Develop Trading Discipline
You need to develop trading discipline. If you come to a point in your market analysis in a trading session when you have no confidence on the accurate direction of the market forecast, choose not to trade. Always remember, a lost opportunity is better than lost capital.
You should wait for the market conditions to become clearer before you enter a trade. You should increase the probability of success by trading when the trade setups are strong and risk to reward ratio is not more than 1:2. This is far more important in forex than in stock markets. The forex markets move a lot as compared to the stock markets.
You need to learn that high leverage will give you the opportunity to make a lot more money much quicker. But in case you go wrong, currency markets are ruthless. You can get your account wiped out. You dont see an opportunity clearly. Try to sit on the sidelines. You dont have to trade every time. Wait for the market conditions to become clearer. You should learn to be a patient trader. Wait for the market to come to you.
You need to learn that leverage is a wonderful money making weapon. It is the essential key to making money in the currency markets as no other markets allow high leverage that this market allows. A leverage of 100:1 means that with a $1000 deposit, you can trade $100,000. This huge amount of leverage will give you the opportunity to make the kind of returns on your investment that you want.
But using high leverage also has the potential of making you lose some or all of your capital if you trade foolishly. Take the example of credit cards. The bank lets you borrow huge sums of money using your credit card on the promise that you will pay it back.
But if you abuse your credit card, it can lead you into heavy debt or even bankruptcy. Just like managing your credit card, you need to manage leverage in forex trading. Just because you have $10,000, does not mean that you should trade 10 lots. Using all your capital would be foolish.
A very conservative yet very effective method would be to never leverage more than 20% of your account. Thus, you should only trade two lots with a $10,000 capital. Using good money management and discipline, you grow your account successfully in a short period of time.
Dont forget the power of compounding. The compounding factor applied to your capital can make it grow fast. Many people want to get rich quick. They take unnecessary risks while trading thinking that a few big wins will make them rich. They dont focus on proper trading principles. You need to develop the discipline in yourself to follow simple money management rules.
Suppose you open a mini account. Start by trading one position of a tenth of a lot. You will not make much money in the beginning. The position size is only one tenth of a normal lot. Be patient! The percentage of returns will compound over time. You will trade a much larger sum of money with the passage of time.
You should make realistic goals that can be achieved over time. Always trade with the money that you can afford to lose! Trading with money that you cannot afford to lose is foolish. Dont borrow money to trade. Dont use money that you would use to pay monthly utility bills. Dont use your life savings. You are not a gambler.
Understand How to Use Risk to Reward Ratio
Many new traders think that for each trade a good entry into the markets is the essential key to success. Most of them are wrong, unfortunately. What is more important is trading with a good risk to reward ratio. A risk to reward ratio compares the potential for reward with the potential for loss. A good ratio has a high probability of making a profit.
Risk is measured by counting the number of pips between the forecasted entry price and the forecasted price at which you want to exit the market in case of a losing trade. A trader must view each trade as a business transaction. Risk is just a measure of how much you can lose in a trade.
Reward is calculated by the pips between the forecasted entry price and the forecasted price at which you would want to exit the market in case of a winning trade. Reward is the expected number of pips that you want to make in a trade that will be a winner.
In order to manage risk, you need to look for high probability trades. Trade only if the risk to reward ratio is 1:2 or higher. Your risk and your reward depend on the time frame that you want to trade. Suppose you are a day trader. You are expecting to make only 30 pips in a trade. For the risk to reward ratio of 1:2, a stop loss of 15 pips is sufficient.
However, suppose you are a swing trader or a position trader with a longer time frame. Your profit potential will be more on a longer time frame. Suppose you choose 200 pips as your expected profit. You will need to set your stop loss at 100 pips.
The reason that you need to set a higher stop loss is that on a larger time frame, small trends occur within the larger trend. Retracements on shorter time frame is much smaller as compared on the larger time frame. Your trade is going to be recycled. In order to be not stopped out, you need to calculate your risk to reward ratio appropriately.
The second most important thing for traders is minimizing losses, next to maximizing profits. A forex trading system that wins on average only 50% of the time can still be profitable. Most of the traders want to make money. But they dont know how to protect what they currently have.
You have a 50/50 chance of the currency market going your way. It is just like flipping a coin. In case, the trade does not develop in your favor and the market is going against you, you should cut your losses by using stop losses. In simple terms, you cut your losses and let your winners run. This simple 50/50 trading strategy earns a profit even when a novice trader might experience a loss.
Consider different risk to reward ratios and how much you need to win to break even. For 2:1 risk to reward ratio, you need 67% winners just to break even. For a 1:1 risk to reward ratio, it means just 50% winners to break even. 1:2 ratio means only 33.5% winners. Never ever trade when the risk to reward ratio is more than 1:2.
Learn To Use Moving Averages & Bollinger Bands?
Moving averages are a very popular tool among the traders because they are a lagging indicator of the price action. Short and long term trends are easier to identify using moving averages.
MAs are calculated on the traders specifications. They can be formatted to different style of trading and time frames. For example, in case you want to use a 90 time frame moving average, the prices of the last 90 times frames is added together and divided by 90.
A moving average can be calculated based on the opening, high, low or closing price within a time frame. Since the closing price is the most important price, most traders prefer to use the closing price. There are three types of moving averages. First one is the Simple Moving Average. Second is Weighted Moving Average and the third is the exponential moving average.
The simple MA is simply calculated by dividing the price in each time frame by the number of time frames as the name suggests. A weighted MA places more weight to the current prices as compared to the prices in the last few time frames. In an exponentially smoothed MA, the chart is exponentially smoothed out with less emphasis on the prices in the latter time frames.
Another important technical indicator is the Bollinger Bands. What are Bollinger Bands? These are bands plotted at a standard deviation above and below a moving average. The base of a band is moving average. The bands width is determined by volatility. The standard deviation is a measure of volatility so the bands are self adjusting. They widen during volatile markets and contract during less volatile periods. Bollinger bands bracket almost 90% of the market action.
Bollinger bands have many useful characteristics. Knowing when the prices are high and low, a trader can make rational investment decisions by comparing price action with the action of other indicators. They are curves drawn in and around the price structure. This provides relative definitions of high and low.
Bollinger bands can be applied to mutual funds, forex trading, futures, indices etc. As volatility lessens, sharp price action tends to occur as the bands tighten. A continuation of current trend is strongly expected when the price moves outside the bands.
A move that originates at one band tends to go all the way to the other band. When bottoms and tops made outside the bands are followed by bottoms and tops made inside the bands, reversal of the trend is highly likely.
When the bands are flat and narrow, this indicates that price volatility is lower than in previous time periods. The 10% price action outside the bands is most likely going to approximate areas where prices will return to within the bands.
When the bands begin to flare and widen, this indicates increased volatility and start of a new strong trend. Wide bands are usually taken as an indication of a very strong move.
Learning to Avoid Emotions in Forex Trading
One of the most crucial yet overlooked elements of successful trading is maintaining a healthy psychological outlook. At the end of the day, traders who are unable to cope with the stress of the market fluctuations will not withstand the test of time. No matter how skilled they may be at the scientific elements of trading.
As a good trader, you need to be emotionally detached in making trading decisions. One of the attributes of good traders is that they accept losing. Your trading decisions must not depend on fear and greed. Make decisions based on an intellectual level. Traders who get emotionally involved in trading make hasty decisions resulting in substantial errors. They try to whimsically change their strategies after a few losses. In case of a few winning trades they become carefree.
Good traders are emotionally balanced. In the midst of a losing streak, they try to take a break before fear or greed starts to dominate their strategy. You cannot win every trade; you must be psychologically strong enough to cope with losses. Even very successful traders go through stretches of losing trades but they are emotionally strong enough to cope with it.
If you are going through a bad stretch, it may be time you think of taking a break. Take a few days off from watching the markets and trading to clear your mind. Continuation to trade relentlessly during tough market conditions can breed greater losses and ruin your psychological confidence.
Make no mistake about it, no matter how much you study, practice and trade; there will be stretches of losing trades. You cannot always win. The key is to make losing trades small enough in order to live to trade another day. By using good money management rules, you can overcome a lot of bad luck in your trading. Never ever put more than 2% of your equity at risk in a single trade.
You need to control your emotions in order to become a master trader. One constant is the human emotional behavior despite many new methods that have been introduced to traders. After all, markets are just people selling and buying. Markets are only a reflection of investors emotions.
People afraid of losing their money start to sell in a panic. Fear of losing money makes the market prices to head lower. Greedy people buy trying to catch a free ride. Fear of losing a good opportunity makes the market prices to go up.
You need to learn technical analysis as a forex trader. Technical analysis will make you understand how to capture profits from movements in the price. You should understand how price action takes place. Develop a trading system that is ruled based. Dont make decisions based on emotions.
The best method to overcome emotions in trading is to develop your own trading system that is ruled based. It should be mechanical in nature. Trading is an art. Learn trading as an art. There will always be 10% of discretion in each trade. Develop a trading system that has clear cut rules for entering and exiting a position and rules out most of the discretion. Discretion means using emotions. Make rules to avoid discretion. Use those rules consistently. There maybe a few losses. With a good forex trading system, you can be sure the number of winner will be greater than the losers.
Why The Foreign Exchange Market Is Different From The Stock Market Article
What is the difference between the Foreign Exchange Market and the Stock Market? Find out here on my Forex trading software reviews blog article.
Trading that takes place between two counties with different currencies is the basis for the fx market and the background of the trading in this market. The forex market was established in the early 1970′s. The forex market is one that is not based on any one business or investing in any one business, but the trading and selling of currencies.
The main difference between the stock market and the forex market is the vast trading that occurs on the forex market. There is millions and millions that are traded daily on the forex market, almost two trillion dollars is traded daily. The amount is much higher than the money traded on the daily stock market of any country. The forex numbers are astronomical!
What is traded, bought and sold on the forex market is something that can easily be liquidated, meaning it can be turned back to cash fast, or often times it is actually going to be cash. From one currency to another, the availability of cash in the forex market is something that can happen fast for any investor from any of the countries trading currencies.
The difference between the stock market and the forex market is that the forex market is global, worldwide. The stock market is something that takes place only within a country. The stock market is based on businesses and products that are within a country, and the forex market takes that a step further to include any country.
The stock market has set business hours. Generally, this is going to follow the business day, and will be closed on banking holidays and weekends. The forex market is one that is open generally twenty four hours a day because the vast number of countries that are involved in forex trading, buying and selling are located in so many different times zones.
The stock market in any country is going to be based on only that countries currency, say for example the Japanese yen, and the Japanese stock market, or the United States stock market and the dollar. However, in the forex market, you are involved with many types of countries, and many currencies. You will find references to a variety of currencies, and this is a big difference between the stock market and the forex market. You must get educated on forex because of the many types of currencies involved.
Oil and Currency Trading
Wall Street watches oil prices like a hawk. Remember the early part of 2008 when oil prices skyrocketed from near $70 to almost $150 within a few months. This was more than a 100% increase in oil prices. Many hedge funds heavily betted on the increase in oil prices and made a windfall.
It is being studied whether the increase in the oil prices was due to speculation by the hedge funds. When the stock markets crashed in the middle of 2008, most of the hedge funds had to liquidate their investments in crude oil futures to cover the redemption pressure on them. Oil prices collapsed. Oil prices are down now due to low consumer demand because of the global recession. But it is being predicted by the experts that with a recovery in the global economy, the oil demand will rise and the prices will go up again. Oil demand in China and India plays a major role now.
As oil prices go up, consumers are forced to spend more on oil. The more they spend on oil, the less they can spend on other products. The less they spend on other products, the less profit companies make. Declining profits made by these companies mean declining stock prices.
The opposite is also true. The less the oil prices become, the more Wall Street becomes optimistic about the profit potential of companies. This increased optimism leads to increase in stock prices. Two large futures exchanges are used to determine the prices of oil. They are the New York Mercantile Exchange (NYME) and the International Petroleum Exchange (IPE).
Historically, rising oil prices have been associated with falling stock markets. NYME is where most of the crude oil futures are traded. By monitoring the movement of the crude oil futures in NYME, you can develop a feel of the future economic situation of the United States. Since oil is heavily traded in US Dollar, this affects the US Dollar. The net effect is however a bit complicated.
Lets take a look at it more closely to understand the two effects that pull USD with oil. When oil prices increase, the demand for US Dollar also increases. Most of the countries need US Dollar to pay for their oil imports. High demand for US Dollar means that it should appreciate.
But this is not the whole story. Increased oil prices also take its toll on the US economy. The question is which effect is more important for the forex markets.
The effect varies for different currency pairs. Suppose you are watching a currency pair that involves the USD and a currency representing a country that does well during the times of high oil prices. Take Canada that has huge oil reserves after Saudi Arabia. The effect would be depreciation in the value of USD/CAD pair. US imports more oil from Canada than any other country. And if you are watching a currency pair that involves USD and a currency whose economy is harmed by the rising oil prices, the demand for USD will rise.
So some currencies have positive correlation with oil prices and other currencies have negative correlation with rising oil prices. The currency pair CAD/JPY shows the strongest reaction to rising oil prices. Japan imports almost 100% oil.
Watch for CAD/JPY currency pair, when oil prices are going to rise again. CAD is positively correlated with oil prices. JPY is negatively correlated. So CAD/JPY has the strongest reaction to the increase in oil prices. It can be a very good currency pair to trade during times of oil price boom.
How to Identify Breaking Support and Resistance?
Support and resistance levels are used by investors and speculators to determine how far they believe a currency pair will move between the two levels. This also tells them at what points the price action may turn around due to the buying or selling pressure and start moving in the opposite direction.
Sometimes, the markets change direction due to a shift in some underlying fundamental factor. The market change of direction due to the shift in underlying economic factors is strong enough to cause a currency pair to break through a previously established support and resistance level. When a previous support and resistance level is broken by the markets, new support and resistance levels are established. However, the broken levels may still have some influence on the market in the future.
Sometimes there are attempted breakouts, this is also known as False Breakouts. With experience, it will become clear to you that prices do not always stop at exactly the same points each time. So if you are going to use strict requirements for your support and resistance, those levels may not hold up every time. This way, you are going to fake yourself out of a lot of valid price movements.
Even when you take all the precautions with your support and resistance levels, you may fall victim to a false breakout. Now, you will ask how I can tell when the price has truly broken through support and resistance in a new direction.
There are primarily two methods that you can use to filter out a false breakout with a true breakout. These two methods are setting price-amplitude benchmarks and identifying role reversals.
Setting price amplitude benchmarks involves analyzing a chart to see if you can identify any moments when the price momentarily poked through the prevailing support and resistance level before pulling back and once again adhering to the previous level.
The dips through the predetermined levels are usually short lived. You can draw a secondary support and resistance lines which you can then utilize as your price-amplitude benchmarks.
A price amplitude benchmark tells you that if the price breaks through the predetermined level but does not break through the benchmark, you dont need to worry about a change in the direction of the trend. However, if the price has enough momentum to breach the benchmark, it has a good chance of continuing in the new direction.
Identifying role reversals method involves watching the price action to see if support levels turn into resistance levels and resistance levels turn into support levels. Often, you will see the price action bounce off a level of resistance, then turn around and start heading lower and bounce off the previous resistance level.
When a resistance level is broken, that same level will turn into a support level. Conversely when a support level is broken, that same level will turn into a resistance level. What this tells is that you can use both the benchmark and the role reversal confirmations in your trading analysis.