Learn How to Trade Forex the Right Way
It is the article about traders’ lofty dreams, breaking down on the financial markets reality and about the eternal question of “how to make money in forex”.
Don’t be scared by the title and the preface, they are just aiming to attract your attention =) I would like to dwell upon HOW MUCH you should be able to do to become a trader. I’ll also tell you what happens when traders want to train as fast as possible, studying thoroughly one of the aspects, ignoring the rest of them (by the way, it’s also about me).
The article may not be praised by many; the facts, I’m going to present are likely to be rejected, argued to make sure that “everything can’t be like that”. I just ask you to read it till the end and try to understand (you may make yourself a cup of tea/coffee to help yourself) whether there are any contradictions. I’m not aiming at making the real things seem negative, or getting you to a “prepare yourself for the worst”. Everything, described below, happened to me; it is a kind of a brief description of my own way, as it was. Later, speaking with other traders, I’ve discovered that everybody went the similar way, as “stupid”, diverse and inconsistent as mine. So, this article is just a description of what you must be prepared for if you want go “all the way”.
In addition, you are going to reject and deny the facts, presented below, and it is a norm. My objective is just to let you know the necessary information. It will provide you with some guidance to help you move on at some point.
1. Trying to prove something to somebody.
If you can, try to remember your childhood. You made sand castles, ran and laughed, played with toys, did something else...And next, remember your school. It wasn’t that fun at school – you had to study, receive good marks, and do your homework, read different textbooks and so on. Each of us is likely to know that, in addition to fun, joy and laughter, there is also sorrow, rage, shame and other negative emotions. It is human nature to try to avoid “unpleasant things” and seek something pleasant.
You won’t touch the hot iron twice, because it is painful. It is a logic reaction; but difficulties start, as a rule, during the school years. The notion of “must” emerges at school. Nobody asks you which subjects you like, you must study everything. I mean, first, you are given the task to do “something” you may not like at all. Next, if you have done that badly, you are punished: you get a bad mark, you are criticized, or even scolded. If you do “this thing” well, you are encouraged: you are praised (sometimes, even in front of your class). But the point is not that you are praised, rather, it is that you are NOT CRITICIZED, that is you aren’t punished. Doesn’t it remind you about something from the ancient times? And what about the circus? =)
Finally, it’s like you start to KNOW IN ADVANCE: if you fail, you’ll be “punished”. And you start criticizing yourself ON YOUR OWN – “I’m bad, I got a bad mark again/failed the exam/didn’t manage to fix the wardrobe”. On the other hand, if you succeed, you have a pleasant feeling like you are great, you deserve an award. Unfortunately, as we all have been living like that for more than ten years, you are getting used to criticizing yourself. And also, out of habit, you start striving for “success”, but not for something YOU PERSONALLY WANT; it is rather an OPPOSITE of “failure”. That is, you, in fact, start forcing yourself.
However, if you remember your childhood again, there is one distinguishing feature – when you were a child you did NOT NEED any praise, neither needed you success. You could just be sitting in the sandbox for hours and digging around, or you could be playing catch-up with other children, or splashing in the water. You didn’t need that an adult would come to say, “Good boy, Sam, you are excellent in digging around, I wish everybody would dig the sand like you...” Am I right? You weren’t aiming at building “the super sand castle” or “the best sand castle in the sandbox”. You were just sitting and building those sand castles because you liked it.
However, if you remember your childhood again, there is one distinguishing feature – when you were a child you did NOT NEED success
I hasten to say, success is a really good thing when you really like what you do and you just want to do it well. Success is not good when you force yourself to seek it, torture yourself, whip yourself, because “you suffer without success”.
Unfortunately, one of the negative features of this striving for success is that we need it SOON, as we are SUFFERING, suffering because Tom, for example, has already bought his third BMW, and I, like a fool, ride a bicycle. We are suffering because Jack and his wife are on holiday in Spain, but I’m, a loser, not traveling abroad in my forties. And we are just making ourselves suffer more, criticizing ourselves, burning ourselves inside, forcing ourselves to HURRY UP to become successful sooner. It is like standing on the coals and burning them by yourself, it is natural, that you want to ESCAPE AS SOON AS POSSIBLE. To somewhere not that hot. But, please, do remember that you once lit that fire by yourself. You are likely to have done it under a pressure, but now, the fire is burning because you have been used to it. We are all used to forcing ourselves and striving, because, otherwise, we would be punished. It is so, and it is not our fault. Just try to give up this habit step by step. It won’t happen at once, because a ten-year habit doesn’t disappear in a moment. So don’t force yourself to hurry up here as well =)
2. Trading is soo simple, screw the studies
A distinguishing feature of the “inner anxiety” is that you can’t do something in peace, thoughtfully, without being in a hurry. If you are standing on the burning coals, you don’t think if you have some water or any burn ointment somewhere around you, you just want to go away AS SOON AS POSSIBLE. To remove the pain.
A beginner trader is behaving in the same way, taking up trading: they want success, they NEED success and they are anxious to succeed. Because of this “inner anxiety”, they need that success AS SOON AS POSSIBLE, and so they’ll be looking for quicker ways to succeed, as they have NO TIME to study the subject thoroughly.
That is where everybody gets caught. It is the human tendency to hope for a “lucky chance”: you read about trading, see lots of nonsense like “money management”, “risk management”, “trading psychology” and think, “Man, what’s the use?” What is all of this for? You can just buy here and sell there. Why do you need to study this entire lot of things, if you just need to understand, WHERE THE PRICE WILL GO? And so on. Our mind is originally focused on “how to cheat the system” =)
Because of the “inner anxiety”, traders need that success AS SOON AS POSSIBLE, and so they’ll be looking for quicker ways to succeed, as they have NO TIME to study the subject.
Besides, I, for example, at the very beginning really wanted to believe that the market is good-natured, it understands my need and my despair and wants to help me. But the market has nothing human, no feelings or emotions; it’s the same phenomenon like rain or lunar eclipse or blooming of trees in spring. It doesn’t care, it lives its own life =)
3. For those, who are crazy about mountain peaks and fast profits
Next, I will describe step by step, what I was focused on and what conclusion I eventually arrived at. As I learnt from other traders later, these steps are quite similar for everybody, so this kind of guidance may help you. I only warn you, don’t be angry with yourself, or don’t criticize yourself for that you are “still here” and he is “already there”. Give yourself enough time.
And the second important thing: I just outline the steps, without criticizing anybody. It is natural that all of us make mistakes and do everything in the wrong way at the beginning. At the beginning we just can’t know what way is right =)
Well, step 1. “A neutral observer”
It begins immediately after you’ve learnt how much one can earn in forex and installed trading terminal on your computer. The best description of a “neutral observer” is “What if it reverses”. It means, when you enter a trade (even not according to the system) and the price goes in the needed direction you are just sitting and enjoying yourself. Next, there are first reversal signals but you don’t take the profit - “what if it reverses?” Your think you are going to miss the profit, aren’t you? =)
If the price, on the contrary, goes against you, you don’t stop the loss: “what if it reverses” You will lose, but you could have avoided it.
At the first step, you know nothing about risk management, money management, let alone trading psychology. You just don’t need to apply them.
Step 2. Increasing your deposit
Having read about “money management” with its “don’t risk more than 1% of your deposit per trade you chuckle and go ahead. When I read about these rules, I figured out that, with my initial deposit of $50, I would get a good amount of money in about 30 years, and I didn’t like it, of course =) And you remember that, at first, you need to do everything VERY FAST, because you are just very anxious. And, of course, it happens that you risk about 10 times more than it is recommended. It is because there is at least a chance (if everything goes well) to increase your deposit during a year or two.
At this step, traders, as a rule, already have some trading system, but the distinguishing feature is that they rely on it very much. Or, if they do not that much rely on it, they hope very much for GOOD LUCK. Having risked 10% of their deposit and gaining 20%, they think: “Well, I’ll be rich in half a year, it is easy”. Next, there is another trade and more profit, and they are growing more confident.
Next, they gain again and have already not $50, but almost $85, and, so far, the market has been “praising” them for their individual approaches and for that they haven’t followed too conservative tips from the books. And next, there is a loss, and there is only $72.5 left on the account, but the traders thought that $85 to be their OWN. Do you see? What are they feeling now? Like someone has TAKEN a part of their money away. And so, what do they need to do? They need to take it back by force! From someone who has stolen it, of course. Gradually, traders are arriving at the conclusion that...
Step 3. “The market is an ass”
That is when all of us start to revenge. It is likely to be the most dangerous for our deposit step. At first, you may trade according to your system, put stop losses and take profits, enter trades according to the strategy. However, when 2 or 3 stop losses in a row work out, you are going to be annoyed and start to revenge. That is when most traders usually trade “breaking bad”. You start treating market like a crazy supervisor, who you can never please – you seemed to be going to buy, but the price went down. And you want a kind of revenge it (“Well, if you want down, let it be down”) and open a sell, but the price goes up. “Are you a fool, or what?”, your mind asks the market and starts to invent some conspiracy theories, like the market is ruled by someone deliberately against us, trying to take our 100 dollars (there is Forex turnover below, for you to make fun of the person, who “pulls the strings”, chasing after our super deposits).
Also, at this step, many actively trade the ways like martingale, when the price is going down and you buy, increasing the trade volume each time. The price is deeper down, and you buy more, because “it will rebound, sooner or later”. But this approach is the same dangerous “revenge against the market” and the desire to beat it, because it hasn’t met your expectations. You treat the market aggressively, struggle with it, fight with it.
Some traders apply the locks. It is when you buy trade is losing, but you don’t exit it and open a sell position instead. On the one hand, you don’t let the loss increase, but, on the other hand, you don’t accept it, hoping that “the situation will somehow clarify” and you will be able to reduce this loss, for example. But the ironic reality is that there are NO such situations in the market, when anything is clear; the price can at any point go both up and down. I will explain it in more detail later.
By and large, I can’t recommend you anything here; you are likely to ignore any recommendations. You should just bear in mind that there is such a step. I do really want you to pass it over, and you’d better do it on a demo-, or at least on a cent account.
Step 4. “I just don’t understand something”.
At this step, traders get less nervous and, more or less, give up on the idea of becoming rich very fast. They think that the problem is because they don’t know something about the market. The entry point may be wrong. The conclusion seems to be logic, as a lot of stop orders have worked out so far. And a stop loss is, in fact, the evidence that you were wrong in your projections. Like, if you haven’t known where the price will move, then you just “lack” some information and need to “learn more”, to make “less” errors”. Is it true?
And here, there is a little problem: the market is not a kind of machine. You can’t “study” it like a device: “Well, if I plug this wire into the socket, the toast will pop up out of there” and so on. In trading terms, the toast can pop up not only out of the hole, but out of the socket, the switch and the power cord as well =) But at first, when you are just beginning to study different stuff like “head and shoulders”, “double bottom” and so on, your brain expects a similar process.
Your brain expects something definite. If the neck line is broken out, the price will go down. Then bang, and the market price goes up! How could it be so? Therefore, it may not be head and shoulders pattern =) Your mind just isn’t yet ready to realize that any market situation can ALWAYS result in 2 ways. And when you want to “learn more” about the market, you, in fact, want never be wrong; I mean, you want stop losses work out MORE SELDOM or never. You deliberately try to “avoid” stop losses, “avoid errors”, because you are already fed up with being wrong at the previous steps.
You can’t “study” the market like the structure of a device. The market is a process rather than a structure.
At this point, traders start “breaking bad” in a different way. They try strategies one after another, attend training, read the Internet forums, study different theories about how “the big guys” trade, how they “trigger stop losses of the crowd”, which NOBODY EVER proves. Just for the sake of argument, you can yourself ask the fans of the “Big Trader” theory, what real facts they are based on.
In general, traders want find a magic trading system at this step. They try to learn more about the market, thinking that it is concealing something from them. They still think stop loss to be a kind of “criticism” by the market, like, “you haven’t analyzed well”. But it isn’t really so.
Imagine a cat. You are pointing with a laser around it. You know that it will either jump on the beam or just beat it with its paw. You expected that it would jump on it, but it just beats it. The same is with your stop loss. You expected one thing, but something different has happened. Does it mean that the cat COULDN'T jump on it? No, it doesn’t. Could you know in advance what it would do? Somehow figure it out by the cat’s eyes, its head, or something else? Of course, you couldn’t. When you understand it, there starts...
Step 5. “It is not the market, it is me”
It is only then, when you start looking at your own self. You begin to understand that the market is not an opponent. You have this feeling because it is painful for you to get your stop losses worked out. The market, itself, wasn’t doing anything bad to you; it didn’t punch you, didn’t make you feel anxious or angry. It was just “being its true self”. The problem was that you wanted it to do something and it didn’t meet your hopes.
You start to analyze your emotions and realize why you have certain feelings. The more you realize it, the less strong these feelings are. Your approach to trading grows more and more businesslike; you treat the market as “an object for research”, rather than an enemy or an opponent.
The market, itself, wasn’t doing anything bad to you; it didn’t punch you, didn’t make you feel anxious and angry. It was just “being its true self”. The problem was that you wanted it to do something and it didn’t meet your hopes.
If you manage to advance to this step, you aren’t likely to trade “breaking bad” anymore. Yes, there will be non-system trades from time to time. You may sometimes even risk “a little more” than you should. But you won’t feel the same emotions; you will just realize that there is no reasons for them.
At this step, people, as a rule, start to systematically test and improve their trading strategies and to work on themselves at the same time. Here, risk management and money management is based on that you take some fixed amount of your deposit (percentage) and trade it with your system, in order to find out whether the strategy is profitable or loss-making in general. Basically, at this stage you understand that there will ALWAYS be stop losses. That both stop losses and take profits are a kind of costs and incomes in business, or like the hit and the missed goals in football; you can’t avoid them. And the skill level is based on that the difference between take profits and stop losses is positive.
Step 6. “Trading is business”
In general, when a trader stops playing with entry and exit points, he/she (Oh, Gods!) understands that MONEY MANAGEMENT is NECESSARY. Roughly speaking, at this step, you have already answered positively the question “is it possible to make money in forex?” You don’t also dwell upon right/wrong entry points, as you treat your strategy, IN TOTAL, like a profitable business, which you need to invest wisely (!) in. If you invest in any business more than you should, you can get the so-called “surplus”, which is not good. If you invest not enough capital, you will get less profits than you can. The link is not completely direct, but the focus in both cases is on the PERFORMANCE of the investment, as the rule like “the more you invest, the more you get” doesn’t usually work either in business or in trading.
Your work on risk management and money management is, so-called “decorative step” when you are just trying to improve you strategy performance. There are, as a rule, no strict rules, because everybody has a different trading system, with different risk/reward ratio, different chances of winning/losing trades. Traders just experiment with the ways to trade that suit them best.
Basically, this step is followed by step “improve until you are not satisfied”, and there is hardly anything special to write about it. I will really happy if you advance to it.
To cut the long story short, beginners will have to go through these steps. If they try to do everything gradually, without haste, it will take a little less time to get through all of them. If they try to do everything all at once, as I did, and as most beginners do, the process may be far longer. I want to again emphasize that you shouldn’t dwell on your mistakes too much at all the steps. The less emotions you involve in trading at the initial step, the sooner you’ll stop treating the market as an “enemy”, and the easier the next stages will be.
If you try to do everything gradually, without haste, it will take a little less time to get through all steps. If you try to do everything all at once, as I did, and as most people do, the process may be far longer.
4. Practical aspects of capital management
In general, managing the capital is quite an interesting topic. But it becomes interesting when you already have a tested trading strategy that yields positive results.
I won’t go into much detail about the calculating of certain values, as I want to focus on their application to the system of capital management.
Let’s study the bottom toolbox in detail:
- Balance is the amount of money you can use at the moment.
- Equity is your deposit amount, including the opened positions.
Example: if the opened position is showing the profit of "+ $100" at the moment, and your balance is 5000$, then there will be $5100 in the Equity section.
If you close the position with this profit, the indicated $100 will move into the Balance section. And then, your balance will be $5100
· Free Margin is the amount that you can use to enter a trade.
The matter is that, to open a position, you need a kind of funding or collateral. It is a kind of frozen when you open a position. According to your financial leverage and the trade volume, the collateral amount can be changed.
As you see, I opened a sell position for GBP/USD at 1.4222; the trade volume is 1 lot. To provide the position,"$284.44" is held from my account. When I close the position (doesn’t matter whether with a loss or a profit), this amount will be back on my account.
You also see that “Free Margin” currently is $ 4725.56. If you add the Margin ("$284.44") to this amount, there will be $5010. It is because my position is with profit ($10). As you understand, the more profit is yielded by the opened positions, the more new ones you can provide. On the other hand, if your positions are loss-making, then you will be able to enter less new trades.
The “Margin Level” section shows your account-margin ratio, expressed in %. In the given case, the own money is $5010, and margin is $284.44. Therefore, 5010/284.44 = 17.6136 or 1761.36%.
Thus, when the Margin Level is close to 100%, it will mean that almost all your funds are applied to provide the opened positions. It won’t much help in managing your capital, as usually Margin Level close to 100% is featured by gamblers, who’d better avoid trading =)
So, out of all this information, you will need only the Balance; you will base on it. You may wonder why the Equity won’t be important. It doesn’t matter because it will distract you from really important things. When you look at the Equity, you see the outcomes of the trade, you haven’t yet exited. If it shows the profit, you’ll be happy’ if there is a loss, you’ll be sad. It makes no sense to see the results of the position you haven’t closed, as the performance is suggested only by closed positions. So, get rid of unimportant things, just the balance you need, just the gist.
It makes no sense to see the results of the position you haven’t closed, as the performance is suggested only by closed positions.
Now, let’s practice the first rule of capital management: find out the risk amount per trade.
For example, you don't want to risk more than 3% per trade. How can you achieve that?
To do it, you need to know:
- Cost of one point.
- Amount of stop loss.
Simply put, the cost of one point is how much you will gain if the price goes 1 point in the needed direction. Or, it will be how much you are to lose, if the price goes one point against you. This amount depends on your trade volume (lot size).
Here is the example:
I opened a sell position by the volume of one lot at the price of 1.4222 (you remember). Currently, the price is at 1.4217.
So, the price has gone 5 points in the needed direction: 1.4222 – 1.4217.
My profit is $50.
After a simple calculation, I get the cost of one point = $50/5 = $10
For a different trade volume, the cost of one point will be different. For example, if the trade volume is 0.1 lots, the point will cost $1. If the volume is 0.01 lots, the point will cost $0.1, and so on.
Let’s calculate the stop loss amount
Well, if I know that the cost of one point for my trade volume is $10, what is the maximum stop loss amount?
I decided that I wouldn’t risk more than 3% of my deposit per trade, which is not more than $150, in my case.
So, I have the following:
- The cost of one point is $10
- The maximum risk amount is $150
The maximum stop loss is $150/$10; it makes 15 points.
Therefore, any stop loss that is less than 15 points fits my rules of money management. If I get a stop loss that is more than 15 points, I won’t enter the trade or reduce the volume.
If your stop loss is more than you risk management allows, you should avoid the trade or reduce its size.
For example, if in the current market conditions, the appropriate stop loss is 30 points, and your maximum risk is $150 (it is always 3% of the deposit amount), first, you need to figure out the needed cost of one point.
A point’s cost is $150/$30 = $5
Well. You remember that if a point costs $10, the volume is 1 lot. Not to be confused, let’s find out how many times the point cost is less than $10.
$10/$5 = 2. So, you need to cut you trade volume by half, and so, open a position for 0.5 lots instead of 1 lot.
If you get the point cost to be not so round (for example, not $5, but $3.33), you can do the same: $10/$3.33 =3. So, the position volume of 1 lot should be reduced by 3 times, and so, it will be 0.3 lots.
The way to manage your capital, when you use the same part of your deposit for all stop losses is called “Fixed Fractional”.
For you to understand, let’s study an example, when you get a loss with the initial deposit of $1000:
Initial- 1000 $
After the first trade 970 $
So, after the stop loss works out and the position is closed, your deposit is 1000 - 30 = $970.
In the next trade, you can risk not $30 already, but $29.1, because your deposit is less and 3% from it (in dollar terms) will be less.
This approach helps you see the most import trading target, to save your money, in the right way.
The drawback is that the stop loss works out according to the “bigger” deposit, and you get take profit from you “smaller” deposit. Let’s study it on the example:
Imagine that your take profit equals to the stop loss (and you’re going to gain due to the high probability of winning trades). Also, imagine that your first position is closed with a loss, and the second one – with a profit. So, you have:
Take profit %
Initial 1000 $
The first position’s result: 1000$ - 30$ = 970$
Take profit %
After the first trade - 970 $
The result of the second trade: $ 970 + $ 29.1= $999.1
So, after you closed two positions with the same parameters, it turns out that you lost a little. But it is natural in trading. If you dwell upon it, it is based on some kind of advantage. For example, you get 50/50 winning and losing trades (provided stop loss is equal to take profit), then, finally, you’ll have a loss as a result, due to the spread. Therefore, you need to be “a little better” to just retain the same capital.
Let’s study another way of money management; it is called “Fixed Ratio”.
It is easier to explain on the example:
Imagine, you the deposit of $1000 and open a position of one lot. This lot yields you $500 of profit, and you decide to increase your position size up to 2 lots.
So, according to the fixed ratio money management, you can increase your next lot when EACH of these two lots yields you $500.
Therefore, 2 * 500 = $1000, that is how much your deposit should increase, so that you can increase your position size up to 3 lots.
For example, you got it, and your deposit is now 1500 + 1000 = $2500.
You can increase your transaction volume next time when each of these 3 lots yields you $500 of profit: 3 * 500 = 1500.
So, next time, you increase your trade size up to 4 lots when there is already 2500 + 1500 = $4000 on your account. And so on.
As for the amount of profit that each lot is to yield, I suggest it be simple. You just take a half of your deposit amount; I think it is a good idea. You’d better not make it too little.
Note that you don’t have to trade some even number of lots. You can start with the position size of 0.3 lots, and when the target amount is gained, increase it up to 0.6. The next checkpoint will be the transaction size of 0.9 lots, and so on. The matter is in being consecutive – first you open the initial volume, next, you increase it by two times, then – by three times and so on.
Summing up, I’ll say the following: if you are only beginning, do not go too much into all these calculation; rather, you should just practice trading. Find a system on the Internet and trade with it, entering many trades, follow your feelings. Do you like the system? If you don’t, look for another one and do the same. You wouldn’t like it, because you don’t seem to know what it will result in, and your mind wants a kind of certainty. Just remember how you were learning to walk; you didn’t know in advance how to do it, did you? You didn’t attend some kind of training or seminars, did you? =) Don’t be afraid, just remember how you trusted yourself when it was about studying the world around.
When you have found “your” trading system (you just feel like), it makes some sense to add the elements of money management; take a fixed part of your deposit and continue practicing. When you have new ideas, try to apply them, test them, and analyze the performance. And when you are satisfied with the results, then you can apply this “fixed ratio” stuff. And you’ll also need to analyze, whether it suits your system, your risk/reward ratio and your amount of take profit/stop loss. =) It is only important to progress gradually and consistently, without any haste.
I hope the article will be of help! I wish you success in your trading career!
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