Category: Forex Trading Articles

Where to learn to trade

There are numerous free resources on the internet where one can learn about trading. Success at trading is the combination of knowledge and experience. Just like learning to draw, you must first know the different types of paper available, the kind of drawing mediums out there, like ink, charcoal, oil, water colour or pen. You definitely would not want to do ball point pen drawing on canvas! And what is the knowledge part equivalent in trading? That is learning about what markets you can trade in, the way you can trade them, where to trade them and how to go about trading them.

Next comes the experience part. First, you have to try things out and see what suits you. For a painter, you may find that oil painting on canvas is what you like and excel in. Similarly, after trading in various markets and trying out different trading strategies, you may discover what you should do that best suits your trading style. You might be a day trader trading 5 mins charts in S & P futures or a longer term trader who specialise in trend following the EURUSD currency pair.

Those who cannot do it, go teach. This is one of the main reasons I am against paying exorbitant fees to “learn how to trade”. In case you think I am slapping myself, this is a trading knowledge site. You need to actually take trades, watch the markets and experiment for yourself to see what actually works for you.

Well, of course there are exceptions to everything in life. A popular way of analyzing the market is by watching and deducing order flows. Unfortunately, I believe this is more the domain of bank traders and dealers. They are the ones who possess the true information about customer orders and are closest to the happenings in the forex market. Extremely informative advice in such areas can also be found online. One notable expert in this area is Sam Seiden.

To learn about the basics of forex trading in particular:

Babypips School
This free online course is quite complete but rather long-winded in my opinion. Haha. If you have the patience to finish it, it’s good.

Investopedia Technical Analysis
A good place to learn about technical analysis basics.

FXStreet Learning Center
Another quality online forex course! And for free as well!

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Top 10 money management rules

1. Pick a side! Bulls make money, Bears make money, Pigs get bulldozed.

In other word, do not be greedy! If you are bullish, do not expect to enter at the bottom of a move and exit at the top. If you are bearish, do not expect to pick the exact market top and ride the market all the way to the lowest low. Making money is our main concern, not catching tops and bottoms.

2. Any fool can get into a market, but it takes a pro to get out right.

Market entry is certainly an important element of successful trading. However, exiting the trade is even more important. Often, a trader allows a market to go against him or her for far too long and way too far, which translates into big trading losses. Remember, money is made when a trade is closed. A perfect entry with a lousy exit will still net you a loss.

3. Use protective buy and sell stops.

One major mistake that many traders make is not using protective buy and sell stops when they enter a trade. Or, traders pull their protective stop order hoping the market will turn in their favor. This is contrary to why we enter stop loss orders in the first place! Do not use mental stops, unless you are a disciplined and experienced trader already who can keep your emotions in check. Determine where to place protective buy and sell stops BEFORE market entry.

4. Do not bet the farm.

Risking a large percentage of your trading account on one trade is stupid. Remember, even professional traders have more losing trades than winning trades over time, and no one can be certain of the outcome of any one trade. The key to success is minimizing losses on the more numerous losing trades and maximizing profits on the fewer winning trades.

5. Cut losses short and let winners ride.

Using a pre-determined protective buy or sell stop will cut trading losses short. Using a trailing protective stop on trades that become profitable allows one to maximize profits on winners and ride it for as long as the market allows.

6. Only the markets know for sure.

Do not ever think you know what a market will do at any given point in time. One of the biggest advantages for sound money management is knowing that you do not know what a market will do at any given time. A recipe for disaster is thinking you know what a market will do. Remember the old trading adage that markets will do anything and everything to fool most of the traders all the time.

7. Be humble and trade according to your plan.

When trading profits are taken, be glad that it was not a trading loss. Do not grouse because a bunch of money was left on the table so to speak after exiting a winning position. A good trade is when you have followed your plan, entering and exiting on the levels you identified and stick to it. It does not matter if you made a profit or a loss.

8. Be careful when selling options.

There are some traders who sell options on futures to make their trading profits. There are many traders that do not. A veteran speaker at a trading seminar once said that he made over 40 trades selling options in a year with 97% winners and still lost money. Remember the old saying, if it sounds too good to be true, it usually is.

9. Do not overtrade.

Trying to trade too many markets at one time is not good money management. If you run into a losing streak, cut down on trading and do not try to trade more markets to quickly recoup lost money. Revenge trading decimates countless trading accounts.

10. To succeed at trading the markets, one must first survive in the markets.

Be conservative with your trading account and trading methods, especially if you are a less experienced trader. Go for those base hit trades. Do not swing for the fence and try to hit a home run all the time. Traders need to survive to trade another day, even if they have to absorb a few losing trades along the way.

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Essential trading tools every trader needs

One of the most important skills a trader can have is the ability to enter or exit the market effectively. You must know the tactics involved in pulling the trade on or off depending on market conditions. You have to determine the best time for entering the market so you can set yourself up for a profit plus you need to understand when it is time to exit the market in order to minimize losses. There are many tools available to help manage risk and avoid the mistakes that are commonly made by the majority of traders.

One such tool is resistance and support levels. It is essential that a trader be able to determine these levels. If support and resistance analysis is done effectively, trading consistency will increase. There are many ways to determine support and resistance areas and horizontal lines. One of the easiest way is to look at trading ranges.

Another method is using diagonal trend lines and internal lines. These will help pin-point specific prices and help you take appropriate measures to maximize income. It is recommended that you use resistance and support lines in association with price action to help inform you about changes that may occur in the near future.

Horizontal support turned resistance after price broke through.
Horizontal support turned resistance after price broke through.
Resistance and support levels determining the boundaries of price movements.
Resistance and support levels determining the boundaries of price movements.

Another crucial tool for successful trading is Fibonacci retracement and extension levels. It resembles the normal lines of horizontal support and resistance, but there is a special characteristic of the Fibonacci technique that differentiates it from common horizontal resistance and support levels.

The entries and exits are determined by the market’s penetration of any of the five Fibonacci retracement levels: 0%, 38%, 50%, 62% and 100%. Most trading platforms and charting software will calculate and plot these lines and numbers for you. You would be surprised how often prices retrace to the 50% level.

The Average True Range or ATR indicator is another great tool to help you determine the highs and lows of the market accurately. It is the average of the high low range for the specified period. For example, a 20 period ATR on a daily timeframe chart will be the average of the high low range for the past 20 days. This indicator is mainly used to estimate the volatility of the asset or currency pair in question.

While resistance/support and Fibonacci numbers serve as multi-purpose tools, Average True Range is designed to accomplish one task. However, you can use it as a stop loss price indicator and to help determine whether the potential of a particular trade has expired or not. That is, if price has already moved by a distance comparable to the ATR, then price may have a lower probability of going further.

Finally, any of these tools can be combined with moving averages. Moving averages are a must-have tool because they visually show the market’s momentum over several days, weeks or months. They give you an idea of the prevailing trend or market condition at a glance.

EURUSD daily chart with 3 moving averages added. The 20 EMA, 50 EMA and 100 EMA. Notice the upward slope of the trend lines signals the direction of the trend.
EURUSD daily chart with 3 moving averages added. The 20 EMA, 50 EMA and 100 EMA. Notice the upward slope of the trend lines signals the direction of the trend.

In order to be a successful trader, you need to master the craft of using these tools for analyzing exit and entry points. As you familiarize yourself with the market, you will learn to use these tools with much more efficiency.

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Overview of the popular metrics that traders look at

Total net profit

Many beginner traders look at this statistic to determine if a trading strategy is tradable. However, this figure is pretty useless on its own. It doesn’t take into account the risk that was assumed in order to achieve this figure. For example, strategy A achieves a total net profit of $80,000 with a max drawdown of $50,000 while strategy B achieves a total net profit of $60,000 and only a max drawdown of $10,000. Should you choose strategy A simply because it has a higher historical profit? What if the drawdown took place at the beginning of the trading period or when you don’t have $50,000 in the first place to survive and continue trading?

Another issue is the distribution of the winners and losers. I would never trade a system that makes its money over a short period of time or over a very small number of trades. These outlier trades may not happen again. A volatile currency pair or stock will also reduce the amount of leverage you can utilize and require a larger initial capital.

Comparing 2 strategies with different levels of volatility.
Comparing 2 strategies with different levels of volatility. I will trade Strategy B over A all the time.

Profit factor

Profit factor can be easily calculated by dividing your total gross profit by your total gross loss. For example, a strategy that makes $100,000 on all the winning trades and lost $80,000 in total for all the losing trades. The profit factor will be 100/80 or 1.25.

A profit factor of 1.2 to 1.5 is desirable.

Maximum Favorable Excursion (MFE) and MAE Maximum Adverse Excursion (MAE)

MFE refers to the maximum profit a trade had before it was closed. MAE, on the other hand, refers to the maximum loss that a trade had before it was closed. If MFE is very high compared to realized profits, that means you trading system had left too much profit on the table and a more aggressive method of trailing and locking your profits might be needed. On the other hand, if MFE is too large, you might be assuming too much risk with your trading. It will be prudent to reduce your trading size.

Maximum consecutive winners and losers

How long a string of winners or losers are does not affect your profitability directly. However, it is an important psychological factor that might affect your trading discipline. For example, a trading strategy that sometimes has 10 losers in a row might prove too much for a trader that can only tolerate at most 5 consecutive losses. He/she might lose confidence in the trading system and fail to take all trades, or attempt to trade a less than optimal trading size.

Trade frequency

This is determined by the number of trades taken and the holding period of each trade. A trading system that trades frequently and exited quickly will need to be more profitable than another which trades less frequently and which holds the positions open for longer. This is because, the more you trade, the more transaction costs you incur.

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Leverage and Risk

There are many misconceptions/myths when it comes to leverage and their relationship to your profitability or ruin.
Many gurus and experts always advise against using high leverage, citing it as a sure thing to failure. What they fail to explain is that it depends on the kind of forex trading strategy you are using, the size of the stop loss, the size of each position and the total size of all your trading positions.
In view of that, I think it would be useful to differentiate them as ‘position leverage’ and ‘portfolio leverage’.

Assume 2 traders, A and B, has one position each (Long 100,000 units of USD/JPY) and a $50,000 USD funded account with 50 times leverage given by the broker.
The value of the position is obviously $100,000. At 50 times leverage, Trader A will need to post a margin of $2,000 (100,000 / 50 = 2,000).
That would mean they have a 2 times leverage ratio, as they now have a $100,000 open position on $50,000 in capital.
oanda-leverage-uj

Trader A trades a long term trend following strategy and has his stop loss set at 300 pips and gunning for a 1000 pips target/TP point.
Trader B has a similar position in USD/JPY, but he is a day trader and has set a 20 pips stop loss while trying to capture a 50 pips profit.
Trader A will be risking $3,000 or a whopping 6% of his capital on a single trade, while Trader B will be risking $200 or 0.4% of his capital. Although they employ the same level of leverage, it does not have any bearing on how much risk they are taking.

Trader C on the other hand, has 3 open positions. They are Long 100,000 EUR/USD, Long 133,680 USD/JPY and Short 100,000 EUR/JPY respectively.
Assuming EUR/USD is trading at 1.3368, he will theoretically have no risk exposure. But he would still be required to provide about $8,000 in margin ($2,674 for each).
I have no idea why he would want to do this.
leverage-synthetic cross eg

Some JPYs are ‘missing’ due to spread and rounding errors in the calculations.
It would be prudent to not risk more than 2% of your account balance on any single trade or 5% on any one currency.
So using the above example of $50,000 in capital, you should only risk a maximum of $1,000 on each trade.
For trader A using a 300 pip stop, his trade size should only be 33,000 units or about 3 mini lots. As for trader B, using a 20 pip stop, his trade size can reach 500,000 units, or 5 standard lots.
Regarding not risking more than 5% on any one currency, imagine you are long EUR/USD, GBP/USD and short USD/CHF at the same time. You are actually long European currencies and shorting USD in all 3 positions.

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Carry trade strategies for Retail traders

Forex carry trade involves the entering of positions in positive interest/carry/yield paying currency pairs.

This is done to profit from interest receipt and possibly the capital appreciation in such pairs as investors flock to such trades. In short, you will want to ‘borrow’ or short a low interest rate currency while ‘deposit’ or long a high interest rate currency.

For example, a consistently popular pair is AUD/JPY.

Currently, AUD interest rate is 2.5% p.a. while JPY interest rate is 0.1% p.a.

When you go long AUD/JPY, you will be borrowing JPY at 0.1%, exchange them into AUD and then buying AUD bonds that pays you 2.5%, netting you 2.4% a year. Coupled with leverage of 50 to 100 times and you will be making a potential 120% or 240% a year on your account funds!

Now, there are a couple of problems with carry trading for the retail investors.

Interest rate spread

Most brokers calculate and pay interests daily with a cutoff time at 1700 (5pm) New York time. An example is FXCM.

The second type of brokers pays interests by the day or even by the seconds. An example is Oanda.

Referring to the above AUD/JPY example, you will not be getting 2.4% on your position as there is also an interest rate ‘spread’.

fxcm rollover and fx rates oanda interest rate-png

As you can see above there is a spread for interest rate payment or receipt. For example, FXCM pays you 0.41 USD per 10k lot size in AUD/JPY or 4.10 USD per 100k for each day you keep your trade open.
audjpy-int income table

Let’s do some Math!!!
We will go long or buy 100,000 AUD/JPY.
5.02 x 365 = 1,832.30 USD p.a. in interest (Oanda actually paid out more.)
4.10 x 365 = 1,496.5 USD p.a. in interest (FXCM)
These are estimated numbers and changes throughout the year. But it provides a good guide.

FXCM has a weird way of calculating required margin but we shall just follow them to calculate our return in this case. A 100k long AUD/JPY trade requires 2,400 USD in margin, although the value of this trade is 100k AUD (which is 90,190 USD in value).

So our interest return is actually only 1.659 % (1496.5 returns on 90190). However, with leverage, you are required to come up with only 2,400 USD for this, giving you a 62.35 % return! (1496.5 returns on 2400) Amazing for now but there is more.

We were assuming AUD/JPY maintains its exchange rate for the full year but that is hardly logical. In fact, AUD/JPY’s yearly price range is about 1,600 pips for the past 3 years and has a monthly range of about 600 pips. (just pull a 12 ATR indicator onto AUD/JPY monthly chart).

What that means is you may need to put aside about 15,000 USD to weather most or all possible drawdowns and keep your position open. So add that to the 2,400 USD margin and you will only be getting a 8.6 % return on your money.  (1496.5 on 17400) Nothing to write home about and you still have to worry about capital depreciation.

Capital depreciation

If AUD/JPY falls by 150 pips or more from your entry point, all your interest income are gone! Of course, you may also enjoy a boost if AUD/JPY goes up, which does happen most of the time. And with that, comes the carry trade cycle and unwinding.

Carry trade cycle and unwinding

Not just retail forex traders, but ordinary currency and foreign deposits investors, hedge funds and banks are also after the interest return. So in the larger financial landscape, money is indeed flowing from low interest currencies to high interest ones using instruments like bonds and treasury bills.

Therefore, there is actually a long bias to such carry yielding pairs and there is a trend most of the time.

As more and more money bet in the same direction, there is often fallout. Simply put, there will always come a point where there are no longer enough money to keep the trade afloat and traders start to cash out.

As a result, margin calls and stops are triggered and you see everyone trying to get out at the same time and price crash big time. 1992, 1997 and 2008 are the 3 most recent massive ones for the AUD/JPY pair. It has happened before and it will happen again.

How AUDJPY carry trade performed

Rate decisions are announced almost monthly and it can change over the year. I have collated some data to see how a buy and hold strategy would likely perform over the year.
audjpy-int income over 6 yrs

Looking at the above data, interest income is insignificant compared to the gyrations in exchange rate which has much more impact on your profitability.

For example, we will invest at the start of 2007, buying AUDJPY at 94.24. At the end of 2012, after 6 years, the price closed at 89.88 in December. You would have gained about 23.55% interest return, while making a loss of 4.63% in capital depreciation. In the meantime, you would have endured an incredible 41.57% drawdown in 2008 when price dropped to 55.06.

Assuming we invested 2400 USD for the margin requirements and a further 40000 USD to survive the max drawdown period. Our effective leverage will be in the region of about 2 times only. This would boost our potential interest income to about 47% over the 6 years or about 8% per annum.

This does not look like an attractive return for me as we would have to endure tremendous risk.
audjpy-monthly

Conclusion

Forex carry trade may not be as good a strategy for retail traders but you can still make some profits out of this knowledge. Even though you may not be able to benefit directly from the interest income, you already know there is a long bias on currencies that pays better. Often times, a trend will develop. Just be sure you have your stop loss in and plan in advance, when, how and where you will exit your positions.

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Forex trading hours

The forex market is opened 24 hours a day as various financial centers open and close with overlapping timings. However, it is important to know at what time of the day there are the most activity and liquidity to be sure you have tight spreads and your orders will be filled with no or minimal slippage. Forex traders need price movements to make money. If the market price does not change at all, there is no profit to be made.

The major financial centers are New York (for the Americas), London (for Europe) Sydney (for Australasia) and Tokyo (for Asia).

It is safe to assume the normal work day to be from 9am to 6pm for the bankers in various countries.

Using GMT time, the trading hours for the following markets will be:

Tokyo – 0000 am (midnight) to 0900 am
London – 0700 am to 1600 pm
New York – 1200 pm to 2100 pm
Sydney – 2100 pm to 0600 am (the next day)

The two important overlap sessions are the Asia-Europe overlap at 0700 am to 0900 am GMT and the Europe-US overlap at 1200 pm to 1600 pm GMT.

Info 1:

This Oanda market hours widget is a good resource.

http://fxtrade.oanda.com/analysis/market-hours

Info 2:

If your trading platform (like MT4) or broker does not display your local time and you are not allowed to change it, check below.

Find the current time bar on your chart and your current time and do the calculations. You will then have your time zones.
In my case, I am 5 hours ahead of the trading platform. So I will just shift my market hours 5 hours back accordingly.

MT4 time example

You can then install this handy indicator for MT4 which you can set your own hours and they will display the trading hours in boxes.

[insert session mt4 ]

If you are using Alpari UK, their platform time is GMT+3 by the way. It may change again in the future, so just make sure you are up to date with any information from your broker.

http://www.alpari.co.uk/cnews/id/3484

Info 3:

Alternatively, you can simply Google search the current time!

google search timeGood trading!

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Forex Trading Strategies Guide

What is forex?

Forex is a portmanteau formed from foreign exchange. It refers to the foreign exchange market and comprises all the different currencies issued by the countries of the world. Common currencies we are familiar with are the US dollar (USD), Euro (EUR), Japanese Yen (JPY), Australian Dollar (AUD) and New Zealand dollar (NZD) among many others.

The forex market exists so different currencies can be exchanged to pay for goods and services. For example, a US construction company buying cement from a China supplier will need to change their US dollar into Renminbi in order to pay for their goods. Alternatively, the Chinese supplier can accept US dollars from their US customer, but they will still need to exchange the US dollars for Renminbi in order to pay for their cost of production.

Large capital amount exchanges for international business are normally conducted with commercial banks who in turn balance their own accounts with each other in the interbank markets.

Smaller exchanges are conducted by local banks, money changers, financial firms or payment companies such as Paypal. When you wish to visit a foreign country, you will need to go to the money changer to exchange for foreign currencies.

2 sides to an exchange

All foreign exchange transactions will always involve both a buy and a sell. When a tourist goes to the money changer with his US dollars to try and get some Euros, he is effectively selling his US dollars to buy Euros. As such, all prices are quoted for a currency pair, instead of for a single currency. The quoted price for EUR/USD might be 1.2500 which means you will need 1.25 USD in order to exchange for 1 EUR.

Picture1

What is forex trading?

Forex trading is the buying and selling of currency pairs for capital gains, interest gains and speculative gains.

Besides facilitating international trade, most foreign transactions are for speculative purposes. Forex prices go up and down just like any other assets, commodities or stocks and can thus be traded for speculative gains. This is the kind of activity we are interested in. if price never changes, no trading can take place, it will be a dead market!

Major currency pairs that are traded and priced with USD include, EURUSD, GBPUSD, USDJPY, AUDUSD, NZDUSD and USDCAD. Minor currency pairs with less volume are USDSGD, USDHKD for example.

Cross currency pairs are also traded and comprise of pairs that does not involve the USD in their price quotes such as GBP/JPY, EURSGD or AUDNZD for example.

major pairs
Major currency pairs.
Minor currency pairs, also called cross currency pairs.
Minor currency pairs, also called cross currency pairs.

Forex trading are predominantly conducted online using software and trading platforms provided by brokers and service providers. Most trading platforms are similar in construction with some special features or twists here and there. Standard components that can be found in all trading platforms include price quotes, charting and the plethora of trading tools and indicators, opened and closed trading orders and portfolio summary.

Price quotes/ bid and offer

2 prices are quoted at any moment in time for each currency pair. They are the bid and the ask or bid and offer or buy and sell. The difference between them is called the spread and this is what the brokers receive as their income for providing the trading and clearing services.

The bid is the price at which the market is willing to buy now, and the ask is the price that the market is willing to sell now. For example, if EURUSD is quoted at 1.2534/1.2536, you can buy immediately at a price of 1.2536 while you can sell your position immediately at the price of 1.2534. Note that if you execute a Buy and then Sell off immediately, you would have lost 2 pips. This is the spread that the broker collects!

Price quotes with bid and offer price.
Price quotes with bid and offer price.

Price charts

Price charts are an important analysis tool that visually displays historical prices in a graphical manner. The price chart is plotted with prices on the Y axis in relation to time on the X axis. Common chart display types are Line charts, Bar charts and Candlestick charts. For bar charts and candlestick charts, 4 price datas are plotted for each time period. They are the opening price, highest price reached, lowest price reached and the closing price of that time period. On the other hand, only 1 price data is plotted at each time period on the line chart. Normally, closing price is plotted. Other chart types are tick chart, Heikin-Ashi, Renko chart and Point & Figures.

Line chart, Candlestick chart and Bar chart respectively.
Line chart, Candlestick chart and Bar chart respectively.

Indicators and analysis tools

In addition to past prices, analysis tools such as indicators are also plotted on price charts. Almost all values in indicators are calculated by using past prices as inputs and are thus backward looking to create a forward view or in short, using the past to forecast the future. Common indicators preloaded in trading platforms includes oscillators such as RSI, MACD, ADX and Stochastic Oscillators. They are called oscillators as their value moves in a fixed range, commonly from 0 to 100 and plotted on a separate section by itself. Another family of indicators are not bound in a fixed range and are commonly plotted together on the price chart. These include the moving averages, Fibonacci retracements & extensions, Ichimoko Kinko Hyo, parabolic SAR, pivot points, price channels, price envelops and trend lines.

A 20 day EMA is plotted together with the Candlestick chart. The MACD and RSI indicator is plotted below in a separate box.
A 20 day EMA is plotted together with the Candlestick chart. The MACD and RSI indicator is plotted below in a separate box.

Another popular technique of trading the markets is based on observing price action and price patterns. Simple trend lines may sometimes be used at the same time to provide clarity. Price patterns can consist of a single price bar such as, pin bars, dojis or morning stars or consist of multiple price bars such as head and shoulders, double tops and bottoms, triangles, pennants and flags, price gaps and more.

Types of trading orders

Common order types that traders can place on trading platforms are market orders, limit orders and contingent orders.

Market orders are sell or buy orders executed right now at market prices. They are filled immediately and will be met with slippages during volatile market environments, such as during major news events.

Limit orders are pending orders away from the current price that will be executed as market orders when price reaches that level. For example, EURUSD is trading at 1.2255 now and you wish to sell the pair at 1.2300 which is a resistance area you have identified. You will then proceed to enter a sell limit order at 1.2300. When price reaches that level, it will be executed as a market Sell at 1.2300. Note that if market activity is volatile at the time the price is reach, you will still be hit with slippage. A limit order does not guarantee a fixed price.

Following the example above, you can tag contingent orders together with your sell limit order. The most common contingent orders are stop loss and take profit orders. When your Sell order at 1.2300 is executed, you might want to protect your position with a 50 pip stop loss order and a 100 pip take profit order. These orders are inputted at the same time you create your limit order.

Portfolio summary, trading capital and margin

The portfolio summary section provides some figures to help you keep track of the equity levels in your trading account. Taking the Oanda FXTrade platform as an example, these numbers include your current Account Balance, Unrealised P&L, Realised P&L, Margin Used and the current Available Margin. Margin is the amount of goodwill deposit you have to utilize in order to open any trading position. Assuming your broker gave you a 100 time leverage facility for trading, it will mean that you need to use at least $1,000 as margin to open a $100,000 position.

Formulating a trading strategy.

A trading plan or trading strategy should be formulated before you begin trading with real money and not during trading hours. During trading hours, you should be concentrating on the task at hand, which is, executing trades according to the way your strategy dictates.

There are 3 main components in a trading strategy. They are entry rules, exit rules and risk management parameters.

Realistic trading time frames and trading hours

Other factors to consider in your trading plan include the timeframe that you are going to trade in and your trading hours. You have to be practical here and really have a good look at how you spend your waking hours. Some traders hold a day job and can only look at the markets and determine trade opportunities before and after work. So there is no point in trading a strategy that is profitable during the most active London hours when you will be at work at the time. Likewise, some traders attempt to do intraday trading by spotting trading opportunities on 1 min charts or lower when they do not have the patience and discipline to stare at the screen with great focus. Not to mention those with weak bladders will find it problematic to stay at their desk while a position is open and the market is volatile. Of course, these problems can easily be circumvented if your trading strategy can be automated and you know enough coding to implement it. This warrants an in depth study all on its own and I will be writing about it soon hopefully. Trading on a shorter time frame offers more trading opportunities at the cost of your free time and greater transaction costs.

Entry rules and exit rules.

Entry rules are simply the way you enter a trade. Take a moving average trading strategy as an example. Trades are taken when price CLOSE above the moving average line, and you enter a long/buy at the open of the next bar. When price closes BELOW the moving average line, you will EXIT your long trade and initiate a short/sell order at the open of the next bar. Most indicator based strategy will require entries on the open of the next bar. If you are trading on the hourly timeframe, a new bar appears at the start of each hour, that very first price of the hour is the OPEN price. Similarly, the last price traded in the previous hour was the CLOSE.

Popular indicators for entry includes SAR, high-low bar close and oscillators among others.

Traders trading based on support and resistance zones or trend lines frequently enter trades once price trades beyond the breakout point. Entering trades when price had closed beyond those levels are just a tradeoff between early entry (and so at a better price) versus more confirmation of a breakout.

More on exit rules.

As mentioned above, some strategies are under the “always-in” category, where exits will mean entering trades in the opposite direction. Likewise, the same indicators used for entering trades can be used as stop loss and exit points as well. A basic trend following strategy will be where one enter long trades when price closes above the previous 10 day high and short when price closes below the previous 10 day low. You can close the trades when price trades below a 20 period moving average for longs, and when price closes above the moving average for shorts. The parabolic SAR is a good trailing stop tool as well.

Risk management parameters.

Risk control is absolutely important and when improperly done can still render you broke even with a winning strategy. Unless you have a 100% win rate, you should never bet the farm or simply enter the largest trading size your margin allows you to take. Even with a trading strategy that wins 9 times out of 10, this might be the one trade that takes out your account. It also does not make sense to bet random amounts or vary your trading size on a whim, you will end up taking a small position on big wins and a large size trading size on big losers. Trading size should be determined both by your account size and the amount of market risk you are taking.

Position sizing can be done in a number of ways and one common way is using the ATR indicator developed by Wilders. This indicator is present in every trading platform, and if for any reason there is not, you can simply add up the high and low range of the past X periods and get the average (in the case of trying to mirror a 20 day ATR, you can find a close approximate figure by calculating the average range of the past 20 days.)

And now, an example to illustrate. Let’s say the ATR for EURUSD in the past 20 days is 110 pips. You get a signal to go long, you may decide to place a stop loss of 55 pips which is half ATR. You are willing to risk 1% of your account on any single trade. Based on an account size of $100,000, that is you are willing to lose a maximum of $1,000 on this trade which it goes against you by 55 pips. Your trading position size will be (1,000 / 0.0055 = 181,818) 181,818 units of EURUSD. This is close to 2 standard lots or 18 mini lots.

The ATR is one of the numerous tools you can use to size your position based on volatility. One of the key advantage is that you can normalise your risk across different asset groups based on their volatility. In short, the first step is always to determine your stop loss level and then calculate your position size accordingly.

And…

This is a general overview of the major topics you will come across or need to know in the course of trading. You can use each new term as the starting point to gain more knowledge about forex trading. This is a never-ending road and there is always something new to learn. Knowledge and practice translates to profits! Good trading!

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