The forex market is the most liquid market; with more than five trillion dollars changing hands every day. A forex trader is buying or selling a currency pair and expecting to make a profit from the swings that characterize this market.
The dashboard is formed by currency pairs organized in two categories; majors and crosses. A major currency pair contains the the U.S. dollar, while all other currency pairs are being called crosses.
A major pair moves differently than a cross in the sense that a cross is prone to move in range most of the time. This is because the U.S. dollar is the world’s reserve currency and this status brings more volatility on those currency pairs.
Every trading platform offers dozens of currency pairs to trade, and one cannot simply trade them all. It is not possible to analyze all of the currency pairs and timeframes needed to properly trade them. Therefore, a sound trading plan should start from this point; what currency pairs to trade.
The forex market is moving based on technical and fundamental reasons, with the technical part giving the direction and the fundamental factors giving the reason why the market is moving. It is vital to understand this and both technical and fundamental analysis should be part of a trading plan.
Before trading the currency markets, a trader needs to consider a number of factors; all of them part of the planning process. It all starts with the forex broker.
This is perhaps the most important part of them all as the forex broker needs to be a partner in this venture. The competition between brokerage houses is stiff and there are many options for the retail trader, but the following details are a must when it comes to picking the right broker:
Regulation: The broker MUST be regulated.
Funds Safety: Look for the broker to offer segregated accounts.
Execution: ECN and/or STP preferred.
Account Types: The more options, the better.
After choosing the broker to open the account with and funding it, money management rules must be set. Such rules can differ from risking only a small percentage of the trading account on every trade, to a maximum percentage to be invested at one moment of time.
The next point to consider when making a trading plan is the time horizon for the trades. This is determined by the trading style; scalping, swinging or investing.
Scalpers and swing traders are looking for quick profits and trades are being kept open for a short period, ranging from a few minutes to a few days. Investors, on the other hand, are mostly macro-traders and managers that look at the overall picture and take a trade based on the fundamental differences between the two currencies that form a currency pair.
Traders that fit in the first two categories are traders that should set weekly and monthly goals. Any planning should begin over the weekend with a look at the bigger time frames. Daily and weekly charts analyze Friday’s closing; look at price behavior and patterns around the main fixing times in the previous week, etc.
Moving forward, after the technical picture is set; the economic calendar for the week ahead must be checked. This is important for the overall planning as it gives traders an idea about what currencies are going to be influenced by the economic news to be released in the week ahead.
For example, if there is a week with a Fed meeting, then the U.S. dollar pairs, or the major pairs, are expected to have an increase in volatility. Knowing this in advance, it may be wise to trade crosses rather than majors to protect the trading account from unwanted swings in the U.S. dollar pairs.
Part of any trading plan and money management rules, setting the proper risk is a major issue. This is defined by having realistic expectations for a trade, both from a price and time perspective.
In a NFP (Non-Farm Payrolls) week, for example, it is unrealistic to expect the market to move until the actual release on Friday. That makes the whole week mostly a ranging week for the major pairs and offers plenty of time for technical analysis considering the event to come.
Finally, a realistic risk:reward ratio should be used for trading the forex market. Expecting ratios like 1:10 or even more is only going to lead to false expectations. While appealing, chances are such a ratio is not realistic.
A proper risk:reward ratio should be set anywhere between 1:2 and 1:2.5. This, together with risking only a small percentage of the trading account, should be enough for constant profitability to be achieved.
Without a trading plan, there’s no point in starting to trade in the first place. Technical and fundamental analysis, no matter how sound they are; are useless if planning and execution is not correct.