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Creating a Trading Plan

It is generally a good idea to create a trading plan ahead of time.  Some trading strategies are more conducive to long term planning than others.  Day trading and scalping, for instance, can't be planned too far in advance, as both largely rely on the trader's almost instinctive reactions to the market as it moves and changes throughout the day. 

But for most trading strategies – even for most types of swing trading – creating a preset plan is an important part of investing.  Paradoxically, it is also important to have the ability to change your plans if things do not seem to be going as predicted.  Having the discipline to stick to a plan, but knowing when to drop a trading plan like a bad habit is one of those aspects of forex trading that simply has to be learned with time – and a constant yearning to refine your trader's instincts. 

Perhaps the most important part of a trading plan are the goals you set.  Not in the general sense – everybody's goal is to make a lot of money – but in the very specific sense of how much profit are you seeking with each specific trade.  You should know ahead of time when you think the market is going to turn, and you should set your sell orders accordingly.  These exits points are critical to your success as a trader.

The little brother of the exit point is the entrance point.  A good general strategy is to plot out where the support is that day, and make you purchase at a relatively calm time in the market when your currency pair nears its support line.

Before you do make your purchase, though, you should evaluate how much loss you are willing to tolerate.  What is the expected volatility?  How confident are you that a break out trend or whatever phenomenon you are looking for is actually going to happen?  These are all questions your should ask yourself when you are making your plan and deciding where to place your stop orders.   

Management of your capital is perhaps the least exciting part of being a trader, but it is the single most important variable in your plan – not because of the potential reward from proper money management, but because you risk taking a hit you can not get back up from if you invest too much.  Similarly, spreading your risk out over various currencies or other investments is of critical importance.

The process of creating an explicitly written out trading not only leads to a very useful document, it also forces you to review your thinking and to look for weaknesses in your strategy and for potential pitfalls in your final plan.  Like any important creative process, it forces you to take a second look at your assumptions and to justify certain conclusions that you may have taken for granted.

So, even if creating and reviewing you trading plan – which should explicitly outline each major step – doesn't change anything this time around, it strengthens your skills as an investor in the long run.