Money management and trading plans
Money management and trading plans
Making money in currency trading should be easily attainable yet a disproportionately high number of forex investors suffer an account wipe-out, even those that have been trading for some time.
Other than having a crystal ball to predict the market movements, is there any other strategy which can help control losses?
The short answer is yes, but it is something which may sound obvious to many and overly simple but its effect on trading can be astonishing.
This revolutionary tool is a written trading plan.
Most investors will have a good idea of how they want to trade but very few commit their strategy to paper. However, having a trading plan mapped out can be pivotal in helping to keep a strategy on track, especially at those times when the lure to deviate from the pre-agreed perimeters is tempting.
The reason why most traders fail is not due to lack of knowledge or a poor trade – everyone has those – but psychological facts overcoming a well-thought out strategy.
When on a losing streak, it can be very easy to keep going, desperately hoping that the market will eventually swing the right way and return a good profit, despite passing the agreed exit point some time ago.
Conversely, hitting a hot spell can lead to overconfidence and abandoning the strategy as euphoria leads to a feeling of not being able to lose. For a while this may be true but eventually the markets will turn and inevitably the losses will be significant.
However, having a printed trading plan will not be sufficient if it isn’t visible – the plan needs to remind the trader of the discipline required every time a position is opened. If possible, stick the plan up next to the PC or hang it on the wall, anywhere to ensure it acts as a reminder.
Many traders like the idea of having a written strategy but don`t know how to start.
There are no prescribed things that must be in the plan; it really is a personal choice. But for those looking for guidance, below is a list of things which might be included.
The size of each trade. A popular reason to end up with a wipe-out is by getting over-excited and placing too much on an individual position. No position is ever guaranteed to make a gain and it is therefore essential to stick to pre-agreed limits – many traders opt for around 3% of their account balance on each deal.
Know the entry strategy. Waiting for the right set of market conditions can be frustrating and it can be tempting to jump right in as soon as there is any hint of favourable indicators. Ensuring that the right set of conditions are well defined, such as moving averages or candlesticks, will help prevent a hasty trade.
Equally, know when to exit prior to opening a position. Deciding to work out when to exit as the trade unfolds is always a bad idea and is open to errors in judgment.
It may help with the exit point to define a risk to reward ratio. This can help prevent sizeable losses on a trade which was never going to make a decent level of profit.
A rather more unusual inclusion in a trading plan can be rules around how to handle losses or even wins. A bit of space to reflect and put things into perspective can help prevent rash trading so it may be worthwhile documenting a 15 minute break, a snack or even a walk every time there is a significant gain or loss.
Overall the most important factor is to not make any decisions whilst the position is open as this will inevitably fail to stick to the strategy for all but the most disciplined of traders.
For inspiration putting a plan together, there is a wealth of forex information available online which should give some more ideas about what to include.
