How to Build a Four-Point Trading Plan
by James Stanley , Currency Strategist
Price action and Macro.
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- Failing to plan is planning to fail; every trader needs a trading plan.
- This article covers the what, how, when, and why that needs to be answered in the plan.
- Sample strategies are referred for multiple trader types in the section for the ‘how.’
Trading plans are a lot like insurance: People don’t usually want it until they’ve already faced a catastrophe. But after that catastrophe; maybe it was a big loss on a single position, or perhaps even worse, a margin call from one bad trade, the trader will often recognize that something needs to be done.
But regardless how one gets there, just the fact that they arrive at the destination of realizing that a trading plan isn’t just a preference, but often a necessity is generally a positive development in the career of the trader.
The next quandary that follows is usually along the lines of, ‘well how do I go about creating a trading plan?’
What follows are suggestions for that trading plan. This is a way where traders can define their approach and strategies for approaching the market: Think of this like the personal ‘constitution’ of the trader; the document that outlines the strategies, operations and procedures with which that trader is looking to implement in the marketplace.
The most important aspect of a trading plan is the definition of the type of trader that you are. And if you’re a new trader and aren’t quite sure of what type of trader you want to be, it’s ok to modify this as you see more results and get a better idea of which direction you want to move towards.
The benefit behind this is that it helps to keep you grounded. Let’s say that you’re a technical swing trader, but with an upcoming NFP report you see an especially attractive setup that you decide is worth of a quick scalp position.
Well, if that scalp doesn’t work out and a loss is taken – the ‘what’ of a trading plan serves as a reminder that you were trading outside of your comfort zone. Below is a table with various types of trader ‘styles’ that one may look to use as a portion of this section of the trading plan.
Various Trader Types and Characteristics of Each
Characteristics of this style
Holds trades for a few minutes to a few hours
Holds trades for less than one day; slightly longer-term focus than scalpers
Holds trades from a few hours to a few days
Holds trades for a few days to a few weeks
Holds trades for at least a day and, if possible, multiple years
Holds trades as long as need-be to build and work a position
Table of potential trader types; Created by James Stanley
A trading plan is worthless without a definition of ‘how’ a trader wants to enter and manage positions. This can be as simple as ‘I’m going to scalp trends,’ to as complex as ‘I’m going to take scalps with 8 period EMA crossovers on the 5 minute chart when price is below the 34 period hourly EMA.’
It really just depends on how in-depth you want to be. The benefit of having a more well-defined strategy in this portion of the plan allows you to come back later to troubleshoot if results aren’t meeting your expectations. A more loosely-defined strategy in this section of the plan may lead to a lack of discipline when you’re actually placing trades as the trader hasn’t made the commitment to the strategy by integrating it as part of their trading plan.
An important note here – the strategy should be yours, customized for your unique risk tolerance and personality. This should also mesh with the ‘what’ of the trading plan, as this is an extension of the type of trader you are.
In the table below, we include links (under the column for ‘sample strategy’) for strategies that have been published by DailyFX for each of the types of traders that we defined above. Once again, you want to make sure that any strategy that is part of your plan is custom-fit specifically for yourself. So please feel free to take the framework of any of the below strategies and modify it as you see fit to more comfortably agree with your trading style.
Potential strategies (available by clicking on each link) for each trader type
Potential strategies (with links) for each trader type; Created by James Stanley
This part of the plan is often missed by traders; as many markets somewhat define when you’re actually able to trade. If you’re a stock trader, well you have to adhere to open market hours. Even then, many traders choose to focus on the first or last hour of the day, as this is where the majority of volatility will often take place.
But in the Forex market, there is quite a bit more flexibility available to the trader – and this isn’t always a positive thing. The FX Market moves 24 hours a day, and will often display differing characteristics based on the time-of-the-day and the area of the world that is providing liquidity. Below is a chart taken from our article Trading the World that helps to define some of these major characteristics.
The session being traded can have a massive impact on results
The importance of defining the ‘when’ of a trading plan is that it allows traders to learn and improve upon their strategies and approach with as few moving variables as possible. If a trader normally implements their strategy during the Asian session , but for some reason couldn’t get to sleep and finds themselves trading during the London open with the same strategy; they are introducing an entirely new and unfamiliar risk into their approach.
Namely, the trader is using a strategy built for a markedly different time-of-day. While the Asian session will often be slower with smaller moves, more amenable for range-trading; the London open is often highlighted by quick, violent, and sharp moves that can make a range-trading strategy look pretty bad. If you don’t believe the deviation that can be seen in a strategy based on the time-of-day or session being traded, take a look at The Best Time of the Day to Trade Forex by David Rodriguez. In the article, David took a simple RSI strategy and showed that it gave some pretty undesirable results when allowed to run all-day, every day (depicted by the red line in the chart below).
But when focused on the Asian trading session (the gold line in the below chart), the same simple RSI strategy looked significantly better.
The same strategy performed better when focused in the Asian-trading session (gold line)
Taken from The Best Time of Day to Trade Forex , by David Rodriguez
Time-of-day is important in the FX market; so define when you’re going to be trading so that you can focus on improving your approach on the type of market condition that you’re speculating in.
The last part of the plan is, in my opinion, the most important. This is where you write down your goals and reasons for becoming a trader. This can be as ambitious as ‘I want to be a billionaire,’ to as reasonable as ‘I want to replace my income so that I can spend more time with my family.’ I strongly encourage you to set realistic, honest goals otherwise they’re nearly impossible to adhere to. I speak from experience.
Trading isn’t easy. It can be difficult, and tough, and costly, and frustrating all at the same time. Especially when we have fundamental environments that, as we say in Texas, ‘is about as clear as mud.’
But the fact-of-the-matter is that just having the opportunity to make money in markets is a privilege. If we look around the world right now, there are multiple areas of the world that seem to be on the brink of some type of conflict. People fight in these conflicts, and if those conflicts get bad enough people lose their lives. In the 21 st century with the massive amount of technology that has made the world exponentially smaller, more opportunity is open to more people than ever before. Markets are one of the few ways that someone with little formal education, and not much start-up money can actually improve their lot in life. The FX market doesn’t care if you come from a farming family in rural China or whether you have an Ivy League MBA from The Wharton School of Business. Anyone can potentially make money, and everyone can lose money.
The ‘why’ of a trading plan serves as the reminder for why you’re willing to go through the pain; and when times get difficult or a major drawdown is seen on the account, this can help to provide perspective of ‘the bigger picture.’ This allows the trader to take a step back in order to realize that the reasons they want to become a successful trader are worth any trials or tribulations that they may go through.
If the goal doesn’t seem worth the frustration any longer, then at the least you know its time to take a step back and either re-evaluate your options, or quit.
To quote Harvey Dent in The Dark Knight, ‘The night is always darkest just before dawn.’ The ‘why’ of a trading plan serves as a reminder that the sun will still come up, regardless of how dark it may ever really seem.
-- Written by James Stanley
James is available on Twitter @JStanleyFX
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