline. Any professional out there will tell you outrightly that without adhering to a properly laid down business plan and rules, you have low chances of survival in business. Unfortunately or fortunately for us traders, we can’t grow, leave alone survive, without following one.
Having a business plan is one thing, being informed of the right content and rules therein is another. And this will be our focus today. Now you’re welcome to serve your second cup of coffee.
So what exactly is your methodology? This is the question I always pose to any new traders I meet out there, and you are not escaping it today. In case you ever meet anyone purporting to be a forex/stocks trader, please do the job for me, look straight into their eyes and shoot, ‘what exactly is your methodology? If they stutter or fumble with words, please be advised. Enough of my counseling!
The first content of your trading plan methodology is to lay down the type of trading system/analysis upon which you base your trading decisions. Is it technical/price action trading (reading the chart patterns)? Or Fundamental trading (trading mainly based on economic-news events)? The latter is not an option for me, and for us at Fourthstreet Consultants. We trade purely based on price action, which is by studying and analyzing naked charts. This is because after all is said and done, everything about the forex/stocks market, including news events is discounted on the chart price movements. Price action is based on the fact that history repeats itself. Some chart patterns that have happened before, could be five weeks back, two years ago, or ten years back, will happen again, and again. Therefore, it is upon us to learn and master these unique chart patterns and trade them to our advantage. At least that is how I am able to foot my coffee bills for our hangouts here. That said, your trading plan must explain your methodology in detail. For price action traders like us, it should document your approach to the markets based on the following:
- Trend following
- Counter trend trading
- Range bound trading
- Candlestick formations
This list doesn’t end there, but it covers the main price action methodologies.
The next aspect that your trading plan must contain as far as methodology is concerned is the specific instruments/pairs that you will be analyzing and trading. This helps you follow up and grasp the patterns of the price movements of the instruments over the long run, which is paramount for the growth of your trading skills.
Listing the timeframes that you plan to be applying for your trading is also an integral part of your methodology. Will you analyze prices charts based on the 1 hour, 4hours, daily, weekly, or monthly time frame? Our Comprehensive Forex course equips you with a strategy we call ‘the top down approach,’ which is tailored to help you make informed trading decisions on the shorter time frame, that are aligned with the long term trend. Again, you’re welcome to join us here for this and more trading mentorship.
Lastly, your methodology should define your entry and exit guides. This is where stop losses and take profits come into play. The forex market platforms offer you with parameters to control your losses as well as set targets for profits without being necessarily online or logged in your trading account. You analyze, set the targets, and go about your other biashara (Swahili word for business).
2. RISK MANAGEMENT
Risk management is the backbone of forex trading. It is the only aspect that ensures your survival in the business of forex/stock/indices trading. It is only by managing your risk exposure that guarantees us of catching the next big move. I covered this and more extensively in an earlier article titled Forex trading as a business, you can catch up with it here when you have some time.
Your business plan must define your total risk based on your trading capital. It should expound the specific percentage of capital that you should risk per trade, and as such, the maximum number of trades you can have open at any one moment. As a general rule, you shouldn’t risk more than 1% of your capital per trade, and a total of 5% of your total capital in all your open trades. These rules are to be followed to the letter to achieve consistent returns in the long run. Our forex course expounds on this topic in videos, and goes further to show sample trades and how to employ the right risk management on a live forex account.
Additionally, your trading plan must inform how to avoid trading correlated instruments. This helps to limit risk exposure. By diversifying your portfolio, you stand to outlive losses and achieve success in your trading results.
At this point, please do the Indian headshake, that way I can confirm that you follow. Okay, let’s keep at it.
3. Record Keeping/ Trading Journal
In business, we talk of keeping inventories. From records of stock supplies, to sales, to profits & losses, to miscellaneous, among others. In forex trading, we keep inventories by filling and maintaining a trading journal. This is a comprehensive document whereby you pen down your trades, right from the specific instrument that you trade, to the entry price, to the reason (set-up) for taking the trade, and the exit price of the trade. You note that I haven’t mentioned listing down your risk to reward ratio because this is like the SI unit of placing a trade position. See what I did there?
Just like any other business, keeping a record of all your trades in your trading journal helps in the evaluation of performance over time. You are able to note the pairs/instruments that are least profitable and the methodology strategies that yields the highest rate of return. This way, you get to grow in your trading career, as you can always twitch where necessary to achieve better results.
4. Psychology/Emotional Balance
I intentionally listed this aspect as the last component of your trading plan. Many a times, traders tend to underestimate how much having the right psychology and emotional balance can influence their trading results, yet it is what defines our long term success, almost ultimately. Throughout our lives, we have been programmed to avoid and hate losses. On the contrary, in trading we encounter losses frequently. I refer to them as ‘our cost of doing business.’ You cannot avoid losses in forex trading, and anyone who takes that path ends up in total ruin. As such, our job is to manage losses through setting up controls such as stop losses, trailing stop losses, and price levels available in our trading platforms.
It is your responsibility as a trader to call yourself to a meeting, understand how strong you can control your emotions of loss and fear. For instance, I advise new traders to keep off the markets for a week or so whenever they encounter a consecutive number of losses, instead of jumping back and trying ‘to make up’ for your losses. The latter only worsens the situation, as your mind won’t be in the right space to make sound decisions and for you to FOLLOW YOUR TRADING PLAN.
Everyone is different and only you can examine and put forth the best approach to help you maintain an emotional balance at all times, regardless of the trading results.
This is where we call it a day. You can master this and other aspects of Forex Trading with out top rated Forex Course. Please feel free to visit our blog on our website for our previous coffee hangouts, Okay, I mean the previous articles on other informative trading topics. Thanks ☺.