What is a Trading Plan?
Alright you are almost done with school, here’s one piece of advice you should always remember.
Be your own trader.
In other words: Don’t follow someone else’s trading advice blindly! Just because someone may be doing well with their method, it doesn’t mean it will work for you.
We’re all in different situations in life, and we all have different market views, thought processes, risk tolerance levels, and market experience. Have your own personalized forex trading plan and update it as you learn from the market.
With rock solid discipline, your trading could look like this.
Developing a Trading Plan and sticking to it are the two main ingredients of trading discipline. But trading discipline isn’t enough. Even solid trading discipline isn’t enough.
Plastic solid discipline won’t do. Nor will discipline made from straws and sticks. We don’t want to be little piggies.
We want to be successful traders!
And having rock solid trading discipline is the most important characteristic of successful traders.
A trading plan defines what is supposed to be done, why, when, and how. It covers your trader personality, personal expectations, risk management rules, and trading system(s).
When followed to, a trading plan will help limit trading mistakes and minimize your losses. After all, “If you fail to plan, then you’ve already planned to fail.”
A trading plan removes any bad decision making in the heat of the moment. Your emotions can consume you when money is on the line, causing you to make irrational decisions. You don’t want that to happen.
The best way to prevent it from happening is to minimize (notice we did not say eliminate) thinking by having a plan for every potential market action. With the right forex trading plan, every action is spelled out, so that in the heat of the moment you don’t have to make any rash decisions. You just simply stick to your trading plan.
The Difference Between a Trading Plan and a Trading System
Before we continue, we have to quickly distinguish the difference between a trading plan and a trading system.
A trading system describes how you will enter and exit trades.
A trading system is part of your trading plan but is just one of several important parts, i.e., analysis, executions, risk management, etc.
Since market conditions are always changing, a good trader will usually have two or more trading systems in his or her trading plan.
Trading systems will be covered more in-depth later on in the lesson, but we thought that it was important to point out the difference between the two upfront to avoid any confusion.
How To Create A Mechanical Trading System
So far, we’ve taught you how to develop your trading plan. We’ve also discussed how important it is for you to discover which type of forex trader you are.
Next, we’re gonna teach you how to add some meat to your thin trading plan frame by showing you how to create a forex trading system.
More specifically, we’re gonna teach you all about forex mechanical trading systems.
Mechanical trading systems are systems that generates trade signals for a trader to take. They are called mechanical because a trader will take the trade regardless of what is happening in the markets.
In theory, this should eliminate all biases and emotions in your trading, because you are supposed to follow the rules of your system NO MATTER WHAT.
If you do a simple search in Google for “forex trading systems” you’ll find many many many people out there who claim to have the “Holy Grail” system that you can purchase for “only” a few thousand dollars.
These systems supposedly make thousands of pips a week and never lose. They will show you supposed “results” of their perfect systems and it will make your eyeballs turn into dollar signs as you sit there and say to yourself, “Wow I can make all this money if I just give this guy $3,000. Besides, if his system making thousands of pips a week, I’ll be able to make my money back in no time.”
Slowww down cowboy. There are some things you should know before you give them your credit card number and make that impulse buy.
The truth is that many of these systems DO in fact work. The problem is that forex traders lack the discipline to follow the rules that go along with the system.
The second truth (Is there such thing as a second truth?) is that instead of paying thousands of dollars on a system, you can actually spend your time developing your own mechanical trading system for free, and use that money you were going to spend as capital for your forex trading account.
The third truth is that creating mechanical trading systems isn’t that difficult. What is difficult is following the rules that you set when you do develop your system.
There are many articles that sell systems, but we haven’t seen any that teach you how to create your own system.
Goals for your mechanical trading system
When developing your mechanical trading system, you want to achieve two very important goals:
- Your system should be able to identify trends as early as possible.
- Your system should be able to avoid you from whipsaws.
If you can accomplish those two goals with your trading system, you have a much better chance of being successful.
The hard part about those goals is that they contradict each other.
If you have a system who’s primary goals is to catch trends early, then you will probably get faked out many times.
On the other hand, if you have a mechanical trading system that focuses on avoiding whipsaws, then you will be late on many trades and will also probably miss out on a lot of trades.
Your task, when developing your mechanical trading system, is to find a compromise between the two goals. Find a way to identify trends early, but also find ways that will help you distinguish the fake signals from the real ones.
If you have no idea where to start, drop by our Free Forex Trading Systems thread in our forums. Tons of forex traders post their ideas for trading systems, so you may find one or two that you can use when you build your own mechanical trading system.
Design Your Trading System in 5 Steps
The main focus of this class is to guide you through the process of developing your own forex trading system. While it doesn’t take long to come up with a system, it does take some time to extensively test it. So be patient; in the long run, a good forex trading system can potentially make you a lot of money.
The main focus of this class is to guide you through the process of developing your own forex trading system. While it doesn’t take long to come up with a system, it does take some time to extensively test it. So be patient; in the long run, a good forex trading system can potentially make you a lot of money.
Step 1: Time Frame
The first thing you need to decide when creating your system is what kind of forex trader you are.
Are you a day trader or a swing trader? Do you like looking at charts every day, every week, every month, or even every year? How long do you want to hold on to your positions? of course my suggestion is to choose swing trading, because it allows you to develop the patience skill needed for both your trading carrier and life in general.... So? choose swing trading.
This will help determine which time frame you will use to trade. Even though you will still look at multiple time frames, this will be the main time frame you will use when looking for a trade signal.
The first thing you need to decide when creating your system is what kind of forex trader you are.
Are you a day trader or a swing trader? Do you like looking at charts every day, every week, every month, or even every year? How long do you want to hold on to your positions? of course my suggestion is to choose swing trading, because it allows you to develop the patience skill needed for both your trading carrier and life in general.... So? choose swing trading.
This will help determine which time frame you will use to trade. Even though you will still look at multiple time frames, this will be the main time frame you will use when looking for a trade signal.
Step 2: Find indicators that help identify a new trend.
Since one of our goals is to identify trends as early as possible, we should use indicators that can accomplish this. Like i teach here at Pips Akademy, Moving averages are one of the most popular indicators that traders use to help them identify a trend... And this is the only indicator I use! No MACD, STOCHASTIC etc
Specifically, they will use two moving averages (one slow and one fast) and wait until the fast one crosses over or under the slow one. This is the basis for what’s known as a “moving average crossover” system.
In its simplest form, moving average crossovers are the fastest ways to identify new trends. It is also the easiest way to spot a new trend.
Of course there are many other ways forex traders spot trends, but moving averages are one of the easiest to use.
Since one of our goals is to identify trends as early as possible, we should use indicators that can accomplish this. Like i teach here at Pips Akademy, Moving averages are one of the most popular indicators that traders use to help them identify a trend... And this is the only indicator I use! No MACD, STOCHASTIC etc
Specifically, they will use two moving averages (one slow and one fast) and wait until the fast one crosses over or under the slow one. This is the basis for what’s known as a “moving average crossover” system.
In its simplest form, moving average crossovers are the fastest ways to identify new trends. It is also the easiest way to spot a new trend.
Of course there are many other ways forex traders spot trends, but moving averages are one of the easiest to use.
Step 3: Define Your Risk
When developing your forex trading system, it is very important that you define how much you are willing to lose on each trade. Not many people like to talk about losing, but in actuality, a good trader thinks about what he or she could potentially lose BEFORE thinking about how much he or she can win.
The amount you are willing to lose will be different than everyone else. You have to decide how much room is enough to give your trade some breathing space, but at the same time, not risk too much on one trade. You’ll learn more about money management in a later lesson. Money management plays a big role in how much you should risk in a single trade.
When developing your forex trading system, it is very important that you define how much you are willing to lose on each trade. Not many people like to talk about losing, but in actuality, a good trader thinks about what he or she could potentially lose BEFORE thinking about how much he or she can win.
The amount you are willing to lose will be different than everyone else. You have to decide how much room is enough to give your trade some breathing space, but at the same time, not risk too much on one trade. You’ll learn more about money management in a later lesson. Money management plays a big role in how much you should risk in a single trade.
Step 4: Define Entries & Exits
Once you define how much you are willing to lose on a trade, your next step is to find out where you will enter and exit a trade in order to get the most profit.
Some people like to enter as soon as all of their indicators match up and give a good signal, even if the candle hasn’t closed. Others like to wait until the close of the candle.
It’s all really just a matter of trading style. Some people are more aggressive than others and you will eventually find out what kind of trader you are.
For exits, you have a few different options. One way is to trail your stop, meaning that if the price moves in your favor by ‘X’ amount, you move your stop by ‘X’ amount.
Another way to exit is to have a set target, and exit when the price hits that target. How you calculate your target is up to you. Some people choose support and resistance levels as their targets.
Others just choose to go for the same amount of pips on every trade. However you decide to calculate your target, just make sure you stick with it. Never exit early no matter what happens.
Once you define how much you are willing to lose on a trade, your next step is to find out where you will enter and exit a trade in order to get the most profit.
Some people like to enter as soon as all of their indicators match up and give a good signal, even if the candle hasn’t closed. Others like to wait until the close of the candle.
It’s all really just a matter of trading style. Some people are more aggressive than others and you will eventually find out what kind of trader you are.
For exits, you have a few different options. One way is to trail your stop, meaning that if the price moves in your favor by ‘X’ amount, you move your stop by ‘X’ amount.
Another way to exit is to have a set target, and exit when the price hits that target. How you calculate your target is up to you. Some people choose support and resistance levels as their targets.
Others just choose to go for the same amount of pips on every trade. However you decide to calculate your target, just make sure you stick with it. Never exit early no matter what happens.
Stick to your trading system!
After all, YOU developed it!
One more way you can exit is to have a set of criteria that, when met, would signal you to exit. For example, you could make it a rule that if your indicators happen to reverse to a certain level, you would then exit out of the trade.
After all, YOU developed it!
One more way you can exit is to have a set of criteria that, when met, would signal you to exit. For example, you could make it a rule that if your indicators happen to reverse to a certain level, you would then exit out of the trade.
Step 5: Write down your system rules and FOLLOW IT!
This is the most important step of creating your trading system. You MUST write your trading system rules down and ALWAYS follow it.
Discipline is one of the most important characteristics a trader must have, so you must always remember to stick to your system! No system will ever work for you if you don’t stick to the rules, so remember to be disciplined.
Oh yeah, did we mention you should ALWAYS stick to your rules?
This is the most important step of creating your trading system. You MUST write your trading system rules down and ALWAYS follow it.
Discipline is one of the most important characteristics a trader must have, so you must always remember to stick to your system! No system will ever work for you if you don’t stick to the rules, so remember to be disciplined.
Oh yeah, did we mention you should ALWAYS stick to your rules?
How to Test Your Forex Trading System
The fastest way to test your system is to find a charting software package where you can go back in time and move the chart forward one candle at a time. When you move your chart forward one candle at a time, you can follow your trading system rules and take your trades accordingly.
Record your trading record, and BE HONEST with yourself! Record your wins, losses, average win, and average loss. If you are happy with your results then you can go on to the next stage of testing: trading live on a demo account.
Trade your new system live on a demo account for at least two months. This will give you a feel for how you can trade your system when the market is moving. Trust us, it is very different trading live than when you’re backtesting.
After two months of trading live on a demo account, you will see if your system can truly stand its ground in the market. If you are still getting good results, then you can choose to trade your system live on a REAL account.
At this point, you should feel very confident with your forex trading system and feel comfortable taking trades with no hesitation.
The fastest way to test your system is to find a charting software package where you can go back in time and move the chart forward one candle at a time. When you move your chart forward one candle at a time, you can follow your trading system rules and take your trades accordingly.
Record your trading record, and BE HONEST with yourself! Record your wins, losses, average win, and average loss. If you are happy with your results then you can go on to the next stage of testing: trading live on a demo account.
Trade your new system live on a demo account for at least two months. This will give you a feel for how you can trade your system when the market is moving. Trust us, it is very different trading live than when you’re backtesting.
After two months of trading live on a demo account, you will see if your system can truly stand its ground in the market. If you are still getting good results, then you can choose to trade your system live on a REAL account.
At this point, you should feel very confident with your forex trading system and feel comfortable taking trades with no hesitation.
Build Your Trading System in 6 Steps
In this section we’ll give you a rough picture of what a trading system should look like. This should give you an idea of what you should be looking for when you develop your own forex trading system.
In this section we’ll give you a rough picture of what a trading system should look like. This should give you an idea of what you should be looking for when you develop your own forex trading system.
Trading Setup
- Trade on daily chart (swing trading)
- 5 SMA applied to the close
- 10 SMA applied to the close
- Trade on daily chart (swing trading)
- 5 SMA applied to the close
- 10 SMA applied to the close
Trading Rules
Entry Rules
Enter long if:
Enter long if:
- The 5 SMA crosses above the 10 SMA and both Stochastic lines are heading up (do not enter if the Stochastic lines are already in the overbought territory)
- RSI is greater than 50
Enter short if:
- The 5 SMA crosses below the 10 SMA and both Stochastic lines are heading down AND (do not enter if the Stochastic lines are already in oversold territory)
- RSI is less than 50
- The 5 SMA crosses above the 10 SMA and both Stochastic lines are heading up (do not enter if the Stochastic lines are already in the overbought territory)
- RSI is greater than 50
Enter short if:
- The 5 SMA crosses below the 10 SMA and both Stochastic lines are heading down AND (do not enter if the Stochastic lines are already in oversold territory)
- RSI is less than 50
Exit Rules
- Exit when the 5 SMA crosses the 10 SMA in the opposite direction of your trade OR if RSI crosses back to 50
- Exit when trade hits stop loss of 100 pips
Okay, let’s take a look at some charts and see this baby in action…
- Exit when the 5 SMA crosses the 10 SMA in the opposite direction of your trade OR if RSI crosses back to 50
- Exit when trade hits stop loss of 100 pips
Okay, let’s take a look at some charts and see this baby in action…
The “So Easy It’s Ridiculous” Trading System
The entire charts below are daily chart loaded with some commonly used indicators; that's if you like to use em.
As you can see, we have all the components of a good forex trading system.
First, we’ve decided that this is a swing trading system, and that we will trade on a daily chart. Next, we use simple moving averages to help us identify a new trend as early as possible.
The Stochastic help us determine if it’s still ok for us to enter a trade after a moving average crossover, and it also helps us avoid oversold and overbought areas. The RSI is an extra confirmation tool that helps us determine the strength of our trend.
After figuring out our trade setup, we then determined our risk for each trade. For this system, we are willing to risk 100 pips on each trade. Usually, the higher the time frame, the more pips you should be willing to risk because your gains will typically be larger than if you were to trade on a smaller time frame.
Next, we clearly defined our entry and exit rules. At this point, we would begin the testing phase by starting with manual back tests.
Here’s an example of a long trade setup:
If we went back in time and looked at this chart, we would see that according to our system rules, this would be a good time to go long.
To backtest, you would write down at what price you would’ve entered, your stop loss, and your exit strategy. Then you would move the chart one candle at a time to see how the trade unfolds.
In this particular case, you would’ve made some decent pips! You could’ve bought yourself something nice after this trade!
You can see that when the moving averages cross in the opposite direction, it was a good time for us to exit. Of course, not all your trades will look this sexy. Some will look like ugly heifers, but you should always remember to stay disciplined and stick to your trading system rules.
Here’s an example of a short entry order for the “So Easy It’s Ridiculous” system.
We can see that our criteria is met, as there was a moving average crossover, the Stochastic was showing downward momentum and not yet in oversold territory, and RSI was less than 50.
At this point we would enter short. Now we would record our entry price, our stop loss and exit strategy, and then move the chart forward one candle at a time to see what happens.
The entire charts below are daily chart loaded with some commonly used indicators; that's if you like to use em.
As you can see, we have all the components of a good forex trading system.
First, we’ve decided that this is a swing trading system, and that we will trade on a daily chart. Next, we use simple moving averages to help us identify a new trend as early as possible.
The Stochastic help us determine if it’s still ok for us to enter a trade after a moving average crossover, and it also helps us avoid oversold and overbought areas. The RSI is an extra confirmation tool that helps us determine the strength of our trend.
After figuring out our trade setup, we then determined our risk for each trade. For this system, we are willing to risk 100 pips on each trade. Usually, the higher the time frame, the more pips you should be willing to risk because your gains will typically be larger than if you were to trade on a smaller time frame.
Next, we clearly defined our entry and exit rules. At this point, we would begin the testing phase by starting with manual back tests.
Here’s an example of a long trade setup:
If we went back in time and looked at this chart, we would see that according to our system rules, this would be a good time to go long.
To backtest, you would write down at what price you would’ve entered, your stop loss, and your exit strategy. Then you would move the chart one candle at a time to see how the trade unfolds.
In this particular case, you would’ve made some decent pips! You could’ve bought yourself something nice after this trade!
You can see that when the moving averages cross in the opposite direction, it was a good time for us to exit. Of course, not all your trades will look this sexy. Some will look like ugly heifers, but you should always remember to stay disciplined and stick to your trading system rules.
Here’s an example of a short entry order for the “So Easy It’s Ridiculous” system.
We can see that our criteria is met, as there was a moving average crossover, the Stochastic was showing downward momentum and not yet in oversold territory, and RSI was less than 50.
At this point we would enter short. Now we would record our entry price, our stop loss and exit strategy, and then move the chart forward one candle at a time to see what happens.
Boo yeah baby! As it turns out, the trend was pretty strong and pair dropped almost 800 pips before another crossover was made! Now isn’t that ridiculously easy?
We know you’re probably thinking that this system is too simple to be profitable. Well the truth is that it is simple. You shouldn’t be scared of something that’s simple.
In fact, there is an acronym that you will often see in the trading world called KISS.
It stands for Keep It Simple Stupid!
It basically means that forex trading systems don’t have to be complicated. You don’t have to have a zillion indicators on your chart. In fact, keeping it simple will give you less of a headache.
The most important thing is discipline. We can’t stress it enough. Well, yes we can.
YOU MUST ALWAYS STICK TO YOUR TRADING SYSTEM RULES!
A forex trading plan is only effective if it’s followed. You have to stick to it. It sounds simple to do. It is really just common sense but most traders still can’t do it. Why, oh, why?
Trader incompatibility. A trading plan should be a personalized plan for you, a plan that fits your own goals, risk tolerances, and individual lifestyle. You must develop each component on an individual basis, never losing sight of the fact that it must be custom tailored to YOU and YOUR needs.
Not your girlfriend’s. Not your boyfriend’s. Not your basketball coach’s. Not even Ronald, your weirdo best friend whose head is shaped like a hamburger who likes to wear pink polka dot pants and is an aspiring rapper.
Your trading plan must be made based on reality, not on hope. If you’re simply trying to copy somebody else’s trading plan or yours is based on false assumptions, then you will not be compatible with it and will have trouble following it.
Solution: Be honest with yourself. Then revise your trading plan.
Trading plans are intended to be long-term. Many forex traders give up on their trading plan, or often more specifically, the trading system in the trading plan, after suffering a string of losses rather than sticking it out through the inevitable rough times.
Solution: Be patient!
Boo yeah baby! As it turns out, the trend was pretty strong and pair dropped almost 800 pips before another crossover was made! Now isn’t that ridiculously easy?
We know you’re probably thinking that this system is too simple to be profitable. Well the truth is that it is simple. You shouldn’t be scared of something that’s simple.
In fact, there is an acronym that you will often see in the trading world called KISS.
It stands for Keep It Simple Stupid!
It basically means that forex trading systems don’t have to be complicated. You don’t have to have a zillion indicators on your chart. In fact, keeping it simple will give you less of a headache.
The most important thing is discipline. We can’t stress it enough. Well, yes we can.
YOU MUST ALWAYS STICK TO YOUR TRADING SYSTEM RULES!
A forex trading plan is only effective if it’s followed. You have to stick to it. It sounds simple to do. It is really just common sense but most traders still can’t do it. Why, oh, why?
Trader incompatibility. A trading plan should be a personalized plan for you, a plan that fits your own goals, risk tolerances, and individual lifestyle. You must develop each component on an individual basis, never losing sight of the fact that it must be custom tailored to YOU and YOUR needs.
Not your girlfriend’s. Not your boyfriend’s. Not your basketball coach’s. Not even Ronald, your weirdo best friend whose head is shaped like a hamburger who likes to wear pink polka dot pants and is an aspiring rapper.
Your trading plan must be made based on reality, not on hope. If you’re simply trying to copy somebody else’s trading plan or yours is based on false assumptions, then you will not be compatible with it and will have trouble following it.
Solution: Be honest with yourself. Then revise your trading plan.
Trading plans are intended to be long-term. Many forex traders give up on their trading plan, or often more specifically, the trading system in the trading plan, after suffering a string of losses rather than sticking it out through the inevitable rough times.
Solution: Be patient!
No discipline: Trading according to a plan requires sticking to it through thick and thin. That takes discipline. Rock solid discipline. Forex traders lacking discipline do not stick to their trading plans. You need to be disciplined. Rock solid. Does it sound like we’re beating a dead horse? Well, good.
Solution: Stay disciplined!
Self-destructive behavior: Some forex traders have deeply ingrained psychological issues that will sabotage them. This can be resolved with hard work on one’s self, but the trader must be self-aware of such issues first. You can’t figure out a solution if you don’t know the root problem.
Solution: Look in the mirror. Hopefully you don’t turn to stone.
If you’re personally having trouble sticking to your trading plan, most likely it’s one of the reasons above. If it is, refer to the solution below it.
Yea!! You done with this Mehn....
No discipline: Trading according to a plan requires sticking to it through thick and thin. That takes discipline. Rock solid discipline. Forex traders lacking discipline do not stick to their trading plans. You need to be disciplined. Rock solid. Does it sound like we’re beating a dead horse? Well, good.
Solution: Stay disciplined!
Self-destructive behavior: Some forex traders have deeply ingrained psychological issues that will sabotage them. This can be resolved with hard work on one’s self, but the trader must be self-aware of such issues first. You can’t figure out a solution if you don’t know the root problem.
Solution: Look in the mirror. Hopefully you don’t turn to stone.
If you’re personally having trouble sticking to your trading plan, most likely it’s one of the reasons above. If it is, refer to the solution below it.
Yea!! You done with this Mehn....
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