Planning Your Trades

Last updated 1/4/2010 8:08 PM EST (GMT -5) 21 Comments

Forex Trading involves high risks, with the potential for substantial losses and is not suitable for all persons. Past performance is not necessarily indicative of futures results.

Bradley W. Gareiss

Technical Analyst, GFT

When most people start trading, they do not put much thought into their trades. They will either buy or sell a currency pair (probably the EUR/USD) because they think they see a trend or maybe even because they put a moving average on the chart. Sometimes there is no reason at all for the trade, they just want in. Either that trade nets a small profit or the trades starts going against the new trader. The trader that gets the small profit will feel invincible and likely base trades in the near future on the same reason as the first one. Of course they expect every trade to win. The trader whose position moves against them leaves their position open, stares at the their computer without blinking, and laments that they will get out if the market only goes back to break even.

Sooner or later, the trader who won their first trade puts on a loser and acts much like the trader above who lost their first trade. After a large loss to the account, the trader then puts on a large position trying to win it back. Inevitably that trade crushes their account, or a trade soon after will. Sound familiar?

The reason that new traders blow out their account is that they assume trading is easy, they don't realize the role their emotions play in trading with real money, and they have no trading plan. Well, it doesn't take long to learn on your own that trading isn't easy, so we won't spend too much time discussing that. However, using a consistent trading plan is the only way to reign in your emotions and develop consistency in your trading. If you enter at random places and exit when your "gut" tells you to, you are in for a lot of pain.

Every remotely successful trader I have ever spoken with has a trading plan. These traders do the same thing every time, occasionally tweaking one aspect of their plan at a time. Trying to change everything at once makes it impossible to tell what is working and what is not. We will go through the important aspects of a trading plan below, and we will go over how the FX360.com technical analysis works with these principles.

First off, I believe it is imperative to identify your entry, stop, and profit target(s) before entering every trade. If you try to determine your exits once you enter the trade, your emotions will skew your view of the facts unless you are a robot. If the exits are planned before entering, it is tough for your emotions to screw you up. By placing your exits in the system when you enter the trade, it is much easier to stay disciplined to your plan. Another advantage is that you don't have to stare at your computer 24 hours a day waiting for a place to exit.

I also feel it is important to know your risk:reward ratio before entering a trade. How on earth can you determine your risk reward:ratio if you don't plan your stop and profit target(s) before entering the trade? It can't be done. To measure this ratio, simply divide the distance between the entry and the profit target by the distance between the entry and the stop. Everyone's concept of a "good" risk:reward ratio varies, but I prefer to have a risk:reward ratio around 1:1.5.

Once you have planned your entry and stop, you can also determine your position size. Your position size should generally be the same percentage of your equity each trade. Most traders risk 1-3% on each trade, using the same percentage for every trade. In other words, all trades are weighted equally. The same amount of capital should be risked on a trade with a 300 pip stop as a 30 pip stop. In order to determine your position size, simply multiply your total equity by your percentage risk per trade (typically 1-3%), which is the amount of money you should risk per trade (X). Next, multiply the number of pips between your entry and stop by the currency's pip value (Y). You can also draw a line from your entry to stop using the value calculator to get Y. Then divide X by Number Y to get the number of lots you should trade. Once you practice this, it is easy.

The methodology we use (geometric pattern recognition) makes it very easy to follow this plan. Everything is already planned out, all you need to add is your total equity and percentage you want to risk for each trade (typically 1-3%). By planning your trades out before you enter you can now trade on any time frame because you are risking the same amount for each trade. This will lead to much more consistent results that using static numbers when determining position size.

Comments (21)

alexjbrandt

January 05, 2010 at 08:56 AM ET

I've think the most simplest trading strategy is to just close your eyes, and randomly click on buy or sell :P lol. Statistically, you should have a 50% win rate. lol.

Semaj

January 05, 2010 at 09:05 AM ET

Your wins better be geater than your losses adding in spreads. Sounds like you play the wheel Vegas, not black jack or poker :)

alexjbrandt

January 05, 2010 at 09:32 AM ET

lol. I was being sarcastic :) I don't recommend gambling or speculative bets for anyone here, oh wait thats what we do :D

In all seriousness, I do use a strategy but not on fib levels or wave patterns - just gives me a headache. I use 4 simple indicators, a good money management plan and a trading strategy that has been fairly successful, after a few tweaks.

bgareiss

January 05, 2010 at 02:40 PM ET

Do what works for you. However, closing your eyes and randomly clicking will not work for you. Ha. Brad

FX4Sure

January 05, 2010 at 05:44 PM ET

technically is not a 50% win rate... is not the same trading in Tokyo or New York session, is not the same trading around the news, the balance is never the same and is never 50/50.

Another easy example is not the same buying than selling on overbought stochastic with price on a resistance level and a bearish trend.... 50% win rate?

I tough the same a couple of months ago... and I know you were joking. :)

bgareiss

January 05, 2010 at 05:50 PM ET

If you randomly click an entry for a random pair and randomly click to exit at the market, it would be a 50/50 proposition over a large sample of trades.. Not that any of this really matters. Brad

Silenus

January 05, 2010 at 08:28 AM ET

Way too complicated! Trading IS simple. Just buy above the X moving average, stop and reverse below it . ( X = your mom's birthday multiplied by your pet's age) No leverage. (Leverage was invented by the Devil) Then... just retire rich. Sound complicated? Oh by the way I am being serious

Semaj

January 05, 2010 at 08:42 AM ET

Even this method needs some thought with the time frame used with an X moving average since you still need to keep an eye on price as it crosses the MA unless you use an alarm of some kind. I have been working with a 21 EMA & price cross as I have found it seems to work extemely well with William's awsome oscillator's zero line cross. This allows for an alarm notification on any time frame.

bgareiss

January 05, 2010 at 02:38 PM ET

If only trading really was that easy. I don't want to ruin your dreams, but it isn't remotely easy. Brad

Crank

January 05, 2010 at 03:43 PM ET

Hi Brad.

Great article, very well written and informative.
I am relatively new to Forex trading, but I have been keeping very diligent about setting up each trade entirely before entering. The one question I have is, what do you recommend for figuring out exit strategies on the winning side? i.e. how do you come up with profit targets?
I have seen many strategies use a trailing stop that will climb with the price as it moves in your favor, eventually stopping you out for a profit, but that does not tell you your risk reward ratio before entering the trade.

I know that if you are trading based on patterns, using tools such as Fibonacci Retracements can give you potential profit targets. But what if your strategy is based on indicators?

bgareiss

January 05, 2010 at 03:48 PM ET

Your exit strategy will vary based on your entry strategy. I would use the same type of tools to exit that I use to enter. That may sound vague, but there is no one way to do it. On another note, I am not a big fan of trailing stops. While they sound good in theory, I think they often stop you out at a poor exit point. I prefer exiting for a "reason" rather than exiting because my 20 pip trailing stop got hit, which I think is an arbitrary point to exit. Brad

Crank

January 05, 2010 at 04:08 PM ET

Definitely, I would much rather have specific targets than an automatic trailing stop.
My only concern is that when a strategy is based on indicators, and there is no strong support or resistance in sight, I feel at a loss for defining a specific exit point.
I've been using systems such as the 2 day low, or parabolic SAR for placing the initial stop --from Kathy Liens book ;)
For the profit side, I've tried using a strategy like "if the stop is 50 pips below, I'll place my target at 100 above to have a 2:1 P/L ratio" But that seems like sort of backwards thinking, and it creates what feels like extremely arbitrary exit points.

Are there any generally accepted ways to generate a smart exit point? Say for example on a range trade using RSI and Stoch crossing their signals to give an entry point.

bgareiss

January 05, 2010 at 04:24 PM ET

There are truly an infinite number of ways to figure out your exit points. I prefer using support and resistance levels because they are more concrete than other methods. I wish I could give you an exact answer, but it is probably better if you figure out your exact method on your own (as I did when I was being taught). Brad

Crank

January 06, 2010 at 11:28 AM ET

Ok, thanks for the advice. (And sorry about the double post!)

Crank

January 05, 2010 at 04:08 PM ET

Definitely, I would much rather have specific targets than an automatic trailing stop.
My only concern is that when a strategy is based on indicators, and there is no strong support or resistance in sight, I feel at a loss for defining a specific exit point.
I've been using systems such as the 2 day low, or parabolic SAR for placing the initial stop --from Kathy Liens book ;)
For the profit side, I've tried using a strategy like "if the stop is 50 pips below, I'll place my target at 100 above to have a 2:1 P/L ratio" But that seems like sort of backwards thinking, and it creates what feels like extremely arbitrary exit points.

Are there any generally accepted ways to generate a smart exit point? Say for example on a range trade using RSI and Stoch crossing their signals to give an entry point.

WarrenWoo

January 12, 2010 at 12:39 AM ET

Hi, I would like to find out more about how you calculated your position sizing?
Assuming my equity is at USD 10,000; 2% risk would give me USD 200.
Again assuming that the entry to stop loss is at 20 pips and the currency pair is EUR/USD what currency pip value should I use - in terms of USD or EUR? Thanks!

alexjbrandt

January 12, 2010 at 02:42 AM ET

If I was risking $200 or 2% of my account and I used a 20 pip S/L I would do 1 lot or $10 pips.

WarrenWoo

January 12, 2010 at 05:55 AM ET

Referring to the formula given the Y = S/L multiple by currency pip value. How do I obtain this value? Thanks

alexjbrandt

January 12, 2010 at 06:08 AM ET

The currency pip value is dependent on the lot size. So 1 Lot would be a $10 pip value. Where as .1 lot would be a $1 pip value.

How I arrived at 1 lot for your solution is I just divided $200(your amount risking) by 20 pips(your S/L) which = $10 pip value. And a $10 pip value means 1 lot.

bgareiss

January 13, 2010 at 07:54 PM ET

Warren, when calculating the risk you use whatever the pip value is for the second currency. GFT has a great tool on DealBook called the value calculator that makes this very easy. You just have to click and drag the distance between the entry and stop and it gives you the amount. Your math was right about the position by the way. I think using mini-lots makes sense because it makes it easier to risk closer to the exact amount you want to risk. Brad

WarrenWoo

January 14, 2010 at 01:04 PM ET

Thanks for the clarification.

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