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FOREX STRATEGY

A simple plan to trading

forex strategy simple forex trading plan

It is generally expected that more than 80% of people who set out to trade for a living will fail.  If we think of trading as a business, then you’d pretty much be buying into a failing corporation.  In fact, trading is a business and needs to be treated as such in order to achieve success.  Why do most traders fail?  There is an array of reasons, but probably to two most common obstacles are loss of emotional control and poor money management.  So, what can we do to ensure our success as aspiring traders?  The answer is actually quite simple…have a trading plan in place.

What is a trading plan?

Before we answer that, let’s elaborate more on the business of trading.  Just as you would create a business model before opening a retail store to sell widgets, the same holds true for trading.  Every trade you make is a business decision that will affect your bottom line.  Trading is not an easy business and therefore having a plan of action in place will increase your chances of joining the 20% that make it.

So to answer the question, a trading plan is a pre-determined strategy or set of rules used to base trading decisions on when approaching the markets.  Our goal with a trading plan is to eliminate the obstacles that hold us back from succeeding.

Trading Obstacles

A trader’s worst enemy is his emotions.  Good or bad, emotions are dangerous.  Generally speaking, emotional trading leads to poor decisions and impulsive reactions.  If you’ve traded before, you’ve probably experienced this.  I know I have and I see plenty of seasoned traders lose control from time to time. 

Negative emotions are obvious.  For example, they come when you lose money on a trade and throw any sensible judgment out the window in an effort to make back what you just lost, rather than moving on to the next well planned trade.  Or maybe you missed a trade and chase after it only to increase your risk and lose double what you initially intended.

On the other hand, positive emotions, like feeling good about a winning trade you just made, can be just as destructive.  That’s not to say that feeling good about a trade is a bad thing.  It’s okay to feel good, we want positive energy when trading.  But we want to keep that good emotion in check to avoid becoming over-confident.  A trader might have 4 great days in a row, then on the 5th loses everything he made for the week.  Why does this happen?  Most likely he was brewing with confidence and swung for the fences, trading bigger, then losing bigger when the trade was wrong.

Let me make this point…Trading well for a few days in a row is not an excuse to trade bigger.  You need to be consistently profitable for months on end before considering an increase in position size.

The second obstacle separating the successful traders from the unsuccessful is practicing poor money management.  To be profitable, you need to instill good risk management principles.  Too many novice traders focus on how much money can be made rather than how much can be lost and before they know it, they’re married to a bad position.

Before entering a trade, the first question should be, “What if I’m wrong?”  If this trade doesn’t work, “where am I getting out?”  In other words, “What’s my risk?”  After you’ve determined that, then, and only then, should you ask, “Where is my profit target?”  Once you’ve identified this, then you can place your trade.

Properly managing your risk will ensure you have enough bullets to withstand several losses in a row.  You’re not always going to be right, but with sound money management, over time you’ll come out ahead.  In fact, you can be right only 40% of the time and still make money by controlling your risk.

For example, assume you make 10 trades and your risk/reward for each is $100 to make $300.  If you lose on 6 of those trades, you’re out $600.  But you win on the other 4 trades at $300 each totaling $1200.  Your net profit is $600.  Of course we want to be better than 40%, but this just demonstrates how important money management is to your success as a trader.

These two obstacles pretty much go hand in hand.  Without sound money management, you will most likely trade off of your emotions.  Vice versa, if you’re trading off of emotions, you’re most likely going to abandon your money management principles.  This is what makes a trading plan vital to your success.  It will control your emotions by managing your risk.

Creating the Plan

How do we formulate a trading plan?  Let me preface this by saying, there is no

one specific way to create a plan.  For this particular trading model, we’re going to use some basic technical analysis techniques to come up with something that is simple, yet effective and based on the philosophy that no market goes straight up or down.  Rather, markets fluctuate off of support and resistance areas.  We’ll apply a simple method to obtain three areas support and resistance which in turn will provide us with key points of reference to base our trades off of.

When analyzing a market, it’s always best to begin with the larger chart time frames and work your way down.  Here we’ll examine the monthly, weekly and daily charts.  Figure 1 shows a monthly chart of the British Pound.  We’ve drawn in the Fibonacci retracement from the peak in November 2007 to the low in January 2009.  Next we’ve taken note of key highs and lows.  When scoping for highs and lows, look for double tops, double bottoms and prior breakdowns and breakouts.  Notice how the 2009 high at 17043 coincides with the 2005 low.  Finally, we’ll add in our trend lines for both long and short term.  When compiling the data, jot it down on paper or in a spread sheet with the level and its description.  For example, 17043 would have a description of Jan 2009 high/Nov 2005 low.  The reason for this is so we always know why we placed a trade.

forex strategy simple forex trading plan monthly chart GBP

Figures 2 and 3 show the weekly and daily charts the using the same methods as before.  In figure 2, note the weekly upside breakout on Oct. 12, the broken weekly uptrend line and the 38% Fibonacci level coinciding with weekly congestion lows.  On the daily chart in figure 3 we’ve added moving averages into the mix.

forex strategy simple forex trading plan weekly charts GBP

 

forex strategy simple forex trading plan daily charts GBP

After keying in all of the reference points we’ve extracted, we’ll have a spread sheet with raw data.  See figure 4.  The next step is to clean up the data and identify pockets of support and resistance.  Begin with the prior day’s settlement and work up for resistance and down for support.  When done, we’ll have our trading map in place.  See figure 5.

 

forex strategy simple forex trading plan spread sheet with raw data

forex strategy simple forex trading plan trading map

Now it’s time to set rules to our plan.  For this strategy, we’ll be buying support and selling resistance.  Next, we’ll set our risk/reward parameters.  To keep it conservative we’ll trade each level once and place our entry orders in the middle of each range.  With three Support and three Resistance areas, that translates to a max of 6 trades being executed on any given day. Our stops will be placed just below the low or high of the respective range.  This can be adjusted to suit your own risk tolerance.  Our profit objectives will be at the next range on our map.  For example, if we were to buy into the 1st Support zone at 16165-16117, our profit target will be at the 1st Resistance zone at 16300-16345.  Or, if we were to buy the 2nd Support zone, our target would be at the prior broken Support zone and so on and so forth.

Additional Rules

You must make every trade the plan offers and stick to it consistently.  I can’t stress enough how important this concept is.  If you shy away from the second or third trades because the prior one lost, the plan will most likely work against you.  You must maintain patience.  Let the market come to you and only trade at your levels.  Do not force trades that aren’t there.

And lastly, sit back and relax and watch your accounts grow.  Now that you’ve got your trading plan in place, you have a solid foundation that will lead you to prosperity.

Jeremy Ascher