Forex Basics: Starting Your Trading Plan

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Takeaway: The purpose of a trading plan is to minimize bad trades, maximize good trades and set a framework where this becomes systematic.

Forex Basics: Starting Your Trading Plan
Source: Flickr/joelmontes
A trading plan is always a work in progress. It changes as you do, reflecting your knowledge and experiences in the market. For currency traders just starting out, a trading plan can be intimidating. In this article, we’ll look at how to start developing your trading plan.

The Joy of the Demo Account

The primary challenge that new traders face when creating a trading plan is that it is hard to plan when you’re not sure what type of trading you want to do. Demo accounts are an invaluable tool for helping you discover your trading preferences. Of course, any tool can also be abused, so it is important to run your demo account as realistically as possible rather than leveraging up on every trade simply because it’s not real money.

Properly used, a demo account allows a trader to test him or herself in order to answer the questions that will become the building blocks of the trading plan. These are:

  • What currency pairs interest you? Although it may seem a bit foolish to anchor your trading plan to a few currency pairs that catch your eye, this is a legitimate question. For fundamental traders in particular, being interested in a currency pair will provide more motivation to monitor and study it deeper. That said, being interested enough to learn the quirks and drivers of a specific pair is useful whether you trade technical signals, news or anything else.

  • What is your time frame? The question of how to choose your time frame is one that will only be answered through trial and error. Charts and strategies can be altered to fit any time frame, so the choice is literally in the hands of the trader.

  • What is your trading style? Like time frames, your trading style develops with experience. There will likely be some types of trading that you instinctually like or dislike immediately when trying them. Traders tend to create a hybrid style over time by combining elements from different styles and finding out what works. To do this, a trader needs to become familiar with the basic styles out there. The advantage of this directed learning is that each basic style - scalping, day trading, fundamental trading and so on - suggest a particular time frame.

  • What is your risk tolerance? Possibly the most important part of your trading plan is outlining how much you are willing to risk and what gains you expect in return for taking those risks. Knowing your risk tolerance won’t affect your trading style or your timeframe or the pairs you use, but it will dictate how many trades you place and for how much. Essentially, risk tolerance is the practical limit on your trading that will not come out in a demo account situation.

The Neverending Story

Developing a trading plan is a process. The reality is that a trader’s answers to these questions are never set in stone. Risk tolerance may increase or decrease with experience, time frames change with market conditions and every other factor is equally fluid. A trading plan is not a document you write once and then follow as gospel. The purpose of a trading plan is to minimize bad trades, maximize good trades and set a framework where this becomes systematic. A trading plan is a living document that grows with the trader who creates it.

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