A good trading plan is crucial to a successful trading endeavor. Without a plan and a rules-based approach the spread trader is simply operating by the seat of his pants. He or she may be successful for a period of time, but without a comprehensive logical approach, replicating that success on a consistent basis will be very difficult.
Furthermore a lack of a trading plan often leads to impulsive trading, which is the most dangerous trading of all. Impulsive trades typically lead to a quick ruin of a trading account because they tend to be reactive and emotionally driven. Often one loss will lead to another as the desire to “make it back” begins to cloud a trader’s judgment and he or she begins to place orders randomly in a futile attempt to extract profits from the market.
A trading plan, on the other hand, serves as steady anchor in chaotic markets, providing a clear reference source of when to enter and exit the market.
The key to crafting a good trading plan is precision and detail. For the trading plan to be useful, it must contain unambiguous rules-based signals for trade selection, stops, entries and potential profit targets.
Here are some questions that a trader needs to consider when constructing a trading plan:
- Will I trade only one specific currency pair or many?
- Will I trade on an intra-day basis or hold my positions for days or longer?
- What will be my maximum risk per trade?
- If I trade on an intraday basis, how many consecutive losses will I tolerate before stopping for the day?
- Will I generate signals using technical analysis or fundamental analysis?
- What will be the specific rules of my setup? (For example: I will enter a long trade when the price crosses the 20-period simple moving average on a five-minute chart.)
- Will I use fixed point stops or chart based stops to control my risk?
- Will I have one profit target or will I scale out of my position?
Once these questions are answered, the trader should actually write out a short but detailed plan of action. On the next page, we have a brief worksheet to help establish your plan.
Next, comes the hardest part — adherence to the trading plan. The best way to ensure that you follow your trading plan is to maintain a diary of every one of your trades. By writing down each trade and the reason for why you made it you can have a recorded account of your trading history. This will not only help you understand the strengths and weaknesses of your trading strategy, it will force you to follow your rules and avoid impulsive trading as much as possible.