Almost every successful businessman will tell you that record keeping is critical to running an efficient business. Whether designing sophisticated aeronautics or simply selling scented soap, all businesses record and analyze their transactions to refine and optimize execution. When it comes to trading FX, however, very few traders diligently record and review their trades. FX trading, with its instantly dealable rates and self-organizing accounting software, makes it easy to forsake the discipline of keeping a trading diary. Yet a diary can improve a trader's performance far more than any piece of advanced technical analysis software or even a $2,000-per-day trading seminar. This article will outline what to record in your journal and will provide an example from the writer's own trading diary.

Why is keeping a trading diary so valuable? First, as human beings with faulty memories, we simply forget many of the circumstances surrounding our best and worst trades and, as a result, we learn little from them if they are not recorded. Second, the gap between what we think we do and what we actually do during trading can be embarrassingly large - a problem that can easily be identified with proper note taking. Finally, the mere act of keeping a diary introduces a methodical element to trading that prevents us from trading randomly and impulsively - the culprit behind most trading disasters. (For further reading, see Ten Steps To Building A Winning Trading Plan.)

Keeping a diary need not be cumbersome or complicated. Here is a list of three key issues that should be covered in every trade:

1. What did you trade and why?
The reason for a trade can be either fundamental or technical (preferably both), but there must be a reason. Too many retail traders put on a trade because they think that prices have either risen or fallen "enough", without any technical or fundamental justification for their opinions. Worse, many traders get into positions out of sheer boredom, forcing a trade and then spending the rest of the time trying to justify it. Even if boredom is the primary driver for the trade, having a diary will make the trader record that fact and he or she will be able to see the consequences of such behavior.

2. Where is your stop and limit and why?
It is astonishing how many traders get into a trade without any clear idea of where to take a profit or when to get out if the trade moves against them. However, by writing down specific stop and limit orders, the trader consciously plans ahead for any contingency that may occur. Even if a trader disregards the initial stop in the heat of the battle, the act of recording all of that activity will be invaluable in doing post-trade analysis and enforcing better discipline on the next trade. (For more information, read A Look At Exit Strategies.)

3. Did the trade work out as planned?
There is often an enormous gap between how the trade setup looks on charts or through the prism of backtesting software and the emotional reality of having money at risk. Comparing the difference between the two can help traders understand their strengths and weaknesses and improve long-term performance. (For more insight, see Backtesting: Interpreting The Past.)

Because trading is such a visual craft, attaching a chart with annotations will complete the diary process by providing a pictorial reference point for further study.

Let's take a look at a recent trade I made in USD/JPY and the various comments I made regarding its outcome.

Figure 1

1. What did I trade and why?
I went short USD/JPY at 1pm EST on June 8, 2006, at 114.27. The pair had already rallied significantly after the dollar was boosted by the death of a major al-Qaida terrorist and the relatively dovish comments of European Central Bank President Jean Paul Trichet. Against expectations by some market participants of a 50 basis point hike, Trichet raised rates by only 25 basis points. Dollar/yen had risen in an almost uninterrupted fashion to nearly 115.00, but at 8am EST it made an exhaustion spike higher and left a shooting star pattern on the charts, suggesting that buyers could not sustain the highs. I felt that 115.00 would be a tremendous barrier for dollar bulls to overcome, as many option-related traders were willing to defend that level very aggressively. When price dipped below 114.15, it suggested that further downside may be on the way and I shorted the pair on a small rebound at 114.27.

2. Where did I set my stops and limits and why?
I set my stop at 114.58. Although that price level was below the swing high of 114.75, I felt that any break above 114.50 by anything more than a few points completely negated my bearish thesis and that I should get out because the market would likely make a second run at the important 115.00 figure.

I always trade with two targets because I believe that while the near-term direction of the currency pair may be somewhat predictable, the amplitude of the move is not. That's why I set the first target at a reasonable distance from entry and the second target farther away in case the move gained momentum. Therefore, I set my first target at 114.01, just ahead of the 114.00 figure, and my second target was set at 113.80.

Did the trade work out as planned?
Partially. Just as I had expected, the pair traded lower and by 6pm EST, it reached my first target of 114.01, allowing me to bank 26 points. I instantly moved my stop to break-even, but then had to step away from the screen for several hours. When I returned, I saw that price had missed my second target by just a few pips and was now trading back near the 114.00 level. As price once again began moving my way, I sold one more quarter of the position at 113.95, locking in another 32 points on that part of the trade. Just a few seconds later, prices collapsed and hit my second target of 113.80. Did I execute to plan? Not quite. I rushed my second exit, fearing the loss of immediate profit more than the lure of additional gain and gave up 15 points of potential profit.

The act of maintaining a diary crystallized my dominant behavioral patterns, clearly showing that I am not capable of holding most of my positions long enough to achieve a 2:1 risk/reward pattern. In my case, it is even more critical to choose only the highest probability setups that have an expectancy rate of better than 60% in order for my trading to succeed.

For other (more patient) traders, the diary process may reveal that they should expand their risk parameters in order to allow for the possibility of capturing larger gains. Regardless of the conclusion, the process of diary writing reveals the true human nature of trading that those clean, crisp charts and the coldly efficient results of backtesting systems simply cannot convey. It also demonstrates why computerized systems have such a difficult time trading markets. In fact, I have witnessed the results of hundreds of systems trade in real time and not one of them was profitable in the long term. Trading requires all of our emotional and analytical capabilities in order to produce success. The act of keeping a trading diary helps us better understand the demons that drive us and, in turn, makes us better traders.

(Follow and discuss traders' journals at TradersLaboratory)

Related Articles
  1. Chart Advisor

    2 Short-Term and 2 Longer-Term Trade Ideas

    Two shorter-term and two longer-term trade ideas to consider, based on trends and the possibility of a breakout.
  2. Chart Advisor

    ChartAdvisor for November 27 2015

    Weekly technical summary of the major U.S. indexes.
  3. Professionals

    The Best Financial Modeling Courses for Investment Bankers

    Obtain information, both general and comparative, about the best available financial modeling courses for individuals pursuing a career in investment banking.
  4. Investing

    Where the Price is Right for Dividends

    There are two broad schools of thought for equity income investing: The first pays the highest dividend yields and the second focuses on healthy yields.
  5. Chart Advisor

    Pay Attention To These Stock Patterns Playing Out

    The stocks are all moving different types of patterns. A breakout could signal a major price move in the trending direction, or it could reverse the trend.
  6. Chart Advisor

    Now Could Be The Time To Buy IPOs

    There has been lots of hype around the IPO market lately. We'll take a look at whether now is the time to buy.
  7. Stock Analysis

    Why did Wal-Mart's Stock Take a Fall in 2015?

    Wal-Mart is the largest company in the world, with a sterling track-record of profits and dividends. So why has its stock fallen sharply in 2015?
  8. Investing News

    Should You Invest in Disney Stock Before Star Wars?

    The force is strong with Disney stock, as it continues to make gains going into the launch of EP7. But is this pricey stock a good buy at these levels?
  9. Investing News

    Silicon Valley Startups Fly into Space

    Space enthusiasts are in for an exciting time as Silicon Valley startups take on the lucrative but expensive final frontier.
  10. Chart Advisor

    Copper Continues Its Descent

    Copper prices have been under pressure lately and based on these charts it doesn't seem that it will reverse any time soon.
  1. How liquid are Vanguard mutual funds?

    The Vanguard mutual fund family is one of the largest and most well-recognized fund family in the financial industry. Its ... Read Full Answer >>
  2. How do mutual funds work in India?

    Mutual funds in India work in much the same way as mutual funds in the United States. Like their American counterparts, Indian ... Read Full Answer >>
  3. Are UTMA accounts escheatable?

    Like most financial assets held by institutions such as banks and investment firms, UTMA accounts can be escheated by state ... Read Full Answer >>
  4. What are the dormancy and escheatment rules for stock accounts?

    While the specific dormancy and escheatment rules for stock accounts vary by state, all states provide for the escheatment ... Read Full Answer >>
  5. Does mutual fund manager tenure matter?

    Mutual fund investors have numerous items to consider when selecting a fund, including investment style, sector focus, operating ... Read Full Answer >>
  6. What happens if property is wrongfully escheated?

    If your financial accounts, such as bank, investment or savings accounts, are declared dormant and the managing financial ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Cyber Monday

    An expression used in online retailing to describe the Monday following U.S. Thanksgiving weekend. Cyber Monday is generally ...
  2. Bar Chart

    A style of chart used by some technical analysts, on which, as illustrated below, the top of the vertical line indicates ...
  3. Take A Bath

    A slang term referring to the situation of an investor who has experienced a large loss from an investment or speculative ...
  4. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
  5. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  6. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
Trading Center