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Previous Lesson: Major - Playing with price action | Next Lesson: General - Putting it all together

Developing your Plan

Topics for this lesson:

a) Knowing is Half the Battle
b) The Bears vs The Bulls
c) Knowing when to Scram
d) Protecting your Butt

Knowing is Half the Battle

You should now be having a basic understanding of when to charge the field and pull the trigger. However, once you step onto the field, you should know when it’s best to exit the field. And the key to this is having a general idea of when to exit even before you pull the trigger.

The battlefields can be foggy and cloudy when you’re in the heat of battle. Emotions can run high and decisions you would easily make on the sidelines is not necessarily the same decision you would make when you’re pitted in battle with some of the greatest warriors in the world.

The Bears vs The Bulls

Consider a moment you see the Bulls are beating all heck out of the Bears and price is raging high. You find a target, pull the trigger, and charge out into the fields joining the Bulls offense. You’re winning the battle, emotions are high, you are slaying Bulls left and right and reaping all the rewards of battle. The Bears defense increases and the Bulls offense is slowing down. At this point price is now stagnant. However, the chatter amongst the Bulls is that they will continue to drive the price up no matter what. You buy into the hype, see the potential of more reward, and you hang on.

However, the Bears defense has slowly but surely turned into an offense and they are now taking the price back down. The sure fire victory you once had, turned to hope that price might go up, and now has turned to prayer that the Bulls will find it in themselves to get price moving back up.

The Bears continue onward and price keeps moving down. Before you realize it, the rewards you once had the chance of gaining have been seized by the Bears and now they are taking more of the resources you had put into risk.

Now you are losing and are not sure when to get out of the field. You know that if you leave you might never be able to get your own resources back. So you continue to press on. It eventually gets to the point where the Bears have taken so much that you now are just hoping the Bulls have what’s left in them for price to move back up to a point where you can break even.

Before that prayer can even be heard, your broker yanks you off the field as you have run out of money. You went into battle knowing what target you wanted, however you had no idea how to get out of the field once you were in it.

Knowing When to Scram

Perhaps you now see the need to have a plan to exit even before you enter. Even the best of the best lose battles from time to time. I’ve even met warriors that lose more battles than they’ve won yet continue to reap profits than some that win more than they lose.

Calculating your risk vs. reward ratio is vital. Before you enter into battle, you should have an idea of how many pips you want to gain with each trade. Likewise you should have an idea of how many pips you are willing to lose.

So for instance, if you enter a trade after you spy the formation of a evening star pattern and decided that you believe you could obtain 30 pips from the trade, you’ll want to be sure that your risk is less than your reward. So you might enter a trade with a 30 pip take profit and a 15 pip stop loss. This would ensure that even if you were profitable 50% of the time you’d make more than what you will lose.

The greater the reward is over the risk, the better the trade. However, you need to allow yourself the opportunity for price to move around a bit. Never at any time should your risk outweigh your reward. This is a recipe for eventual disaster. Be realistic. Watch price move and get comfortable with a pair before you actually pull the trigger. Take notes and experiment around with various profit levels and stop loss levels. If you have a 1 pip stop loss and a 100 pip take profit, you might find you don’t have the most realistic risk/reward ration. 1:2 or 1:3 is far more realistic and obtainable.

Protecting Your Butt

At this point, you should be getting an idea of when to enter the battlefields and when to pull out. Now it’s a matter of protecting your assets. When you go into battle, you are risking everything you bring out into the field with you. As a result you want to be sure you only put at risk what you’re willing to lose. While this is a war, you have to focus on each individual battle at a time. If you lose everything, then you have nothing else to fight with.

As a result money management is critical to your overall success. You should never risk more than 2% of your trading account.

A pip is a relative value. For some a pip can equate $100, while to someone else is can equate a single penny. Allow the size of your trading account to determine how much a pip is to you.

Say you have a $1000 trading account. If you decide to risk 20 pips per trade, at 2% of your trading account at most you should risk $20. Therefore, each pip should equate $1.By risking 2% per trade, you are allowing yourself 50 losses. Even if you were flipping a coin to predict trades, it is not likely would you sustain 50 straight losses. In actuality it would be more than 50 losses, as your pip size would decrease with each losing trade, but the example is more or less for simple mathematical purposes and understanding.

Also, by risking a set percentage, your profits will grow exponentially as your account size increases. This should be very appealing to those that think you need a lot of money to trade Forex. Even if you start with a nominal amount, by utilizing sound money management rules you can create a fortune.