A trading plan, also known as a strategy, is a must-have tool to have in your trading journey. The plan helps you identify trading opportunities, mitigate risks, and be a profitable trader. It can also help you maintain mental balance when things go wrong. Let us look at the ideal steps you need to follow when creating your trading plan.
Identify the currencies to trade
The first step of creating a good trading plan is to identify the assets you will be focusing on. You can decide to focus on small-cap companies, penny stocks, large-cap stocks, or even technology firms in the stock market. You can decide to focus on precious metals like silver and gold and agricultural products like corn and soybeans in commodities.
Similarly, there are three main types of currency pairs in the forex market you can decide to trade. You can focus on currency majors like the EUR/USD and GBP/USD, minors like the EUR/GBP and EUR/JPY, and exotics like EUR/ZAR and GBP/TRY, among others.
While advanced traders know how to trade all these pairs, new traders should focus on a small group of currencies. Preferably, they should start with majors like EUR/USD, USD/JPY, and GBP/USD. This is because these pairs tend to have deep liquidity, have vast amounts of news and economic data, and are generally predictable. Exotics, on the other hand, are relatively difficult to trade, mostly among new traders.
In short, identify potential currency pairs and possibly write them down.
Type of trader you want to be
The second part of creating your trading plan is to introspect and assess the type of trader you want to be. Fortunately, there are enough types of traders to suit any personality:
- Scalper. You can be a scalper if your goal is to open tens of trades every day. In this trading approach, you will mostly use a one or three-minute chart to identify emerging patterns, initiating a trade, and exiting once you make a small profit. You should then repeat the process tens of times every day.
- Medium-term day trader. If you are a medium-term day trader, you open several trades every day while avoiding leaving them overnight. This approach is most suitable for a part-time trader who has a full-time job. Many full-time day traders use the strategy too. In this, the ideal charts to use range from 15-minute to 1-hour.
- Swing trader. A swing trader holds their trades for a few days. Their goal is to identify an emerging pattern, place a trade, and wait for the results within a couple of days. These traders typically use a four-hour or a daily chart for their analysis.
- Long-term trader. A long-term trader identifies and holds their trades for a few weeks and months. These traders typically use a daily or weekly chart.
At this stage, you should assess your risk appetite and find the best trading style that suits you. You should use a demo account to do this.
How will you identify buy and sell signals?
After identifying and writing down your preferred currency pairs and the ideal timelines, your next step is on how you will identify your trading signals. Again, there are several approaches to do this:
- Using technical indicators. You can decide to use technical indicators like moving averages, the Relative Strength Index (RSI), moving average convergence divergence (MACD), and the Donchian channels, among others. In this stage, if you are a new trader, you should spend a few months learning about how these indicators work and how to use them.
- Using chart patterns. You can use chart patterns to identify entry and exit strategies. Some of the most popular patterns are triangles, pennants, channels, rectangles, and head and shoulders, among others. Also, you can learn more about candlestick patterns like Doji, engulfing, and stars.
- Copying trades. You can decide on being a copy trader. In this approach, you use the broker’s tools that allow you to copy trades from other experienced traders. If you are a new trader, this approach can help you leverage the experience of master traders and generate a profit. It is ideal for new traders and people who are not able to trade profitably by themselves.
Other ways of initiating trades include using trading robots and conducting intensive fundamental analysis before opening new trades.
Risk management strategies
Forex trading is often a risky practice that can see you lose all of your funds within a short duration. Therefore, as you draw your trading plan, it is important that you put in place risk management strategies to minimize potential loss. There are several approaches to use.
First, you need to identify the best leverage to use in your account. Most brokers offer a leverage of up to 1:500 for traders outside the European Union. Still, to reduce your risks, we recommend that you start your account with relatively small leverage. This will help ensure that you don’t lose a lot of money.
Second, come up with a good risk/reward ratio. This simply means that you identify the amount of money that you want to make and lose per trade. While there is no standard for this ratio, most traders prefer not to risk more than 3% of their funds per trade. Having such a ratio will help you be more profitable and reduce the overall risks you can make.
Third, figure out the size of the trades you will be executing. In forex, the size of trades is known as volume or lot sizes. Ideally, a lot size of 0.01 will make you a smaller profit than a 10-lot size trade. However, a bigger trade is always riskier than a smaller trade. Therefore, identify your sweet spot or the ideal lot sizes you will be using.
Finally, identify the time of the day when you will be trading. Fortunately, the forex market is usually open for 24 hours every day, Monday to Friday. This means that regardless of your schedule, you can easily find the time of the day when you will be trading.
Your trading plan should be sacred to you, meaning that you should ensure that you develop it within a long period. You should also write down the key aspects of the plan in a book that you read regularly. The plan will also help you simplify your trading and boost your returns in the long term.