Part III. Dealing Directly With Trading Plan (Finally!)

Dealing Directly With Trading Plan - Forex School
Commander in Pips: Although we are coming very close to the moment of trading plan creation, still you need to answer some questions. If you remember we’ve agreed about this earlier.

Pipruit: Yes, I’m ready.​

Commander in Pips: Fine, first is a question about your goals. Remember that we’ve said – your goals should be specific. Depending on your goals we will have to trade differently, particularly with different intensity and risk.

Pipruit: And what choice do I have?​

Commander in Pips: Well, almost like in plane. When stewardess comes to you with some food and offer to you, you may ask:

- “What is it?”

- “Food”

- “And what choice do I have?”

- “To eat or not to eat.”

But seriously speaking - let me a bit explain to you, since your choice will have significant impact on overall trading plan.

Let’s define the goals 

Fast rule that always works is explanation “what is a goal?” A goal is a reasonable balance between your wishes and possibilities, and preferably that they match to each other. Want to buy a goat? No, I do not have a wish to do that. May be you want to buy Porsche? Well, I would like but do not have a possibility. Do you get it? They have to match. Other worlds, if you have 10K and want 10K every month – this is some kind of “I want Porsche, but I can’t.”

Pipruit: Ok, I’ve got it. So, how we can specify this equilibrium more definitely?​

Commander in Pips: Simple. This is the risk/return riddle. As higher return you want – the greater the risk you have to take. You may risk all of your account in one trade with the highest leverage that you ever can get – this is the ultimate risk with the ultimate potential return. But as we have said that trading is a long-term business, there is another limiter that exists for these kinds of stupid impulses. This limiter is durability of standing in the trading business, consistent profit, discipline and the probability of large numbers.

Pipruit: What should I do then?​

Commander in Pips: Ok, let’s take a look at risk first. Your first thought should be – Do I have any money that I’m ready to lose, that I afford to lose? This money should be relatively free – you must not sell or put in pledge your house, car or jewelry. You must not sell down the river your wife, or a kidney. Understand? This should be sum that you afford to loose – if it will happen that you lose all this money, you should not be frustrated too much. Besides, if you will trade with money that is reserved for paying your bills or mortgage – this will be a huge psychological impact on you. You will not be able to think rationally, and constantly will be under stress. How do you think – could you win something in such conditions? This is what always happens, that market just crushes you, when you are most unprepared for that. Day by day you will see how your home, car, lunch are driven away. Next will be your wife and children. At the end you will stand without home, starving and spend your nights sleeping in the gutter. Do you want this? I guess not, but if you do – come on, put all of your hard money on Forex. Make the bet of your life.

Pipruit: That’s absolutely horrible! I do not want it how you’ve just described!
Commander in Pips: Oh, you’re really a smart guy to see this. Then you must apply strict money management rules (we will speak about them later) and sit with demo as long as you will need it – until you will not understand what dump you’re really diving into.

Commander in Pips: So we have determined what kind of money we can put in business. Now is a question about more precise goals. That’s important, since you may trade differently, depending on your goal type. This is obvious that you want to be profitable and preferably that it will be on consistent basis, but how much profitable? Since trading is a rather risky business, we want to get a corresponding premium for that. At minimum it has to be greater than bank deposit interest, following common sense. But “greater” is not the answer. Depending on what you will answer – you will probably trade at different pairs, different time frames, apply different leverage and hence risk.

Let’s suppose that you want to get 15% annually on your account. This is a good target. It will allow you to trade not too much, applying daily or even longer time-frame charts. You can spend a trading just small part of your time, and combine trading with another job. Since you will be primarily focused on daily and higher time frames, you do not need to pay for fast real-time quotes. This will be enough if you will pay for quotes with 30-min delay, for instance. You do not need have a fast and sharp broker for execution of your orders and you do not have to be an expert in market mechanics. Your target of 15% will let you apply small leverage, so drawdown of your account will be shallow. Hence, this type of trading also will be preferable for those who feel uncomfortable with large drawdowns and try to avoid them.

From the other side, you will have not many chances to trade and time lag between your trades could last some days or even weeks. Also you will have to wait the same time till completing the trade. So, this style demands the ability to be patient.

Pipruit: And what is drawdown?​

Commander in Pips: Well this is the distance between the most recent high of assets in your account to the next lowest level.

Another type of target could be much more ambitious – earn 100-150% annually. That’s quite a different story. In this case you have to spend much more time in front of your monitor. Time that will be dedicated to trading will be significant, since you will have to prepare 3-4 trading plans per day, or even greater. You hardly could work somewhere else. You will need good software and a data supplier, a fast internet connection and a good broker. So, your expenses will be much greater. You will have to apply much greater risk and leverage so your drawdown could be greater. You have to get a solid knowledge of market mechanics, since you mostly will trade on intraday charts, where behavior of dealers and market-makers are crucial to understand. Since you will not have a minute to rest while you’re trading you need an excellent stress-control system. Your trading expenses, such as fees and commissions will be greater.

From the other side, you will have a lot of opportunities to trade and your trades will be fast. Since you will trade mostly intraday - your initial trading account value could be much smaller, because orders will be much tighter.

So make your choice by yourself. Still, as we already once said – trading on longer time frames is simpler, just because you have a lot of time to think.

Anyway both approaches demand discipline and study. The second approach demands more time on study.

Pipruit: Well, I see. Probably, since I have no good knowledge of market mechanics, and have just started with this business, I’ll try to trade daily initially. Beside, I have a job that I can’t leave right now and I have to feed my family.​

Commander in Pips: Reasonable choice. 

Now the second question that has to be resolved before starting with your trading plan directly is the one about your life style. How much time could you spend on trading?

What time do you really have?

Pipruit: Well, when I come home after work, probably I have somewhere around 5-7 hours.​

Commander in Pips: Well that’s significant. So, here what you have to do during this time:

- create short-term trading plans, since you can make 2-4 trades during this period or even more;

- sit in front of your monitor to watch the market closely to accomplish your trading plan or adjust it if the market will move second way;

- Control your order executions;

- When the trading day will approach to end – fix all your trades in a journal;

- spend some time on study;

- analyze your trading system trying to understand what could be adjusted or improved;

- run through previous trades to see - are you moving in the right direction or not;

- and…

Pipruit: Wait a minute, ok, hold your horses, Sir. I will come home after my work day. First, I need some rest. Second, I have to dedicate some time to my family, since they have not seen me for a whole day, then I have to help my wife with some routine housework, help children with homework and play with them for some time. Besides, at 9 PM my favorite TV series is on. Then I have to…​

Commander in Pips: Ok, I’ve got it. It looks like you have much less time than 5-7 hours, right?

Pipruit: You’re probably right. I just didn’t think about it. So, what I can do then?​

Commander in Pips: Well, answer is simple. When you trade you can’t have any pause and digressions. You have to be 100% focused on the trading process. If you trade at home – put the lock on the door and use it. If this does not help – trade outside of your home. Otherwise, all that you will get as a result – losses and blow out of your account. You have to soberly evaluate the situation and determine the real amount of time that you can spend on trading. The rule is simple – as longer time frame you trade – as less time you need. For instance, trading daily, you can spend just an hour to make a trading plan, place orders on the market, and you will have even some time to read something or run through your trading journal.

Pipruit: I see. Thank you. Probably I’m not ready for day trading – as in terms of time that I have, as in terms of professional qualities.​

All rise! Trading plan is now in session! - Forex School
Commander in Pips: So, we’ve answered all of our preliminary questions – how much time we can spend on trading, will we intend to trade long-term or short-term, and what our goals are. Next we create an approximate business plan for start trading as a business. Let’s try to develop a trading plan.

Initially, since you’re new to markets, it’s better that your trading plan will not be too extended. Later, when you will start to get more and more experience your trading plan will become sharper, more definite and strict. But let me to offer you some ideas that could be a starting point. Based on these questions you will be able to create your first trading plan:

1. Define currency pairs, that you would like to trade, or markets if you suggest to trade at some others;

2. What particular setups do you intend to trade. For instance, you might say – I will trade MA trends, or Harmonic patterns (all or some particular ones) or classical reversal patterns, I think you’ve got the idea;

3. Specify entry point that launches the trade. For instance, Butterfly 1.618 extension target, AB=CD in Agreement with Fib resistance, crossing on neckline of H&S patterns – anything. If you apply the method of some mentor or well-known trader you will use entry/exit rules that were specified by him/her. Usually mentors describe the way and signals of how to enter and exit the trade;

4. Determine the market conditions that void the trade. Some unwelcome signs near your potential entry point. For instance too fast of a CD leg at AB=CD pattern, or a gap right at the 1.618 target of a Butterfly. By seeing these conditions you must not enter the trade;

5. Specify your trading lot volume on Forex, or number of shares, contracts etc.;

6. Specify your money management rules – how much risk you can take in each trade. This point is linked with previous one and next one;

7. Define the algorithm of stop-loss order placement. Usually the technique of stop-loss placement tightly corresponds with the system that you will use in trading. If this is Fibonacci – beyond the levels, if this is harmonic patterns – beyond completion points, MA trading – breakouts, Elliot Waves Theory – wave swings, for instance wave overlapping, etc.;

8. Determine take profit targets and how you will move stop-loss orders. This is the same – it depends on the trading system.

Use these questions and return to them again and again until this becomes second nature. They are suitable for any system that you will choose.

Here I would like to help you a bit with risk management and offer you a very simple but effective rule that could be very useful for newbie traders who have not created their own money management system just yet. Later probably you can do it better.

“Do not risk more than 2% of your current account value in each trade. Preferable risk is 1%”

This rule gets together points 5, 6 and 7. Let’s suppose, that you system tells you to place your stop by some predefined way. You may calculate 1% from your assets, and then determine lot size

Second is “3-period” rule. This rule has much deal with the 4th point. We’ve discussed it ones:

“If market does not show expected price action within 3 periods after your entry and your position is in current loss – give up the trade and exit”

For instance, you intend to trade hourly Butterfly and enter short, but during 3 hours market has not shown reversal price action and you have small current loss on it. It’s better to close it. Although you probably will miss some potential profitable trades – this approach will save you much more that you will miss.

A nice habit is to write the major point right on the chart and keep it before your eyes. Here is how it could look like – an example of butterfly that we’ve traded in our daily/video researches:

Chart#1 | 4-hour EUR/USD Butterfly trading with plan
4-hour EUR/USD Butterfly trading with plan - Forex School
Pipruit: It looks not too difficult… Besides, we’ve studied already how to deal with patterns and other tools.
Commander in Pips: Right, but there is a lot of use from it. First you will be focused on a process by trying to match what is happening and what you’ve appointed in the plan – to not miss necessary action in time. Second, you clearly understand what you are trading – this lets you precisely determine expectations about target, failure point and stop loss placement.

Commander in Pips: Third, you have an action algorithm - what you have to do at any specific moment.

Fourth, you specify right before the trade the risk value and decide to trade or not to trade in this particular case.

Fifth, by following your trading plan you control your emotions, since you act not occasionally but strictly by predefined actions. If emotions will override execution of the trading plan – that will clearly show you that you make a “mistake”, so that later you will see that you were wrong by stepping out from your trading plan.

Also, here we’re discussing a static historical chart, but when you are one on one with the market in real time – that’s quite another story. Pressures increases significantly, and to follow some predefined wise actions is much simpler that to trying invent something on a road.

And the last one, but not least – always following the trading plan falling in some positive habit and improve your discipline.

Pipruit: Well, I agree with all statements, except “mistakes.” How we should treat the situation, when I’ve followed the trading plan but lost money, and my stop has been triggered. Will it be mistake also?​

Commander in Pips: No. “Mistake” is when you do something wrong, in opposition to the rules. For instance, you do not follow trading plan, occasionally increase your risk limit, place tighter or farther stops that is opposite to your trading system, change entry/exit points by gut feeling, increase lot size etc. If you do not break the rules and get loss – this is not the “mistake”. Trading is a probability business. Sometimes, and very often you finish with loss. The most important item here is to have a system that has a positive probability of success. If you do not make any mistakes, but loose money anyway – then this will be the sign that your trading system is bad. Here is another useful feature of trading plan…

Also I would like to share with you a bit extended trading plan that involves different possibilities to trading and application of multiple time frames. Here are the major points of this plan:

1. Money management and mental/psychological control;

2. Market mechanics;

3. Trend estimation and direction that we intend to trade;

4. Overbought/oversold analysis;

5. Entry rules and technique;

6. Exit rules and technique.

Each of these points demands some education and experience:

1. For example, how you can apply mental and psychological control to yourself, if you even have not started to trade yet? Here you need some experience to understand yourself a bit. What is your endurance limit, how much you can trade without significant rest, and how much time will you have to rest and so on. On money management initially you can apply relatively simple rules – something like we’ve specified earlier. Later you can read some books on that topic and apply some more efficient technique.

2. We’ve spoken about market mechanics already. If you will trade on a daily time frame and higher you will not need a deep knowledge of it. But if you intend to trade intraday, even on very short-term charts – you will have to study it, since you will collide head-on with market-makers and dealers. So, you have to know what games could be played around significant levels, order executions etc;

3. Depending on your system here you have to estimate the overall direction that you have to trade with. It forces you to have some system of trend identification and overall direction. For instance, if you trade MA’s – then you will apply rule of penetration to identify trend. This also could be another indicators instead – MACD, Parabolic SAR etc. Also you may filter it by additional limitations. For instance, you want to see not just a MACD bullish trend but some thrusting move. Beside trend indicators, you may apply some patterns that could overrule the trend. For instance, during a Butterfly, a “buy” is forming, the trend is strongly bearish, but a reversal appears fast, and it could overrule the trend. Another example is Joe DiNapoli directional patterns. He has developed some patterns, “Directional signals” that overrule trend. If the trend, say, is bearish, but the market forms a bullish directional pattern – he trades according to the latter, since it cancels the former. Usually in any trading system of any mentor such issues exist. So initially you may try with some approach that you see as suitable for you and clear;

4. Here have to specify how you will analyze overbought/oversold. You may apply different oscillators and indicators here. We’ve discussed this in the indicator chapters;

5. Here you have to specify the rules to enter the market, depending on your system. On the example above with a butterfly we’ve shown this. This is a very important point, because it also relates to money management and stop-loss placement. Usually it tightly links with trading method or system that you are applying. Specific combinations of different indicators and methods could demand a different approach in entry technique, as well as profit targets estimation and stop-loss placement;

6. Exit rules suggest profit target estimation and stop-loss placement and moving.

If want to see how you could use this trading plan on practice – visit our education forum page and read any weekly thread.

As you can see, a trading plan is a much broader term than just a market analysis method that you will apply. Analysis method contains points 3-4 and partially 5-6. The trading plan itself is just a part of your overall plan – such nested doll…

Pipruit: I see. But now it becomes much clear for me. ​


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