The Importance of Having a Forex Trading Plan

January 6, 2012 06:02 AM

When approaching a field like forex trading where personal decisions translate into profits or losses, having a well-outlined and easy-to-follow plan can make the difference between success and failure.

Having a plan to be successful in any field of endeavor is highly recommended, but trading the forex or any other financial market without a plan is almost a sure recipe for failure. Virtually every successful trader in the markets depends on some sort of plan or guidelines for their success.

How Traders Develop Trading Plans
A trading plan to a trader is much like a road map to a traveler. The road map shows a traveler where they are and how to get to where they are going and it gives them an overall trade strategy to follow.

In essence, a trading plan gives a forex trader all the information they need to initiate a trade, liquidate the trade for a profit or take a small loss if the trader was in error.

Most traders use some element of technical analysis to develop their trading plans. Technical analysis involves the study of prices and volume of a currency pair, commodity or stock as well as indices.

Technical analysis also consists of different indicators based on the price and volume information that generate buy and sell signals in the market. An example of one of these indicators would be a "moving average."

Moving averages are just that: an average of the price of the currency pair or commodity over a period of time, for example a 10-day MA would be the average of the price over a 10-day period.

Using Technical Indicators for a Trading Plan
As an example of an indicator that might be included in a trading plan, two moving averages of different time-frames crossing over could constitute a trading signal. Let's assume the 30-day moving average has "crossed over" the 10-day MA, meaning that the 30-day has gone above the 10-day.

In an upward moving market, the indication would be bullish and would constitute a buy signal for the trader. The trader may then initiate a trade, buying the currency pair or commodity.

The above was just an example of how a trader might incorporate a technical indicator to a trading plan to initiate a trade. Other elements tend to be added to the plan, including a risk-management component.

Risk and How Traders Control It
Any good trading plan will include a risk management component. Risk management makes up one of the most important elements of a trading plan and will keep a trader in business even after a string of losing trades.

Once positions are initiated, a savvy trader will use "stop-loss" orders, in other words, if a trader initiates a position by buying EUR/USD at 1.35, they can immediately enter an order to sell the position if the pair drops to 1.34, taking a loss on the trade, but limiting the loss nevertheless.