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surprised if they occur. Through a process of education and adaptation, they stay
ahead of the pack and are continuously finding new and creative ways to profit from
the evolving market.
Managing Leverage
Although these mistakes can afflict all types of traders and investors, there are issues
inherent in the forex market that can significantly increase trading risks. The significant
amount of financial leverage afforded forex traders presents additional risk that must be
managed.
Leverage provides traders with an opportunity to enhance returns. But leverage and the
commensurate financial risk is a double-edged sword that amplifies the downside as much
as it adds to potential gains. The forex market allows traders to leverage their accounts as
much as 400:1, which can lead to massive trading gains in some cases - and account for
crippling losses in others. The market allows traders to use vast amounts of financial risk,
but in many cases it is in a traders best interest to limit the amount of leverage used. (For
more insight, read Forex Leverage: A Double-Edged Sword.)
Most professional traders use about 2:1 leverage by trading one standard lot ($100,000) for
every $50,000 in their trading accounts. This coincides with one mini lot ($10,000) for every
$5,000 and one micro lot ($1,000) for every $500 of account value. The amount of leverage
available comes from the amount of margin that brokers require for each trade. Margin is
simply a good faith deposit that you make to insulate the broker from potential losses on a
trade. The bank pools the margin deposits into one tremendous margin deposit that it uses
to make trades with the interbank market. Anyone that has ever had a trade go horribly
wrong knows about the dreadful margin call, where brokers demand additional cash
deposits; if they don't get them, they will sell the position at a loss to mitigate further losses
or recoup their capital.
Many forex brokers require various amounts of margin, which translates into the following
popular leverage ratios:
Margin Maximu
m
Leverage
5%
20:1
3%
33:1
2%
50:1
1%
100:1
0.5%
200:1
0.25%
400:1
The reason many forex traders fail is that they are undercapitalized in relation to the size of
the trades they make. It is either greed or the prospect of controlling vast amounts of money
with only a small amount of capital that coerces forex traders to take on such huge and
fragile financial risk. For example at a 100:1 leverage (a rather common leverage ratio), it
only takes a -1% change in price to result in a 100% loss. And every loss, even the small
ones taken by being stopped out of a trade early, only exacerbates the problem by reducing
the overall account balance and further increasing the leverage ratio.
Not only does leverage magnify losses, but it also increases transaction costs as a percent of
account value. For example, if a trader with a mini account of $500 uses 100:1 leverage by
buying five mini lots ($10,000) of a currency pair with a five-pip spread, the trader also
incurs $25 in transaction costs [(1/pip x 5 pip spread) x 5 lots]. Before the trade even begins,
he or she has to catch up, since the $25 in transaction costs represents 5% of the account
value. The higher the leverage, the higher the transaction costs as a percentage of account
value, and these costs increase as the account value drops. (For more, see How Does
Leverage Affect Pip Value?)
While the forex market is expected to be less volatile in the long term than the equity
market, it is obvious that the inability to withstand periodic losses and the negative effect of
those periodic losses through high levels of leverage are a disaster waiting to happen. These
issues are compounded by the fact that the forex market contains a significant level
ofmacroeconomic and political risks that can create short-term pricing inefficiencies and play
havoc with the value of certain currency pairs.
Conclusion
Many of the factors that cause forex traders to fail are similar to ones that plague investors
in other asset classes. The simplest way to avoid some of these pitfalls is to build a
relationship with other successful forex traders who can teach you the trading disciplines
required by the asset class, including the risk and money management rules required to
trade the forex market. Only then will you be able to plan appropriately and trade with the
return expectations that keep you from taking excessive risk for the potential benefits.
(Check out our Forex Walkthrough - Level 1: Forex Intro, Level 2: Markets.)
While understanding the macroeconomic, technical and fundamental analysis necessary for
trading forex is as important as the requisite trading psychology, one of the largest factors
that separates success from failure is a trader's ability to manage a trading account. The
keys to account management include making sure to be sufficiently capitalized, using
appropriate trade sizing and limiting financial risk by using smart levels of leverage.
everything about our nation and your day-to-day life. Watch the eye-opening video
presentation here.
If you have a written trading or investment plan, congratulations! You are in the minority.
While it is still no absolute guarantee of success, you have eliminated one major roadblock.
If your plan uses flawed techniques or lacks preparation, your success won't come
immediately, but at least you are in a position to chart and modify your course. By
documenting the process, you learn what works and how to avoid repeating costly
mistakes.
Whether or not you have a plan now, here are some ideas to help with the process.
Disaster Avoidance 101
Trading is a business, so you have to treat it as such if you want to succeed. Reading some
books, buying a charting program, opening a brokerage account and starting to trade is not
a business plan - it is a recipe for disaster. "If you don't follow a written trading plan, you
court disaster every time you enter the market," says John Novak, an experienced trader
and developer of the T-3 Fibs Protrader Program.
John and his wife Melinda, who is also his business partner in Nexgen Software Systems, run
a number of educational trading chat rooms to help traders learn how to use their software
and, more importantly, learn how to trade. In a nutshell, their software
identifiesFibonacci areas of support and resistance in multiple time frames and provides
traders with specific areas to enter and exit the market. Once a trader knows where the
market has the potential to pause or reverse, he or she must then determine which one it
will be and act accordingly.
"Even with the best program, market data and analysis, odds for consistent success range
from slim to none without a written plan," says Novak. The Nexgen website offers examples
of trading plans and useful market information for the benefit of both clients and non-clients
alike.
"Like the markets, a good trading plan evolves and changes, and should improve over time,"
says Melinda Novak.
A plan should be written in stone while you are trading, but subject to re-evaluation once the
market has closed. It changes with market conditions and adjusts as the trader's skill level
improves. Each trader should write his or her own plan, taking into account personal trading
styles and goals. Using someone else's plan does not reflect your trading characteristics.
until the report is released than take unnecessary risk. Pros trade based on
probabilities. They don't gamble.
6. Trade preparation Before the trading day, reboot your computer(s) to clear the
resident memory (RAM). Whatever trading system and program you use, label major
and minor support and resistance levels, set alerts for entry and exit signals and
make sure all signals can be easily seen or detected with a clear visual or auditory
signal. Your trading area should not offer distractions. Remember, this is a business,
and distractions can be costly.
7. Set exit rules Most traders make the mistake of concentrating 90% or more of their
efforts in looking for buy signals but pay very little attention to when and where to
exit. Many traders cannot sell if they are down because they don't want to take a
loss. Get over it or you will not make it as a trader. If your stop gets hit, it means you
were wrong. Don't take it personally. Professional traders lose more trades than they
win, but by managing money and limiting losses, they still end up making profits.
Before you enter a trade, you should know where your exits are. There are at least
two for every trade. First, what is your stop loss if the trade goes against you? It must
be written down. Mental stops don't count. Second, each trade should have a profit
target. Once you get there, sell a portion of your position and you can move your
stop loss on the rest of your position to break even if you wish. As discussed above in
number three, never risk more than a set percentage of your portfolio on any trade.
8. Set entry rules This comes after the tips for exit rules for a reason: exits are far
more important than entries. A typical entry rule could be worded like this: "If signal
A fires and there is a minimum target at least three times as great as my stop loss
and we are at support, then buy X contracts or shares here." Your system should be
complicated enough to be effective, but simple enough to facilitate snap decisions. If
you have 20 conditions that must be met and many are subjective, you will find it
difficult if not impossible to actually make trades. Computers often make better
traders than people, which may explain why nearly 50% of all trades that now occur
on the New York Stock Exchange are computer-program generated. Computers don't
have to think or feel good to make a trade. If conditions are met, they enter. When
the trade goes the wrong way or hits a profit target, they exit. They don't get angry
at the market or feel invincible after making a few good trades. Each decision is
based on probabilities.
9. Keep excellent records All good traders are also good record keepers. If they win a
trade, they want to know exactly why and how. More importantly, they want to know
the same when they lose, so they don't repeat unnecessary mistakes. Write down
details such as targets, the entry and exit of each trade, the time, support and
resistance levels, daily opening range, market open and close for the day, and record
comments about why you made the trade and lessons learned. Also, you should save
your trading records so that you can go back and analyze the profit/loss for a
particular system, draw-downs (which are amounts lost per trade using a trading
system), average time per trade (which is necessary to calculate trade efficiency),
and other important factors, and also compare them to a buy-and-hold strategy.
Remember, this is a business and you are the accountant.
10. Perform a post-mortem After each trading day, adding up the profit or loss is
secondary to knowing the why and how. Write down your conclusions in your trading
journal so that you can reference them again later.
Parting Notes
"No one should be trading real money until they have at least 30 to 60 profitable paper
trades under their belts in real time in real market conditions before risking real money,"
says Novak.
Successful paper trading does not guarantee that you will have success when you begin
trading real money and emotions come into play. But successful paper trading does give the
trader confidence that the system he or she is going to use actually works.
The exercises in "Trading in the Zone" walk the trader through trading a system based on a
simple indicator, entering the market when the indicator gives a buy and exiting when it
gives a sell. Deciding on a system is less important than gaining enough skill so that you are
able to make trades without second guessing or doubting the decision.
There is no way to guarantee that a trade will make money. The trader's chances are based
on his or her skill and system of winning and losing. There is no such thing as winning
without losing. Professional traders know before they enter a trade that the odds are in their
favor or they wouldn't be there. By letting his or her profits ride and cutting losses short, a
trader may lose some battles, but he or she will win the war. Most traders and investors do
the opposite, which is why they never make money.
Traders who win consistently treat trading as a business. While it's not a guarantee that you
will make money, having a plan is crucial if you want to become consistently successful and
survive in the trading game.
by Matt Blackman (Contact Author | Biography)
Matt Blackman, the host of TradeSystemGuru.com, is a technical trader, author, keynote
speaker and regular contributor to a number of trading publications and investment/trading
websites in North America and Europe. He also writes a weekly market letter.
the inertia favors the bulls, and when EMA falls, inertia favors thebears. To measure market
momentum, the trader uses the moving-average-convergence-divergence (MACD)
histogram, which is an oscillator displaying a slope reflecting the changes of power among
bulls and bears. When the slope of the MACD histogram rises, bulls are becoming stronger.
When it falls, the bears are gaining strength.
The system issues an entry signal when both the inertia and momentum indicators move in
the same direction, and an exit signal is issued when these two indicators diverge. If signals
from both the EMA and the MACD histogram point in the same direction, both inertia and
momentum are working together toward clear uptrends or downtrends. When both the EMA
and the MACD histogram are rising, the bulls have control of the trend, and the uptrend is
accelerating. When both EMA and MACD histogram fall, the bears are in control, and the
downtrend is paramount.
Refining Entry Points
The above principles for determining market inertia and momentum are used to identify
entry points in a precise style of trading. If your time frame of comfort corresponds to the
daily charts, then you should analyze the weekly chart to determine the relative bullishness
or bearishness of the market. To determine the market's longer-term trend, you can use the
26-week EMA and the weekly MACD histogram on the weekly chart.
Once the long-term trend is gleaned, use your usual daily chart and look for trades only in
the direction of the long-term weekly trend. Using a 13-day EMA and a 12-26-9 MACD
histogram, you can wait for the appropriate signal from your daily comfort zone.
When the weekly trend is up, wait for both the 13-day EMA and MACD histogram to turn up.
At this time, a strong buy signal is issued and you should enter a long position and stay with
it until the buy signal disappears. By contrast, when the weekly trend is down, wait for the
daily charts to show both the 13-day EMA and MACD histogram turning down. Such an
occurrence will be a strong signal to go short, but you should remain ready to cover the
short position at the very moment that your buy signal disappears.
Techniques for Exiting Positions
The major reason momentum trading can be successful in both choppy markets and markets
with a strong trend is that we are searching not for long-term momentum but for short-term
momentum. All markets trend within any given week, and the best stocks to trade are those
that regularly exhibit strong intra-day trends. With that in mind, you must remember to step
off the momentum train before it reaches the station.
As already mentioned, once you have identified and entered into a strong momentum
trading opportunity (when daily EMA and MACD histogram are both rising), you should exit
your position at the very moment either indicator turns down. The daily MACD histogram is
usually (but not always) the first to turn as the upside momentum begins to weaken. This
turn, however, might not be a true sell signal but a result of the removal of the buy signal,
which, for the impulse system, is enough impetus for you to sell.
When the weekly trend is down and the daily EMA and MACD histogram fall while you are in
a short position, you should cover your shorts as soon as either of the indicators stop issuing
a sell signal, when the downward momentum has ceased the most rapid portion of its
descent. Your time to sell is prior to the trend reaching its absolute bottom. As contrasted
with a carefully chosen entry point, the exit points require quick actions at the precise
moment when your identified trend appears to be nearing its end.
Conclusion
As you have probably already noticed, the impulse system of trading on momentum is not a
computerized or mechanical process. This is why human discipline continues to hold so
much sway on your degree of success in momentum trading: you must remain stalwart in
waiting for your "best" opportunity to enter a position, and agile enough in keep your focus
on spotting the next exit signal.
Until next time, all the very best in your trading endeavors
place. One of the best ways a trader can learn is by experimenting - within reason. This
experience may also help reduce emotional influences.
Finally, traders should periodically review and assess their performance. This means not only
should they review their returns and their individual positions, but also how they prepared
for a trading session, how up-to-date they are on the markets and how they're progressing in
terms of ongoing education, among other things. This periodic assessment can help the
trader correct mistakes, which may help enhance their overall returns. It may also help them
to maintain the right mindset and help them to be psychologically prepared to do business.
(For more, see Ten Steps To Building A Winning Trading Plan.)
Bottom Line
It's often important for a trader to be able to read a chart and have the right technology so
that their trades get executed, but there is often a psychological component to trading that
shouldn't be overlooked. Setting trading rules, building a trading plan, doing research and
getting experience are all simple steps that can help a trader overcome these little mind
matters.
by Glenn Curtis (Contact Author | Biography)
Glenn Curtis started his career as an equity analyst at Cantone Research, a New Jerseybased regional brokerage firm. He has since worked as an equity analyst and a financial
writer at a number of print/web publications and brokerage firms including Registered
Representative Magazine, Advanced Trading Magazine, Worldlyinvestor.com,
RealMoney.com, TheStreet.com and Prudential Securities. Curtis has also held Series 6,7,24
and 63 securities licenses.
Ten Common Reasons Traders Lose Discipline And How To Avoid Them
Ten Common Reasons Traders Lose Discipline And How To Avoid Them.
There is very little that is new in the world of trading psychology but mastering the basics
and mastering our mind is essential if we are to develop as highly efficient traders. The
following are common discipline issues and suggestions to counteract them. Discipline is
needed if you are to succeed as a Forex trader
1. Boredom and a need to trade for the buzz
Try to use dead time between trades for things like self improvement training i.e. read a
book by your favorite personal development guru or learn to meditate/practice Yoga!
Anything that keeps you in the right frame of mind for the job of trading. A positive mindset
will have a positive impact on your bottom line over time.
2. Trading when tired.
One of the great things about trading is that we can close for business whenever we want. If
you are not in the correct mindset for trading then shut the shop! There will be no customers
banging on the door shouting for you to open up.
Patience.
It's a virtue...Especially in trading.
Arnold H. Glasgow, an American humorist, once said, "The key to everything is patience.
You get the chicken by hatching the egg, not by smashing it."
Developing your trading plan will take time. Developing skills will take time.
Waiting for the right trades requires patience. Entering and exiting a trade at the right
moment requires patience.
Discipline.
Discipline is also a virtue, and it means doing the things you need to do to progress and get
better....even if you don't want do it.
This means preparing for each trading day or week with research and chart study.
If you're a mechanical or automated trader, this means back testing systems and constantly
trying different settings and strategies as the environment changes.
And of course, don't forget about journaling and reviewing every single day you trade.
Journaling is the one trading task that separates the wannabe traders from the real deal
traders. Unfortunately, most newbies won't do it.
Trading concepts and techniques are simple and easy to learn. What's hard to learn is how
to be patient and disciplined to do the right things and make good trading decisions.
Truthfully, it will be one of the most difficult endeavors you will ever take on.
To a newbie, sitting on the sidelines and watching the markets move while you wait for your
best setups means you're missing out on profits.
This way of thinking leads to a failure of patience and discipline and causes some of the
most notorious trading mistakes in the book:
Impulse trades
Letting losers run too long
Cutting winners too quickly
Revenge trades
These actions will kill your account!
Remember that your job as a newbie is to learn how to make good trading decisions
and SURVIVE!
The best thing you can do to stay patient and disciplined is to look at your career as a trader
as a marathon and NOT a sprint.
This is not an overnight, get-rich-quick scheme.
This is a commitment to build skills that will allow you to profitably trade in any environment
the market will throw at you at any time.
And essentially, free you from the chains of the "Man." Fight the Power!!
If you stay patient, maintain discipline, and commit to constant improvement, then your
results today as a forex noob will probably be nothing compared to the results of the trader
you will become after years grinding it out in the markets.
Another thing....
Always remember that opportunities for good trades occur ALMOST EVERY SINGLE DAY!
No need to rush into bad trades. They will only set you back from reaching your goals.
Stick to your best ideas and setups, and if they don't come that session, just wait for the
next.
Unless the world stops trading currencies (knock on wood) then there will always be
opportunities around the corner