One of the most common mistakes new Forex traders do, is that they have no trading strategy. Because of the many appealing characteristics (24 hours, trade both short and long, leverage etc) most of the new traders entering the market are eager to prove themselves in an often egoistic approach. Egoistic in that they believe that they can become very profitable and make a fortune in the short term, but soon enough they end up with a bad psychology which at the end accelerates their loosing pattern. In fact, the most successful Forex traders are people recognized for their humility and discipline. These qualities are acquired trough experience and accepting some simple realities of the Forex market.
The first step towards becoming profitable in the Forex market is to devise a trading strategy/plan. Creating a trading strategy is of paramount importance and is actually very easy.
To create a successful trading strategy, traders should address the following considerations:
1. Reasoning of the trade: Why buy or sell? Which pair? 2. Timing of the trade: Why now? Before economic news releases or after? Day or night?3. Trading objective: What is the take profit target? What is the stop loss? 4. Money management. 5. Documentation and analysis of the results.
Before entering a trade there should be a good reason. Many times traders are entering a position because of boredom or just to feel the excitement of being long or short. This is a recipe for disaster! You should always buy or sell any pair on a reason that makes sense to you.Whether this reason is fundamental or technical or both, always make sure there is a reason.
What currency pairs will you trade?
This sounds simple, but it is easy to get confused if you don’t define this. From our experience we strongly believe that is best to concentrate on some (not all) major pairs (such as EURUSD, GBPUSD and USDJPY) and don’t waste time with illiquid, choppy pairs.
You also have to determine when you will trade and how often you will trade. Are you going to be a day trader or hold positions for a longer period of time? Your schedule and responsibilities may have some impact on that.
Should you trade before economic releases or after? Should you trade heavily on nights, during UK open and close etc?
It is important to define these basic ideas to begin to form some consistency and discipline.
The second step is to define your trading objectives. What is your end goal? What is your take profit target and your stop loss limit?
Try to place your take profit and stop loss before entering the trade as you can always change that, if something important happens in the markets in the meantime.Most traders tend to take their profits early while letting their losses run. This is because in the inexperienced traders mindset is very difficult to accept that he/she is wrong.Placing your stop loss at the time you open a trade will help you create discipline and learn that sometimes you will be wrong. Furthermore, most new traders have completely unrealistic goals. Making big returns in the first year of trading is possible but highly improbable. These unrealistic Placing your stop loss at the time you open a trade will help you create discipline and learn that sometimes you will be wrong. Furthermore, most new traders have completely unrealistic goals. Making big returns in the first year of trading is possible but highly improbable. These unrealistic expectations wipe out a lot of traders before they even had the chance to learn the market. Breaking even in the first year is an admirable goal; many traders do not do that. If a trader makes 20-30% on their initial investment in their first year, that is outstanding.
Money management is probably the most important aspect of trading.
First you have to accept that in trading nobody can have a 100% winning ratio and everybody (even the most experienced traders) are sometimes wrong. Accepting that sometimes you might be wrong is again of paramount importance.The key here is accepting you are wrong before your mistake becomes too big. To do that you need to determine how much equity you have to fund you account. Then you must determine how much risk you are willing to take on each trade. Most experienced traders risk 1-4 % of their account balance on each trade. This may look too low to the new Forex traders, but will definitely help you avoid big losses, create the necessary discipline and keep you in the market in order to get the necessary experience. Also very important is to have a positive percentage of winning trades compared to losing trades and a positive average profit compared to the average loss ratio. If your average loss is two times your average profit that means you need to make 10 profitable trades to cover 5 losing trades. Keep this in mind.
Along with money management, it is vital to keep track of your past trading and results in order to recognize past mistakes and avoid them in the future.
This is just a basic start to having a successful trading strategy in the long run but will definitely help new traders get the discipline required to be profitable in the very exciting Forex market.
Solid Trading Tips part 2: Optimizing your trading strategy by analyzing your Risk/Reward Ratio.
As we have said in our previous article, one of the most important aspects of trading in any market and especially Forex, is Money Management.oney Management can be defined as the way a trader manages his equity, number and size of trades, open positions, stop loss limits and take profit targets and optimizing its Risk/Reward ratio in order to yield positive results in the long run.
To understand this, first you have to recognize that no one can always get it right and we all get losing trades. This is a fact in a traders life and the soonest a trader accepts it the better his chances of being profitable in the long run.We often hear traders speak as if they are certain what the markets will do next. We try to view the markets in probabilities and always have an analysis to support our opinion.
Whether you are looking at fundamental news announcements, a combination of technical tools, or a simple moving average, what traders are looking for are patterns that put the probabilities in their favor so they will profit in the long run. In other words, we are looking for how the market has reacted in the past to certain conditions, and speculating how the market will react in the future to similar conditions. When it comes to trading, there is no absolute certainty. That is why good money management is essential in making trading profits grow over time.
To take an extreme example lets suppose someone has inside information about an interest rate change ahead of its release. Can this fact alone predict exactly how the market will react? What if other insiders also knew this information and acted in advance as well? What happens if there are real orders from big corporate or banks that need to buy or sell after the announcement? What if enough market participants felt the rate would move higher and bought prior to the announcement - they took profits after the announcement causing the currency to move lower (buy the rumor, sell the fact)?
So the big question is how to put the probabilities on our side? Actually any trading plan that is profitable in the long run is good enough. Some traders lose far more trades than they profit, but when they profit , they usually profit big. Some traders utilize a strategy targeting to profit the vast majority of their trades while risking a lot, but gaining little.
We try to use a more calculated approach in our trading tactics by applying money management considerations to our analysis of the market situation. First we recognize that the market is always trading on a trend or a range and that we have much better probabilities of being profitable if our trades are following the trend..
- If the market is on a trend we try to follow the trend on the vast majority of our trades (usually around 80% of our trades are following the trend).In this case we apply a risk:reward ratio of 1:2 with a big stop loss (usually more than 150 pips) and a big take profit target (usually more than 300 pips).
- If we have a trend and still decide to go against the trend for the correction we apply a risk reward ratio of 1:1 but with much smaller stop loss and take profit (usually around 50 pips).
- In the case the market trades within a range we are trading the extremes of the range applying a risk:reward ratio of 1:1.5 with a medium stop loss (less than 100 pips) and take profit target (usually more than 150 pips).
Since in both market situations (trend or range) the risk:reward ratio is ranging between 1:1.5 and 1:2 (except when trading corrections which is a rare situation), even if we trade profitably just 50% (or even less) then this model gives very good returns over time. Anything above 50% profitable trades would be outstanding. Based on this model, it is pretty easy to see why it makes little sense to get very excited when a trade wins or very upset when a trade loses which results in one more very important added advantage in forex trading- much better trading psychology.
Charis Charilaou is the Head Treasurer for TFI fx - www.tfifx.com
Treasurer
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