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How to create a forex trading plan? — Step-by-step guide

When experienced traders discuss trading plans, beginners often get distracted from what is actually important. Isn't it just a matter of "learning a setup" or "executing the setup"? Unfortunately, it is not that straightforward.

Forex trading has multiple degrees of complexity, ranging from the most basic (buying and selling) to the most complicated (planned risk management, entries, exits, timeframes, and goals). Experienced Forex traders will know that the consistent application of a combination of these elements is essential for a successful trading career.   This article will work as a blueprint for achieving consistency and success in trading. It will also answer some important questions, such as why it is vital to have a trading plan and how to build a trading plan.

In this article

    Key takeaways

    • A trading strategy is a road map for how you execute trades.
    • A trading plan should be documented and executed in full. It should only be changed if it no longer works or unless you discover a method to enhance it.
    • A basic trading plan comprises guidelines for trade entry and exit, risk management, and position sizing.
    • Having a trading plan and then sticking to it is critical for trading success.
    • A trading strategy may be reevaluated and updated as market circumstances change.
    • A good trading plan suits the trader's psychology and goals.

    What is a trading plan?

    A trading plan is a set of guidelines you should follow in order to succeed in your goals. Its foundation is always money management and risk management, and from these come decisions on trade size and entry/exit criteria. A trading strategy will also set rules about how you handle open positions, what instruments you may trade, and various other relevant rules.

    How does a trading plan work?

    A trading plan combines trading principles to form a set of rules you will use in achieving your trading objectives. Assume your primary objective is to avoid major losses. Then, following a string of losses, your trading plan should include a section where you are supposed to stop trading and take a break. In the event of an extended losing period, you should try to identify flaws in your strategy and then modify your trading plan accordingly.

    Your trading plan could be simple when making a long-term investment (position trading). However, trend, swing, and day trading require detailed rules that cover numerous aspects of a trading routine. In this case, you can quickly determine if something is wrong so that you can take action and manage the outcome. Even if a trade goes against you, your trading plan should help you minimise your losses.

    Why do you need a trading plan?

    Some people believe that they don't need a trading plan to succeed. This approach may work for a short time for novice traders. However, a lack of a trading plan can result in substantial losses since a trader will inevitably have difficulties managing emotions during periods of intense market volatility or after a string of wins/losses.

    A trading plan is necessary since it can assist you in making rational trading choices and defining your ideal entry and exit criteria. A trading plan benefits you in the following ways:

    • Trading is easier since all the preparation has been done beforehand, allowing you to trade according to your pre-set criteria.
    • You already know when to close a position (take profits or cut losses), thereby reducing the effect of your emotions on your trading.
    • By strictly following your trading plan, you will come to understand why certain trades succeed, and others don't.
    • Keeping a track record of your trades in your trade plan will help you to learn from previous mistakes and enhance your skills.

    How to create a trading plan?

    Staying focused on your trading goals will be much simpler if you have a trading plan in place. Your trading plan will tell you what to do so that you can stay disciplined while limiting your losses.

    Here are some crucial aspects that you have to consider when drawing up your trading plan:

    Evaluate yourself

    Before creating your plan, you should honestly assess your market experience, your objectives, and weaknesses. For example, complex trading strategies may not be the best place to start if you're a complete beginner. It's also a good idea to establish the financial instruments with which you're most comfortable and to start by focusing on one or two markets. Whatever your ultimate aim is, be sure your strategy is designed with your motivation in mind. Consider where you want to be in 10 years and make ten yearly goals to get there. You'll want your trading plan to capitalise on your strengths over the long term.

    As you develop, you'll learn more about your strengths and shortcomings, so review and revise your strategy on a regular basis.

    Determine your trading style

    You should be able to determine which trading style suits you best. Trend or swing trading may fit you well if you're looking for long-term results and don't want to spend too much time in front of a computer screen. Alternatively, you might explore day trading if you want to trade full-time without having the risk of running your trades overnight.

    Pay attention to market hours.

    Although the forex market is open 24 hours a day, five days a week, currency pairs may only be liquid during certain hours. Volume increases when the London and European markets open because large financial institutions start trading. Trading volumes also rise after the New York session begins.

    There is a gap between the close of the New York markets and the start of the Sydney session. This is typically when trading volume falls and spreads widen. When the forex markets lack direction, you may be vulnerable to trading noise and confusion. If your strategy isn't working, it might be because you're trading at the wrong time of day.

    You can learn more about forex market opening hours here.

    Stop-loss

    Forex markets can be fast-paced.  Consequently, stops and limits should be used to help you manage your trading. Stops work as safeguards to protect you from significant losses. While limits can help you take profits on sudden favourable moves. The distance between your opening level and stop loss, multiplied by the size of your trade, should equal the percent amount in your trading capital you are willing to risk per trade. 

    Forex pairs

    You can choose from forex majors, minors, and exotics. Forex majors have the most liquidity and narrowest spreads, whereas minors and exotics can often have less liquidity and larger spreads. But again, consider market hours particularly if looking to trade exotic pairs. Developing trading strategies based on the majors means you can focus on a few pairs. But you may well find profitable opportunities outside of the majors. So make sure that you plan your trades according to your strategy, and you can always check historical data to help identify forex pairs with the most trading opportunities.

    You can learn more about the best forex pairs to trade here.

    Risk to reward ratio

    Determine what your risk-to-reward ratio will be on each trade. Will it be a constant, or may it vary for different conditions? If the latter,  then what conditions? Typically any risk-to-reward ratio equal to or above 1:1 can be profitable as long as your strategy has a good strike rate. However, the higher your risk-to-reward ratio, the better.

    Psychological aspect

    How is your emotional well-being? What are your thoughts? Have you had enough sleep? How is your relationship going? Do you say or do things out of poor emotional impulse control? How is your emotional intelligence? How do you deal with taking a loss? Do you believe you're up to the task ahead? Being self-aware is very important for making the right trading decisions because it will help you avoid mistakes like revenge trading, which is desperately trading to make back a loss.  

    Take the day off if you are not emotionally and mentally prepared to compete in the market. You’re more likely to suffer losses because of poor trading decisions if you are angry, busy, or otherwise distracted for some reason. Furthermore, your trade space should be clear of distractions. Remember that trading in forex as a career is like performing any other skill, and distractions can cost you money and peace of mind.

    Money Management

    Establish how much money you are prepared to risk in total. Remember, this is margin trading which employs leverage. As a consequence, it is a very high risk. Trading is speculation, not investing. So, your risk capital must be money you can afford to lose if everything goes wrong. It’s not your savings or holiday money. Once you’ve established this, split it up into discrete bundles. Some traders will never risk more than 1% of their risk capital per trade; others may go up to 5% or more. But the smaller the percentage, the more trades you can make. Although if you don’t have much risk capital, 1% may not be enough to trade every market, once you take risk management into account.

    Trading journal

    Most successful traders have one thing in common: they keep a trading journal that records all their trading activities. Whether they win or lose, they want to know why and how. Your trading journal will cover details such as goals, entries and exits, expectations, fundamental and technical aspects, timing, and remarks about how it turned out and how you feel.

    You should also be prepared to regularly go back and analyse the profit or loss, drawdowns, average time per trade, and other critical elements of the trades. Journaling will help you evolve over time and sharpen your skill. 

    Template to build a forex trading plan

    Here's what you will need to build a good trading plan:

    Strategy

    Understanding how markets operate means learning market structure and market dynamics, being aware of macroeconomic news events, and analysing their outcomes. Find and better understand your edge. In addition, you will have to accept the pros and cons of your trading edge. Accept that you may experience losses early in your trading career. Don't expect to win every trade; choose nearly perfect trade setups according to your edge and let them work for you.

    Understand the concept of probability, which means your edge is likely to be successful a certain number of times. For example, you may find a setup with a 70% winning probability over the past 20 years of historical data. There’s no guarantee that the 70% probability will work going forward. But you may consider working with that setup as long as you also incorporate strict risk management. 

    Always have a backup plan if your trading plan stops working. Find the flaw in your strategy and try to cope with it. In some cases, you will have to find an entirely new edge. Just don't lose hope, and keep going. 

    Tactics

    You must work to understand the ideal market environment for your trading plan. In other words, work out the best scenario for your strategy. 

    Find setups that have good risk-to-reward ratios. Define your risk per trade. As discussed above, this could be no more than 1% of your total risk capital on each trade. Remember: this is the difference in points between your opening level and your stop loss, multiplied by your trade size. 

    You can also create a  risk deployment strategy. For example, if you have a substantial amount of risk capital, you don't have to put all the money in one position; you may scale up and add positions as the price goes in your favour. Another technique that swing traders use is putting limit orders to catch corrections or short-term pull back to get a better entry.

    Then you need to set criteria for trade management. It will cover the how and why of your entries and exits. Are there predefined goals? Volatility goals? What about trailing stops?  Should you close a position if something doesn't feel right? How will you address your gut feeling? The goal here is to run your winners while cutting your losers as quickly as possible. Your trading plan can help with all this. 

    Psychology

    Consider your fundamental ideas about the market, yourself, and how the world works.  Do you execute trades based on what you feel or see and understand? Is that consideration based on your trading signals or your emotions?  Instead, it can help to be mechanical when thinking about trading and when forming your trading plan. 

    It is common knowledge that excellent physical health leads to greater mental health and vice versa. It is usually advised to avoid trading if you are not in good physical condition. Mindfulness is a byproduct of good physical health. Taking on too much risk will have negative consequences for your health, mental and physical. Make sure you always have stops in place so that fears of an adverse market movement don’t keep you awake at night. 

    Try to maintain strict discipline in your trading and only take action when there is a reason. The objective is not to find the Holy Grail that will reveal the secrets of markets because there isn’t one.  Instead, try to find a trading method that matches your personality and can help you make money in the future. 

    You must know yourself and not pretend to be someone you are not.

    Should you demo trade?

    Getting good results in demo trading does not ensure success when trading with real money. It’s during the latter that emotions enter the picture. However,  demo trading can help you find an edge by back-testing or forward-testing. You can use what you learn on a demo account to help you create your trading plan.  There is no way to ensure that every trade you make will be profitable. But careful risk and money management will boost the longevity of your trading career, and that in turn can help boost your chances of success. 

    People also ask

    Why is having a trading plan important?

    A trading plan instils discipline and helps you control your emotions. 


    What should a trading plan include?

    A premarket and postmarket routine which involves a study of trading conditions and consideration of risk management. Stop Loss, and Take Profit levels must be included in a trading strategy.


    Are trading systems and trading plans two different things?

    A trading system outlines the trading strategy of how you want to enter and exit trades.

    A trading plan will tell you how and when you will execute your trades with defined criteria such as analysis, executions, risk management, and so on.


    What is the trading golden rule?

    If you are persistent, learn from your errors, and use risk management, you can expect to be successful in trading.


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