Have you already seen in your trading career that professional Forex trading is simply a numbers game? No fund manager is able to win 100% of the time. This is impossibility. Forex markets, by their very definition, are unpredictable. And we, as traders, are in the business of trying to predict them. Sounds a little ‘iffy’ to me…
Does this mean that profitable Forex trading is not possible? Certainly not! What it does mean is that you should not expect a 100% win rate and that you should adapt your expectations to meet the personality and behavioral characteristics of the Forex market. You must bring yourself in alignment with the way that the Forex market works—NOT try to bend the Forex market into WHAT YOU THINK IT SHOULD BE.
In this article I want to help you understand a few things about Forex trading so that it will help you to become a professional Forex trader and so that you can make profits on a consistent basis. Forex trading involves both potential profits and potential loses. For this reason, minimizing the risks of this fast-moving market is critical to achieve success in your daily trading and over the duration of your entire trading career.
Always Look for Opportunities to Reduce Risks and Increase Successful Outcomes.
This article is entirely designed around the idea of helping you to reduce risks at every given opportunity you can find. There is little value in placing a successful trade that wins $1000 if on the next trade you have the potential of losing $5000. How frustrated would you be if you won 4 times in a row for a total of $4000 gain and then lost all your gains PLUS an extra $1000 on your next trade which was a loser? This is just one quick, little example of how improper risk strategies can severely affect the quality of your trading results. Let’s look at this some more…
You Can Be A Master With Only 60% Win Rates (Or A Loser With 80% Win Rates).
You can imagine the frustration here I’m sure…. In this previous example you have won 80% of your trades (which is a very respectable win-ratio) but yet your results still show negative gains (losses). Very frustrating indeed!
I can tell you right now, however, that some of the best and most profitable of traders (and trading systems) win only 55-60% of the time or less. Nial Fuller even shares great tips on how to be profitable with only 45% winner trades.
How Then Are These Systems So Profitable?
Let me explain another set of numbers to you here with this simple example. Let us assume that the professional money manager has a 60% win ratio and they are risking $1000 on every trade that has the potential to pay them $5000.
This is directly disproportionate to the first example of risking $5000 for a chance to make $1000… are you seeing the difference here? The professional manager can afford to lose 4 trades in a row because on the 5th trade he or she is going to make a $5000 gain and come out $1000 positive over the course of those 5 trades. Isn’t that a powerful concept?!
I did not want to turn this into a specific example but rather just illustrate a simple point that the numbers in Forex mean everything. This is why it is possible to lose every other trade (50% win ratio) and still become a millionaire within a relatively short amount of time in Forex… It actually depends on how much money you’ll invest, but yes, it is possible to earn millions of dollars in Forex and even more. I want to teach you about these numbers and some of the strategies that correspond with reducing risk (which in turn lends itself to increasing profitability and putting the odds squarely on your side).
The Basis of Profitability in Forex Comes Down to Mathematical Formulas & Market Entry Timing.
Think with me for a moment about the above example… in this case you were able to see that the win-ratio of your trading business/system has, in reality, not all that much to do with your success in Forex. The more important factor in this example is the risk and reward per trade. I hope you are starting to see how there are many factors at work that determine the profitability (or lack thereof) of a Forex trader/system.
I’d like you to see now this specific example of a 3:1 trade which would nicely put the odds of profitability in your favor. Here is an image of the most current CHFJPY DAILY chart with an orange horizontal line marking the entry point (just after the appearance of the last red arrow).
Follow the ORANGE ARROW on the chart to see the course of the trade. This trade would have taken many days to realize as we are currently viewing the DAILY charts here. Each candlestick bar on the chart represents 1 day’s price action. This trade would have taken about three weeks’ time.
In this case, we could use the most recent swing point as a nice place for our stop loss, which would make it approximately 165 pips stop loss. We’ll use a relatively round number for the sake of our illustration here. You may notice also that this screen shot was taken on the weekend when the spread has increased (the spread is not typically 10 pips on the CHFJPY pair during normal open trading hours) but this does not matter for our example; I just wanted to point it out for you.
For this example, which is just for the sake of illustration, we will use a 1:3 risk/reward ratio as our target. With 165 pips as the stop loss, a 1:3 trade would place our take profit level at three times the risk or 495 pips in this case. (165 x 3 = 495)
This is a quickly chosen, cherry-picked trade to help illustrate this lesson about the power of our risk and reward levels. It is not possible to always pick out such winning moves of course, but I wanted to use this to illustrate to you the power of a good risk/reward ratio.
Let Us Now Look at Ways to Reduce Our Overall Risk When Trading
There are a few factors here that I want to point out to you which will help reduce the amount of risk you are taking when trading. As your skill increases then likely your ability to spot proper setups will also increase. Trading, of course, is not an easy business. It can become simple, but it will never likely become easy.
This doesn’t make Forex a bad business, just one fraught with many challenges and difficulties. What we want to do as traders is reduce our amount of exposure and risk in the foreign currency markets. I have four suggestions that you can employ to help you reduce your overall risk when trading.
1. Use the Appropriate Trade Size Based On Your Account
There are several ways to properly measure and use risk when trading currency. One of the popular methods is to use a percentage of the account’s equity. The other popular method is simply to use a fixed lot size or fixed dollar/euro/pound amount per trade.
With the example of using a fixed dollar amount, you might identify that you are comfortable with risking $100 on every trade you take. This should be your baseline and you should not deviate from it until you are ready to move on to larger position sizes (or unless you have lost some trades and now have less equity in your account; at which point you now decide that you are going to risk just $85 per trade, for example).
This method will require you to calculate your stop loss level when placing the trade as well as the size of the trade itself (the number of lots you are going to need to use to equal the amount of dollar-risk you want to use). When trading larger timeframes this is usually not a problem at all because you have time to think and to plan ahead of your entry point. Trading lower timeframes, however, can make this style of money management problematic.
Saving Time With Accurately Placing Trades With Correct Lot Sizes.
This calculation can be time consuming unless you use another method like fixed-lot-size trades or a software/auto-calculating tool like the Trader On Chart software, as pictured here. This software has a wonderful ability to help you manage risk according to different options such as percent-risk and fixed-lot-size.
Many of my clients and subscribers like to use this software because it simplifies their trading and helps them to focus on the most important thing for them: identifying correct setups and entry points. They don’t have time or the desire to fiddle with the trade entry parameters through MetaTrader 4. They much prefer to use a software like this which streamlines the order entry process. Scalpers also very much enjoy using this software because of the speed of entry which it can provide.
You can see also in the image that there is an option for Risk %. This allows you, if this is your preferred method of managing risk on each trade, to trade based upon the available equity in your account. If you win a trade and are ready to place a new trade, the software will automatically detect the equity growth in the account from the previous trade and auto-calculate the correct position/lot size based upon the size of your stop loss level. Can you see how powerful a tool this can be to help you reduce your risk? 😉
Are You Trading Too Aggressively to Be Safe?
Increasing your position size may generate you big profits, but may also cause you to head down a path of destruction. Always control your trade size because, even with good analysis of the market, the possibility of losing always exists. There is always a loss coming around the corner and you need to be prepared for it—both emotionally as well as with your risk-management plan.
Forex traders must always be patient and wise when making a decision to increase their trading size/risk. Do not ever make a knee-jerk decision to power into a trade when the price just seems to be taking off like a rocket—maintain your discipline and your money management!
Are You Trading Too Aggressively to Stay Actively in The Game After 5 Consecutive Losses?
A typical percentage of your margin to risk is 2% only when opening a position. So if your margin has $1000, you need to risk maximum $20 when opening a position. That will give you the chance to trade with $4000 in one trade with 200:1 leverage. These are fundamental numbers that many trainers teach but in some ways they are just random numbers and you should trade with the amount that you feel comfortable with for your account. It must be an amount that you could safely lose that would not affect you emotionally or affect the future performance of your account.
Trade Only With Money That Can Be Lost With Little or Ideally NO Emotional Attachment.
This is a fundamental that you should always use to run your business and your trading ‘game’. If you have no emotional attachment with each trade that you place then you are free to let trades run and you are free to keep in control over your trading day. Even if you face a loss or two then you are able to continue on looking for good setups.
2. Control Losses With Stop Loss Orders On Each Trade
The stop loss order is one of the most effective ways to minimize your loses in Forex trading. This function will close your opening position when it reaches a pre-determined point that you adjust depending on your analysis of the pair movement and its resistance and support points.
This is a very simple matter but I just wanted to mention that you must always use a stop loss. If you have been a trader for more than a few months then you have probably already realized the absolute necessity of placing a stop loss with every trade.
Some professional traders will trade with a ‘mental stop loss’ and watch the charts closely as the trade progresses, closing manually if need be. They may close at their mental stop point or prior to it if they see a shift in the market conditions and the anticipated move does not seem to be working out. This is not recommended for new traders of course. Always place your stop loss at the outset of each trade. This will protect your account from huge losses (drawdowns) and will help you manage your trading risk appropriately.
3. Study the Market Like a Mad Scientist
One of the most obvious ways to gain experience and to learn about trading is to follow the market, studying it like one would study a foreign language. Make use of both types of analysis; technical & fundamental analysis before starting your trading day.
Technical analysis tends to study the past currency pair movement and predicts its future movement based on its history and certain mathematical signals. On the other hand, fundamental analysis studies the economic factors and watches the events that may affect the price of certain currencies.
Fundamental analysis can be posted to your inbox on regular basis from a number of popular sites like ForexFactory.com; but for a good technical analysis you need to study and to understand how to read currency charts and how to apply different signals on them to get a better understanding of the currency’s future movements.
There are several different news sites that can help you with learning about fundamental analysis. You can do a simple Google search for them and you will find plenty. Another popular one is DailyFX.com of which you can be alerted to the news for each day. I recommend that, if you are an active trader, you keep on top of the high impact news releases that come out each day or week that can (and do) affect your trading pairs.
Do Professional Traders Know More About Forex Than You Do… Or Less?
If these professionals know more about Forex than you do, and they are making more money than you do, what does this tell you? Perhaps it is a call or signal to you to increase your study of the markets. Do you need to study the economic reports more? Less?
Imagine for yourself what the professionals do and also read about what they do. If you do the same things that the professional fund managers do, doesn’t it seem likely that your results and your profitability might increase as well? Indeed you would be likely to earn more and find better results if you were to treat your business with the same care that the professional fund managers give to their accounts.
There is an expression in business and personal achievement that states: “If you want something in life, find someone who is already getting the results that you want, find out what they are doing, and then do the same things.” Doing the same things will tend to create the same results for you. Consider this with regards to your trading business as well. I think you can use this one principle to help overcome some hurdles that you might be facing at the present time.
4. Expand The Pairs You Trade (or Focus on Fewer)
Some traders prefer to stick to just one currency pair. When the market conditions don’t appear to be valid for trading with this pair, they just stop trading. This is the correct thing to do. However, even worse though, if the market conditions continue to be undesirable for a long time they may lose patience and start to trade recklessly and without proper setups. This, even with the pair they are most familiar with, will often cause serious losses.
You may wish to increase the number of pairs that you watch if you are finding yourself often getting caught in times of unfavorable moves. You will also want to check the time of the day that you are trading since not all times are created equal in the currency trading world.
Some traders have the issue of trading/watching too many currency pairs. This can be a huge trap that many traders fall into. Have you been there yourself? I’m guessing that at some point you have. It is deceptive to want to look elsewhere for the setups you are looking for rather than being patient to wait for them with the pair you are focused on.
There are advantages to both focus and diversified charts but make sure that you are not overwhelming yourself and ‘missing the forest for the sake of the trees.’ After all, it is very easy to get ourselves overwhelmed when it comes to the currency markets; the data alone that flies at us is overwhelming. Don’t add to this overwhelm by trying to trade too many pairs.
Increase Your Education & Compound Your Experience.
I don’t think I will be able to emphasize this point enough. Are you actively reading books on Forex trading and on trading success in general? If you are not then you are missing the boat and not growing as a trader as fast as you could be.
Nothing Can Replace Raw Experience.
At the same time, books are wonderful but nothing can replace the raw experience that comes from placing live trades (on both demo and real accounts alike). Demo accounts will not give you quite the same emotional involvement as a live account but still it is very valuable experience that cannot be replaced by any quantity of reading or study time.
Make sure that you are constantly taking action on what you have learned and on implementing your trading system. This does not mean to trade recklessly or to avoid obeying the rules of your system just so you can place a trade for experience. It means rather that you will only gain experience by gaining experience.
Imagine that you have been trading for five more years than what you have traded now… will you be better and much more experienced at this point in your life? We both know the answer to this coaching question. This should compel you to continue on taking action on that which you are learning. You should continue studying your trading system with a fine-tooth comb but then at the same time apply what you have learned by placing trades according to the rules of your system. This QUANTITY of experience is what will add up to make you a much better trader in the end!
Know Your Trading Edge and Work With These Principles to Reduce Your Risk On Each Trade.
If you know your system well, and you know what you are looking for with each trade setup, then you will continue to get better and better as a trader as you gain experience. Remember that nothing can replace this raw experience, whether trading on a demo account or a live account. The live account will give you the best experience because of the emotional involvement (only make sure, of course, that you are trading with conservative and appropriate risk settings based on your level of experience).
Go out there now and create for yourself an action plan. Maybe you need to buy a trading education book (I have a great list of books on Forex trading for you here) and begin studying it. Maybe you need to revisit your trading strategy and learn all of the rules by heart. Maybe you need to open up a new demo account and start again from scratch. Maybe you need to buy a trading journal where you can write down all of your trades and the results of those trades.
Whatever the action is that you need to take, I encourage you to go and do it now without any further delays. Only study and focused action will move your trading success forward. Let me know below what you personally are going to do today to better your trading business—I can’t wait to hear what you will do with this information and encouragement! Good trading to you this week ahead!