If you think trading is all about using a trading strategy, then this section will prove you wrong.
There is more to day trading forex than just following a set of trading rules. A trading plan is an important element to the success in forex trading.
Forex traders should have a trading plan because it helps in forex trading psychology as well.
This section is devoted entirely to how you can create a forex trading plan. You will learn the importance of forex psychology and why it matters.
Professional traders understand the importance of trading psychology, which is why they follow a trading plan.
How to make a forex trading plan?
A forex trading plan is often confused with a trading strategy or a trading journal. But in fact, a trading plan is close to your trading strategy.
In other words, trading strategies show you when you buy or sell. Whereas a forex trading plan helps you to navigate the markets.
A forex trading plan is a blueprint for your trading system.
Many traders unfortunately, do not have a trading plan. They focus mostly on the trading strategy instead.
In this section, you will learn what is a forex trading plan and its importance. We will combine the concepts of using a trading strategy into your forex trading plan.
Why should use a forex trading plan in the first place?
A forex trading plan is the result of doing your homework in the currency markets!
If you use a trading strategy in isolation, it is prone to failures. But a trading plan helps to paint the big picture.
Traders do not realize this but creating a trading plan is important because the markets are related to each other.
What happens to the USD will impact all the major currency pairs. Likewise, the direction of these currency pairs may change.
A trading plan not only helps you connect the dots. It also helps you to understand what the markets are doing.
If your trading system signals you to a long position in the market, you should validate this signal. A forex trading plan will help you validate this.
To use a trading plan, you need to start somewhere. But we have you covered.
Your trading plan should be made up of the following:
- Planning your trades ahead
- Your trading strategy
- Risk management
Let's take a look at each of these in a bit more detail.
Planning your trades
Even before you start forex trading, planning what you want to trade and how you want to trade should be the first step.
Traders have different approach to planning their trades. Your trading style will also influence you at this point.
But you can start by looking at the forex currency pairs for the week ahead. A weekly trading plan helps you to analyze the forex markets.
As forex markets are closed on the weekend, it gives you time to thoroughly vet the different instruments.
It is prudent to always start out with a fundamental analysis in forex trading. Ask questions such as:
- What happened in the financial markets last week?
- What are the big events coming up in the next week?
- How do the forex markets look like from your vantage point?
The above three questions will help you to zoom in closer into using just a few forex pairs you may want to trade.
Armed with this knowledge, you can then move to your trading system.
How to apply your trading strategy?
Now that you already have a potential list of currency pairs, the next step is to see whether there are any trading opportunities. You will also have to validate the signals itself with the help of your trading plan.
For example, traders usually assess the viability of a trading signal. This is done by looking at the reward risk ratio for the trade they want to take. If the risk is too high, move on to another currency pair.
Never feel obliged to trade every signal your trading system points you to!
At this stage of the trading plan, you should bring in your technical analysis skills. Remember that trading involves risk, and even the best trading strategies fail.
So, it is all about how you create a trading plan where risk is an essential aspect to it.
Applying risk management concepts
Risk management will play an important role in your trading journey. It is a vital element of your forex trading plan which you cannot ignore.
You can create a trading plan that looks good in theory. But if you fail to execute it, you will end up taking undue risk.
It is extremely easy to blow up your account in forex trading! All it takes is one mistake and you will end up paying heavily for it.
Forex traders should combine the concepts of their risk tolerance alongside their trading style. This will give you a brief overview of what your money management will be.
You can start by looking at what your trading capital is and how much leverage you are using. With this information, you can then break it down into a per trade basis.
The general rule of thumb is to risk no more than one percent of your capital per trade
This 1% per trade can be from as little as $10 to $100 or even $1000. At the end, your trading capital and risk tolerance will dictate how much risk you can take in the forex market.
This information will now tell you how many trading lots you can afford for your trade.
By applying your trading style, you can tie in the money management concepts to find good risk to reward ratio set ups.
Why create a forex trading plan?
A forex trading plan helps you stay grounded. Without trading discipline, you can easily lose yourself in the heat of the moment.
A string of winning trades or losing trades can easily change your perception of the market. Hence, trading plans are essential to help you control this in forex trading.
We also recommend that you maintain a trading journal. A trading journal helps forex traders to keep track of their trading activity. Whether you lose money or make money, the trading journal will show your strengths and weaknesses.
It is always good trading practice to revisit your trade frequently. This practice helps you understand how well you are following your trading plans.
Forex psychology and why it matters
As a trader you may not realize this, but the state of your mind plays an important role in forex trading.
Trading psychology is the least understood concepts in forex trading. Yet, it plays a very big role in your overall success as a trader.
The psychology of trading is broadly categorized into two main emotions:
There are many quotes about this. From Gordon Gecko's Greed is good, to Buffett's contrarian view.
When you are trading forex, your emotions play a big role because you are dealing with money. Nobody likes to lose money, but everyone loves making money.
Even if you are trading with capital that you can afford to lose, it still leaves positive and negative emotions.
Traders get into the forex market for the sole purpose of making money. And when this purpose fails, your mental state can lead you to take wrong decisions.
What can you do to prevent these emotions from influencing you as a forex trader?
Truth is, you can't do much about it. You cannot simply prevent an emotion. You can only learn to control it.
Successful forex traders know how to control their trading psychology.
It takes years to master this but remember that everyone started at the beginning. So this is not something that is too difficult to master.
In this section on forex trading psychology, we will discuss its importance and also give you tips on how to manage your emotions when trading forex.
What is trading psychology in forex?
Forex trading psychology deals with managing your emotions when trading. It is all about understanding the emotional aspect of trading.
Emotions play a big role in our daily life. The forex market is no different. Traders have to accept losing trades, just as they welcome winning trades.
When you get too emotionally involved in forex trading, that is when mistakes creep up.
A common example is when your trading capital is set back after a couple of losing trades. This sparks different emotions. From not accepting the fact that you are wrong, to trying to get back at the market.
During such emotions, traders end up taking on more risk.
This is prevalent especially during volatile markets. You may have noticed that how markets can defy general logic. They end up moving in the opposite direction to what you thought.
In such times, the trading plan is ignored, and one feels tempted to trade in this new direction. But once you are in the trade, the markets reverse direction once again. This whipsaw market can easily make you lose more money.
As you can see, without a trading plan, you start risking more money than usual. At this point, forex trading turns to pure gambling. You have no idea what the market is doing. A trader's mind is made up to try and make money, one way or the other.
Some end up losing money entirely on their trading account, while many traders jump to the next best trading strategy. If this cycle continues, you end up with no trading strategy at all and instead lose money more frequently.
Can you control your emotions when you trade forex?
The answer is yes! It is possible to control your emotions when trading forex. But as we mentioned earlier, it takes a lot of practice.
The main thing is to detach yourself from the market. A good exercise is to compare how you trade using a demo trading account and a real account.
When demo trading, you will notice much greater success. The reason behind this is because you subconsciously know that the money is virtual.
Hence, you can risk more than usual. If your trading stop loss is hit, you don't bother much.
You move on to the next trade.
When you trade with real money, you always wish that your stop loss is not hit. On the contrary, you wish your trade to be profitable. But this does not happen all the time.
Of course, there are times when your trades hit profit multiple times and consecutively. These are rare moments. But traders also fail to keep these profits. Greed takes over and once again, you end up taking on more risk.
Eventually trading decisions are ruled by emotions. Consequently, you risk more and end up giving back the profit you made on your earlier trades back to the market.
Tips on forex trading psychology
As outlined numerous times, you cannot expect to master trading psychology by just reading a few articles. Neither can you master it by taking a trading course in psychology.
Practice alone can help you control, if not master your trading psychology
Below are some practical tips that will help you learn how to trade forex successfully, from an emotional standpoint.
#1. Start with a clear mind
Even before you plan to trade, it is important to have a clear mind.
This means having no distractions. If you think all you need is a few minutes to follow your trading strategy, then you are wrong. Trading the financial markets requires traders to navigate through various obstacles.
Find a time that you feel you are at your best and dedicate this time to create a trading plan.
#2. Technical analysis alone will not help to overcome emotions
Forex traders give technical analysis a lot more credit than what is due. Traders need to understand that technical analysis is just one piece of the puzzle. Therefore, do not spend too much time into applying different technical analysis strategies.
This is a trap that many traders fall into and is known as analysis paralysis
You end up analyzing the markets so much that you end up not knowing what the markets will do. This can be detrimental to your forex trading efforts.
#3. Leave emotions out of your trading decisions
When you begin to make trading decisions based on emotions, you are bound to go wrong. The best way to avoid this is to create a trading plan.
Traders need a plan that will guide them when the markets turn choppy. Hence, being prepared is the best option.
And the only way to prepare is to lay out clear rules for when to cut your trades and when to keep them open. At the very least, this will help you to control fear of losing or getting into the greed zone.
#4. Have a mindset of not to chase profits
Do not keep profits as the sole purpose when you start trading. Profits are just the result of a trade that was managed well.
When forex traders focus on profits, you are in essence trading on greed. All it takes is a few losing trades and that is when fear creeps in. These factors can influence your emotional side. It will lead you to risk more than what you should.
#5. The markets are always right
Traders who lose money find something to blame. Either their trading strategy, or their broker or the markets itself.
Forex traders who lose blame just about everything except themselves.
The golden rule is that the markets are always right and sadly there is no way around it.
John Maynard Keynes, a famous economist sums it up.
The markets can stay irrational, longer than you can stay solvent
Hence, if you plan to fight the market, you will certainly fail in the long term.
Accepting the truth can help you change your mindset. This is when you begin to understand the mistakes you made. Remember that sometimes you may be right, but the markets decide to flip instead.
This is perfectly normal.
Trading plans and psychology go hand in hand
In conclusion, a forex trading plan and trading psychology go hand in hand.
You cannot disassociate one from the other. In this section the main takeaway is that success in trading forex is not just about a strategy.
It is also not about how well you know your technical or fundamental analysis. Success in forex is all about applying the knowledge with a goal of managing your risk.
You can have the worst trading strategy, but with good money management, you can still churn a profit.