Gino D’Alessio
There is a great deal of advice that can be applied to trade forex successfully – but here are 6 ‘rules’ which should always be included in any strategy. Six principles which should be the foundations of any long term trading processes;
1) Trading Plan
Create a trading plan and stick to it. Your trading plan should take into account how many hours a day you will be trading, the time horizon for your trades (for example, very short term trades for 10 or 15 pips or longer term trades with a target profit of perhaps 40 or 50 pips). These points will also help define your stop loss and profit limit. You also need to define which factors will get you into a trade. It could be purely technical, using charts and analysis, or it could be solely based on fundamental data or a mix of both. In any case your trading plan should suit your style and schedule.
2) Study Economic Data
Learn about economic data – one of the greatest things about the FX markets is that all the information and economic data is readily available and accessible. But it is also important to understand what effects economic data can have on the economy and therefore on a currency. Once these have been mastered then it is easier to establish the overall picture.
A strong understanding of economic data also opens up the possibility of trading on the back of economic data releases.
3) Manage risk
Don’t use excessive leverage. Often traders are attracted by the large possible gains that are available with high leverage rates. But high leverage also means high risk. If you have a £1000 account and you go for 100:1 leverage you are putting most of your capital at risk on every trade. Let’s say you trade GBP/USD on 100:1 leverage – you would be able to trade 1 full lot size, or £100,000, which sounds great. Usually the more the better, right? But this ratio of leverage means that a move of just 10 pips will see you losing more than half your principal capital in one trade that could last just a few minutes.
Another way to look at it is by asking the question “how much risk do the professionals take?” Hedge Funds are known for taking risk and in theory being professional. Depending on the strategy followed they put on leverage of anywhere between 3 to 10 times their capital. The Global Macro Hedge Funds, that trade in currencies, on average take their positions with 5:1 leverage. This perhaps sounds very low, and they manage hundreds of millions of dollars, so in theory do not need the leverage. We could then presume that as retail traders we should be able and willing to take on more risk. It would certainly seem feasible to take on leverage of say 10:1. With this lower ratio, a much smaller percentage of the overall trading fund is at risk per trade.
4) Use stop losses
Another rule concerning risk management – Have a clearly defined stop loss amount and maximum daily drawdown; this is another soft spot for many traders. As often happens we don’t want limitations, especially when we are down on the day. But identifying maximum losses per trade and per day will allow you to live to trade another day. This risk management process also helps you define how much leverage you should be trading with. Taking again the example of a £1000 account. You want to trade GBP/USD only and your idea is to put on 4 to 5 trades a day max. Well if you used 100:1 leverage you could have your account wiped out in one trade, if the market goes against you. That obviously doesn’t sound like a great plan, as we are trading for the long run. You also want to be able to put on 4 to 5 trades a day, so how much of that £1000 are you willing to lose in one day? Let’s call it £400, now you want to be able to put on at least 4 trades, 400 divided by 4 makes £100 per trade. At this point 100:1 leverage is simply unviable. However most important of all is to stick to your stop losses and maximum drawdown – simply stating them is not enough if they are not implemented. Discipline is a key skill in any form of trading, but certainly Forex.
5) Do not over-trade
As traders we often get caught up in our own ego and desire to succeed. There is always a feeling that we will get it right after a series of losses or that we can continue to get it right after a series of wins. Have a well-defined limit to the number of trades you want to make a day, depending on how many markets you are going to follow and how long you plan to spend trading each day. Try to stick to that number and it could save you from going from a bad day to a disastrous day, or from going from a great day to a not so great day. After all, somebody who is serious about trading is looking for long term, sustainable model. Staying in the game and growing your capital is more rewarding and will reap larger gains in the long run.
6) Know your markets
Don’t trade in markets (FX pairs) where you are not able to follow fundamental data; most fundamental data is readily available and easily accessed. However some of the more exotic markets may not be so easily understood or have information so easily available.
Thai Bhat, Malay Ringgit, or Indian Rupee may sound alluring but it takes a lot of specific knowhow and insight to follow those types of markets effectively. Headline news for these types of markets is highly specialised it would take some research to find out where you can get access to the appropriate news. These markets are also more volatile as they are less liquid than major currencies pairs, so they should certainly be approached with caution.
Those then, are 6 rules that should help any trader. Good discipline and being absolutely aware of risk are key.