About 'forex for beginners'|Forex Trading For Beginners | What all Traders Should Know
The foreign exchange market is a universe of possibility for traders. There are so many approaches to trading in this market; it is bewildering to most beginners. For this reason, many people who are new to trading forex get lost in the details. They start trading before they are ready. These people enter a trade before they really know why and they aren't prepared for the disastrous results that usually follow. For these new traders (and perhaps for the more experienced ones too), I have included a list of points that are essential to every trading plan. 1. Know your risk tolerance Your personal risk tolerance is one thing you need to establish first. This is very important because it can affect your ability to trade wisely. If you think you can handle risking 5 percent on each trade, then you better have a strong stomach. Every trader and every system undergoes what is called "drawdown." This is the period that every trading strategy hits when it continually loses trades. If your system hits four losing trades in a row, which is statistically very likely in forex trading, and you are risking 5 percent of your capital on each trade, you will have a drawdown of 20 percent. This is a lot of money for some people. If you can't handle a drawdown of over 10 percent of your account, you may not want to ever risk over 1 percent of your capital on each trade. We will cover how you can take control of your own risk on each trade in a later point. 2. Know your risk/return ratio After determining how much you are willing to risk on a trade, you need to make sure that each trade has the potential of giving you more than you risk. The reason is obvious. If you have a losing trade that takes out 1 percent of your capital and then a winning trade that gives you .5 percent of your capital, you are still behind. Whatever your strategy is, it needs to have at the very least a 1-2 risk/return ratio. This means that you can lose more trades than you win and still end up profiting. Most trading systems have fewer winning trades than losing trades. These systems can still make money though, because they have a good risk/return ratio. Something to keep in mind on this point is that there are different market environments that will greatly affect your trading plan and your returns. There are two basic kinds of market environments: trending and consolidating. You need to have different trading strategies for these different market conditions. A consolidating market probably won't give the kinds of returns that a trending market will give you. Keep this in mind. The next very important point is knowing your entry. 3. Know your entry The point at which you enter a trade really is the definition of your trading plan. What conditions need to be met before you enter the market? There are endless options for traders on when and how to enter the market. Traders rely on a library of different indicators to tell them where to enter. Things like MACD, Stochasitics, Average True Range, Bollinger Bands, Exponential Moving Average, Standard Moving Average, Fibonacci Retracements, Gann Fanns, and Elliot Wave theory are only a few of the types of helps that traders rely on for entering the market. The list of indicators can be exasperating for new traders. Many new traders will make their charts look like a game of pick-up-sticks with all the indicators all over their screen. This is not the way to trade. Each trader needs to determine his own strategy and style. Once that strategy for entry is picked, you should stick with it and see if it makes money. Backtesting the strategy with historical data is a time-intensive process but is absolutely essential for knowing if your strategy will make money in the long term. Find one strategy for each market environment and trade it consistently. This is crucial for consistent profit. 4. Know your exits This step is probably more important than knowing your entry. Every trade must have two exits planned: a stop order and a limit order. You need to decide where to cut your losses (stop order) and where to take your profits (limit order). These exits should be planned before the trade is ever executed. These exits also must reflect your risk/return ratio. If your stop loss is 10 pips beyond your entry, your limit order should be about 20 pips in the other direction. Some of the details depend on the currency pair and the market environment but the basic point is simple: Know your exits before you place an entry order. One quote to remember here is, "It's not about how much you make; it's about how much you don't lose." Knowing your exits is not enough, however. You need to make sure that you let your exits do the work. There are many sad stories of traders moving their stops because they refuse to admit their analysis was wrong. When you place a stop and a limit you need to leave it there. The goal is to see if your trading system works in the long run. If you trade the exact same way time and time again, will you make money consistently? This is what you are trying to figure out. If you intervene and move your stops, you'll never know how your trading system is performing. Once you identify the place where you want to put your stop you can calculate how many lots to trade consistent with your risk tolerance. Many people trade a default 10 lot without considering the risk. Someone with a $1000 account may want to buy 10 lots and have a 50 pip stop loss. This trade is risking 5 percent of his capital! The lot size needs to be adjusted based on how much risk can be tolerated. In order to find out how many lots to buy or sell there are lot size calculators for free to download all over the web. These calculators need to know the kind of lots you trade (standard, micro, or mini), the amount of pips until the stop loss, your account capital, and the percentage of risk you can handle. This calculator then tells you how many lots to trade. This is a helpful tool for smart money management on each trade. 5. Follow your "If-then" syntax" The "If-then" syntax is really just a complicated way of describing your rules for entry and exit. You need to have "if" criteria that must be met before you enter the market. For example, you could say something like, "If the 60 minute candle closes below this particular moving average in a trending market......then I will sell a 1-4 risk/return profile." The "if" defines the conditions that must be met before you will trust the market with your money. This is a business transaction. With any other business you require a certain number of details so that you know your money is wisely invested. The same is true in forex trading. The market must obey your conditions before you ever give any of your hard-earned money away. This objective and business-like mentality will save you from a lot of foolish trades. 6. Trade your plan This final point seems redundant and obvious, but it is absolutely essential. Once you have defined your plan you must trade that plan. The main reason why most people lose at forex trading is because of the psychological element. People want to be right in their analysis of the market. If you were wrong about the market, okay, let your stop take you out. There are good trades that lose money and bad trades that make money. You shouldn't feel good if you made money but violated your own plan. Why? Because you have a plan so you can repetitively and predictably make consistent profit. If you violate your own rules, you are not a good trader, even if your account is growing. Ultimately, you will lose. Don't fall into the trap of so many traders who try and trade without a plan. Form a plan, follow it and watch your account grow. Want to make your 1st $1000 in forex trading? Spend the time and effort on finding a good plan and getting in tune with the market. Make sure the market plays by your rules before you give it any of your money. |
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