Summary
1. Trading systems 2. Managing your funds 3. Trader Psychology 4. Summary
There are many different methods, systems and strategies which traders, “newbies” and old “pro’s”, apply to the market to make a profit from the movements in the prices. Each trader will assert that his or her methods are the best and the most profitable, but the truth is that each trading system has its strengths and weaknesses. The real keys to making money from the Forex market are the following:
1. Having and clear and simple trading system, and applying it consistently 2. Managing the funds you are trading with tight disciplines 3. Taking control of your psychology
This article will examine each of these three keys separately and propose some simple guidelines for traders to follow to avoid being trapped by the market during the inevitable periods of volatility which occur daily.
1. Trading systems There are essentially two types of systems which traders employ. These are:
a. Price following systems b. Price prediction systems
Let’s examine each one briefly.
Price following systems
These are systems which rely on momentum indicators, oscillators and averaging methods to simply follow the market in the direction in which it is moving. The simplest of these is to find a suitable moving average (MA) and trade in the direction the MA is pointing, with the price on the correct side of that average.
One can add to that a whole variety of other indicators such as MACD, Stochastics, RSI and Bollinger Bands etc. One charting package I use has 29 different indicators, leading to an overload of endless possible combinations to use. Furthermore, there are about 20 different possible time frames to study. Its not hard to see why traders end up with the commonly know “paralysis of analysis” which is recognized by the comatose mouse hand and glazed eyes of someone sitting in front of the screen for 12 hours without taking a trade.
They key is to keep it simple. Decide on the time from you choose to trade from (scalpers may prefer 5 minute or 15 minute charts, whereas session/day traders may prefer 1 hour, 4 hour of day charts) and look for a very simple system which combines no more than 2 or 3 indicators. Such systems may also incorporate simple trend line studies, with the trade direction following the prevailing straight line trend.
When the signals are given by your system, take your trades confidently and consistently. Do not abandon your method and start searching for another after the first loss.
Price Prediction systems
These are systems which are generally longer term systems, applied to session, day or longer periods. They involve deciding the overall direction of the currency pair over a longer time frame and then trading a simple “buy on dips” or “sell on rallies” approach, depending on the direction you have decided on. There are various tools to help the strategy trader, such as horizontal lines, trend lines, Fibonacci retracement levels, moving averages and so on. These will help to a) identify the direction of trade, b) identify a logical entry point and c) identify a logical exit point. These trades can then be programmed into the dealing software and left to take care of themselves, allowing the trader spend his time doing other things. This form of trading requires more skill and experience, but this can be learned with time and practice.
Essentially, price following systems generally tend to be shorter term “scalping” type systems, which involve screen watching for a large part of each day. Price prediction systems tend to involve strategies lasting 8 hours up to several days and allow the trader to get away from the screen and enjoy more free time.
Everyone has their preference but I have found from my own experience and observations that intense screen watching cannot be sustained for very long by most traders, before burning out after several weeks or months. You can recognize these traders immediately by their bagged eyes, short tempers and lack of social skills.
2. Managing your funds Whilst most traders can invent or learn a reasonable trading system to suit their styles of trading, many cannot manage their account safely enough to prevent large losses and the dreaded margin call. Even the some best traders in the World suffer from temporary lack of sanity in this area (including “yours truly”). Interesting case histories are described, for example, in Jack Schwager’s book “Market Wizards: Interviews with Top Traders”
There are three simple rules which can be applied here:
a) Never leverage over 10:1 and as your account grows larger, reduce this to below 5:1 b) Never risk more than 5% of your equity on a given day, and as your account grows, reduce this to less than 2% c) Never take a trade where you are risking more than 50% of the projected gains from the trade with your stop loss. In other words, the Win/Lose ratio (profit target in pips/stop loss in pips) should be 2:1 or higher.
Following these simple rules, even with a half baked trading system, will ensure that you can lose 2 out of every 3 trades and still break even on your account.
3. Trader Psychology All humans are subject to two (often opposing) forces – the mind and the emotions. The key to successful trading psychology is to prevent your emotions from dominating your mind.
The emotions you will experience will fluctuate wildly from fear to greed, to self-doubt and elation. These are all the enemy of the trader and need to be tempered by clear, objective and logical thinking.
Work out your trading strategy based on your previously defined system. Apply the system with safe account management rules, and shut out the emotional noise which will attempt to convince you to close early, over leverage, risk too much, risk too little etc.
4. Summary It is clear that the best traders aim for small and consistent gains without seeking “the latest” system to produce enormous profits. There simply are no such systems which work reliably day in and day out. Keep your money management tight and keep your emotions in check and you should succeed.
Finally – it is well worth the money spent on good education. Attend a seminar by a truly active trader and teacher, and buy lots of books on the subject. Do not think you can go from “zero to hero” in the FX market without investing time, effort and money in learning from experienced players. The money you might save initially will probably be lost many times over as the market works you over later.
TEAMFOREX James de Wet
http://www.teamforex.com/
