How To Create A Profitable Trading Plan That Works
“Give me six hours to chop down a tree, and I will spend the first four sharpening the axe.” This quote by Abraham Lincoln fully highlights how important your trading plan is to your success. Let’s embark on a journey together where you will learn to create a winning strategy that suits your trading style and portfolio.
On this page
- What Is a Trading Plan?
- What to Consider When Creating a Trading Plan
- How Much Time Can You Commit?
- What are Your Short-Term and Long-Term Goals?
- How much are you willing to risk?
- Which broker is more suited for you?
- Why do You Need a Trading Plan?
- How to Develop Your Trading Plan
- Write Down Your Trading Goals
- Choose a Trading Strategy
- Develop Your Trading Strategy
- Entry and Exit Rules
- Trading Appetite
- Choose a Risk-Reward Ratio
- Have a Good Trading Routine
- Learn About Risk Management
- Backtest Your Strategy and Make Sure it Works
- Track Your Trades
- Manage Your Emotions
- Keep a Trading Journal
- The Key to a Winning Trading Plan
What Is a Trading Plan?
A trading plan serves as a roadmap that guides your trading decisions. It details all aspects of your forex trading activities from beginning to end and ensures you control your trades to the best of your ability. A trading plan outlines your trading strategy for entering and exiting trades. Profiting from the forex market requires more than luck; it necessitates a robust skill set and a well-defined trading plan.
What to Consider When Creating a Trading Plan
Here are some key questions to answer before creating your trading plan:
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How Much Time Can You Commit?
Can you trade during your work hours? Do you need to monitor your trades early in the morning or late at night? Depending on your time zone, you can only trade specific forex trading sessions, and you’d have to tailor your trading plan to suit that particular session.
If you aim to execute many trades daily (scalper), you will require a greater time commitment. However, if you only have a few hours to trade daily, you might prefer position trading. You can always use stop loss, limit orders, and alerts to mitigate risks.
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What are Your Short-Term and Long-Term Goals?
Your goals will determine your approach to the market and your preferred assets. Long-term or short-term investment goals will also affect your risk tolerance and trading style.
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How much are you willing to risk?
Your goals will determine your approach to the market and your preferred assets. Long-term or short-term investment goals will also affect your risk tolerance and trading style.
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Which broker is more suited for you?
Many traders are unaware that their broker selection significantly impacts their trading success. A reputable broker offers convenient trading conditions such as cheap spreads, transaction costs, and fast execution times.
Why do You Need a Trading Plan?
There are many advantages to sticking with a trading plan, including:
- A trading plan allows you to create performance metrics and analyze your trading operations. You’ll know if you’re winning and how to continue your winning strategy. It also lets you learn from your previous trading blunders and improve your judgment.
- It reduces your risk of developing emotional turmoil as it eliminates impulsive decisions.
- Working with a trading plan lowers the number of bad trades you make. You already know when to take profits and cut losses.
- A trading plan makes trading easier. You don’t have to worry about what to do in specific situations.
How to Develop Your Trading Plan
A trading plan acts as a map for your trading activities, giving structure and discipline to your approach. Here is a step-by-step guide you can use to create a winning approach to trading:
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Write Down Your Trading Goals
Having goals you are passionate about gives you something to look forward to every morning. Set clear, achievable trading goals, as they help you understand what you want to get out of your trading and give you a way to measure your progress.
It’s essential to use the SMART criteria when setting goals, which stand for Specific, Measurable, Achievable, Relevant, and Time-based. For example, “I want to increase the value of my whole portfolio by 100% in the next two months.”
You can easily break this down to a 12.5% increase weekly and a 2.5% increase daily if you only trade five times daily. There will be setbacks, but you’ll know at the end of the week if you are on track to meet your goals, and learn valuable lessons as you do this.
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Choose a Trading Strategy
There are different ways to trade. Your choice should match your trading goals, how much risk you can take, and your money goals. Here are the most common trading ways for Forex traders:
- Scalping: This involves making many trades per day, for a few seconds or minutes, to try to make small profits that add up to a significant amount.
- Day trading: This is a way to trade that involves buying and selling on the same day to take advantage of short-term price changes.
- Swing Trading: Swing trading is a way to trade that involves holding trades for a few days to take advantage of price changes that will happen in the next few days or weeks.
- Position Trading: Position trading involves keeping trades open for a long time, like a few weeks, months, or even years. Most position traders use fundamental analysis to find long-term trends and look for chances to enter and exit trades.
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Develop Your Trading Strategy
After choosing your trading way, there are other essentials to develop. A detailed strategy needs to be made. First, outline rules for selecting trades. This can include technical indicators, fundamental analysis, or a combination of both. Finally, when building the strategy, you must specify entry and exit tactics, how many trades you want to take, and position sizing.
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Entry and Exit Rules
Define the conditions that must exist before you enter or exit a trade. If, for example, you have five conditions, but a trade setup meets only three or four, you should not take that trade.
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Trading Appetite
This refers to the number of trades you want to take and the relative chances of success. A big portfolio allows you to take many trades.
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Choose a Risk-Reward Ratio
Before you start trading, figure out how much risk you will take. Think about how much you could lose on a single trade and overall. Deciding your risk limit is fundamental.
Market prices constantly change, so even the safest investments have some risk. Some new traders prefer to take less risk to start, while others take more risk, hoping to make more significant profits. It’s up to you.
It’s possible to lose more trades than you win and still make a profit overall. This depends on your risk versus reward. Traders often use a risk-reward ratio of 1:3 or higher. This means the possible profit on a trade should be at least double the potential loss. To find the risk-reward ratio, compare the amount you could lose to the amount you could gain.
For example, if you have $1,000 to trade with. You decide your maximum risk per trade is $50. You enter a trade where your potential loss is $50, but your potential profit is $200. In this case, your risk-reward ratio is 1:4 ($50 risk for $200 potential reward). Even if you lose a few trades like this, as long as you have more winning trades, you can still be profitable overall because your wins are more prominent than your losses.
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Have a Good Trading Routine
Successful trading relies on maintaining consistency in your trades and lifestyle. If you’re not a full-time trader, chances are you have various other responsibilities to juggle, so it’s crucial to incorporate trading into your daily schedule.
Remember, it’s not necessary to trade every day. If you’re feeling under the weather or unfocused, skipping trading for that day is okay. The markets will still be there tomorrow. The key is to approach your trades consistently and focus whenever you actively engage in trading activities.
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Learn About Risk Management
Bouncing back from small losses is easier because you learn more as you trade. Risk management involves protecting your capital as much as possible. It is a crucial component of trading that safeguards your investment:
- You should set aside a portion of your investment for each trade and stick to the predetermined limit for your account. This limit should match the amount you’re prepared to lose in a trade. It’s generally advisable not to risk more than 2–3% of your investment capital per trade, which is sound financial and psychological advice.
- Understand how to use stop loss, take profit, limit orders to cap losses, and establish clear profit targets to lock in gains. Being overly greedy can have negative effects over time, so knowing when to exit trades is critical. Secure your profits on a position per trade and on a daily basis.
- Diversify your portfolio and learn about the correlation of different assets. Ideally, you want to trade assets with minimal or no correlation.
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Backtest Your Strategy and Make Sure it Works
After you’ve developed a trading plan that suits you, the next step is to put it to the test with historical data through backtesting. This means applying your strategy to market conditions to evaluate its performance. This can help you pinpoint any flaws in your approach before trading with real money.
Tools and platforms, such as the Pine script on TradingView, are available to assist you in backtesting your strategy effectively. Using a large dataset is vital to ensure that your findings are statistically valid. If a trading strategy proves ineffective, it’s wise to set it aside and refrain from making trades until you devise a new plan.
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Track Your Trades
Keeping track of your trades is essential, but it doesn’t have to be complicated. You can use a spreadsheet or a binder to record your trades. The important thing is to have a system in place.
Whenever you enter a trade, take a screenshot of the chart. Save the screenshot in your spreadsheet or print it out and put it in your binder. Do the same when the trade is closed to record the outcome.
Organize your trades in a way that makes sense to you, such as by market or trading strategy.
Tracking your trades will help you:
- Spot patterns in the markets and your trading approach.
- Learn from your losses. Review past trades and look for similarities.
- Reflect on your progress. You’ll have a physical record of how far you’ve come.
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Manage Your Emotions
Your trading strategy is designed to help you keep your emotions under control, but because the financial markets are so volatile, it is easy to deviate. To effectively implement your trading strategy, you must also manage your emotions. You can read books on trading psychology to learn how to handle the market and your emotions effectively.
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Keep a Trading Journal
It’s important to have a trading journal to keep track of the essential highlights of your trades. Record all your trades in your journal, and it will give you insights into what strategies are successful and what needs improvement.
Remember to note the technical aspects like entry and exit points, the reasoning behind your trades, and how you felt during the process. If you stray from your plan, note why and what happened. The more information you include in your journal, the more beneficial it will be.
The Key to a Winning Trading Plan
A good plan requires careful consideration of your goals, risk tolerance, trading style, and strategy. Following the steps outlined above, you can create a personalized trading plan that serves as a roadmap for your goals. Make sure to keep yourself updated about market trends, economic updates, and the latest trading strategies. Read relevant books, participate in seminars, and stay connected with trusted financial news outlets. Remember, a thriving trader is always a learner. A trading plan is not a static document but should only be updated when discovering another effective approach.
