Many people ask me about trading currencies, forex trading, and forex trading strategies. They hear all kinds of rumours and they have this idea about it that is either too “optimistic” or, on the other extreme, they see it as “something really scary and impossible.” I will expose elements about good forex trading strategies and what a good forex trading system looks like, how currency trading works, what are the risks, and what are the challenges for the trader. If you are curious, read on, even if you know nothing at all about it or about finance or economics.
A recap of the basics
I will NOT go over all the basics, as this has been covered in an earlier post and is also covered very well in many websites. I will just give a very quick recap. You do NOT need to be a financial guru or a pro economist to trade currencies, but you DO have to want to learn and “understand what is going on” at least a minimum to make sustainable profits over the long run.
First, YES, it IS possible to make money trading currencies, and quite a bit of it, actually. About 90% of retail forex traders lose money, on average… But about 5% make good profits, and another 5% make unreal profits month after month, often to the tune of 10% and even 20% monthly returns, month after month (yes you read that right, there is no typo) for the best and and most risk-tolerating of them. This is NOT hype or a rumour or exageration, it is true and verified.
When you trade currencies, you buy and sell “pairs” in the form xxxyyy, where xxx is one currency and yyy is the other, such as usdcad or eurusd or gbpaud. You do this via a forex broker, with whom you deposit money that allows you to buy and sell currency pairs. Forex stands for “Foreign Exchange” and is by FAR the largest financial market in the world, dwarfing ALL other markets by several orders of magnitude. There are honest and solid brokers and others that are shaky — be sure to choose a reputable one such as Oanda. Theoretically, the broker makes money with the “spread” — the difference at which he buys and sells currencies to you and I, just like the place where you change your money at the airport when you travel, only on a much larger scale.
In practice, most brokers also have a trading desk, and the traders of the broker seek to make money by trading against their own clients by taking the opposite side of the trades of their clients and hoping that the clients will lose, on average (which obviously is true, based on statistics), which is like a casino: you are “betting” against the house, which means there are certain things you need to be aware of such as “stop hunting” and other issues (we’ll cover that further down). Remember that trading is a zero-sum game, (even a negative sum game): the gains of one are the losses of the other. However, the “game” is significantly fairer and better in forex relative to the casino (and stocks) and the odds of winning are significantly higher for good traders, because the price of the pair fluctuates mostly beyond the control of your broker, and THAT is what is good about it, as the pair will follow quite closely the global market price. The currency market is a MACRO market, a bit like a stock index — this is the opposite of a MICRO market on a specific stock, which is subject to a LOT of erratic fluctuations and market manipulation. Note that currencies can also be “manipulated” and pushed in one or the other direction for a short period of time and a few pips, but other than big central banks, the currency generally follows macro market forces that are beyond the control of even the largest financial institutions — we will get back to these macro forces later. The setup looks like this:
I don’t want to explain all the nitty gritty details, as the “operational details” of forex trading are relatively easy to learn and are NOT the problem or the main challenge, so I will just say this:
- On every trade, you are always buying one currency and selling the other. If you buy usdcad, you are buying usd and selling cad. If you sell usdcad, you are selling usd and buying cad.
- You do NOT actually buy or sell anything “for real” — don’t worry, you don’t need to have a bunch of USD or EUR to trade ;) Your broker takes care of all that for you and you just tell your broker what to do by clicking “sell” or “buy” buttons (it is literally that simple).
- You “buy” xxxyyy when you think that xxx will appreciate versus yyy and/or yyy will depreciate versus xxx (or both). More simply, you buy xxxyyy when you think price will go up. In that case, you are “bullish” on the pair, which is the same as being “bullish” (long) on xxx and/or “bearish” (short) on yyy. If you buy the pair and price goes up as you thought and you exit at the right moment, you make a profit, which is immediately added to your account.
- You “sell” xxxyyy when you think that xxx will depreciate versus yyy and/or yyy will appreciate versus xxx (or both). More simply, you sell xxxyyy when you think price will go down. In that case, you are “bearish” on the pair, which is the same as being “bearish” (short) on xxx and/or “bullish” (long) on yyy. If you sell the pair and price goes down as you thought and you exit at the right moment, you make a profit, which is immediately added to your account.
- You can “cash in” your profits (transfer from your account with your broker to your bank account) at any time.
- With Oanda, you can start trading with as little as 100$ and you can take risk that is essentially symbolic, where a “big” profit or loss would be 20 cents. With good brokers, don’t worry when they write “losses may exceed deposited funds” — this is written for security, but it does not happen. If you deposit 1000$, that’s the most you will lose, and if you proceed with caution, you will not lose it all that fast and once you are good, it will grow, perhaps even quite significantly.
- You can also trade with a demo account (fake money), but I recommend trading with “real money” (even if it is only 100$) as soon as possible, so that you get a feel for the real thing. Once you start making 20 cent net profits (or whatever) regularly, just know that the SAME winning strategy will automatically translate to 200$ or 2000$ profits with a bigger deposit, provided your psychology and emotions remain unchanged with the bigger amounts… a long story…
- You should see your first “tries” with 500$ or 1000$ as “tuition fees” to learn: expect to lose it gradually as you go through the process of “learning by doing” and take it truly as the cost of “trading education.” There is nothing strange about it. Some people pay 100k for a bachelor’s degree, yet people freak out at the idea of losing 1000$ to learn profitable trading? What is this???
- In currency trading, you use “leverage”: you can buy or sell 10, 20, 100 times the value that you actually have in your account. This increases profits and losses considerably.
- When you start, I suggest you: 1) start with a small amount, something between 100$ and 1000$, and 2) use LOW leverage. Once you can make profits (in cents) on a regular basis, increase your deposit and leverage.
- Forex profits are calculated in “pips” and pairs have 5 decimals: one pip can be worth 1 cent, 10 cents, 1$, 10$, 100$, 1000$, and more — it all depends on your account size and leverage. For example, if the pair eurusd goes from 1.0575 to 1.0595, price increased by 20 pips.
- I recommend that the typical beginner have a setup such that 1 pip = 1 cent. Then you can move to the more “real trading” world for retail traders, where 1 pip has a value between 10$ and 100$. Typical daily net profits can be 20 to 100 pips, depending on trading style, trading competence, risk management, and risk tolerance.
The main currencies that are traded are USD, EUR, JPY, GBP, CHF, AUD, NZD, CAD with all the possible “pairs” between them. “Majors” are the ones with USD in them. The spread (which you can simply see as a transaction cost) is lower on the more liquid pairs such as eurusd and usdjpy and is lower during normal business hours, but you can trade 24/7 from Sunday evening to Friday 5 pm and you can keep open positions for as little as a few seconds to as long as several months, if you want to.
Fundamentals vs Technicals
Humans have this ridiculous tendency to cling to identities. “I am a believer that only fundamental analysis is important” … “I think that only technical analysis works” … “I only use indicators” … “I only use pure price action” … Useless childish pissing contests of ego-driven individuals who need to chill out and relax and most importantly, try to have a more flexible and adaptable mind and spirit — a very good thing for long run survival in trading.
Let me start with one thing: ALL knowledge you can get is useful in forex. Period. Pure technicians that have NO idea what is going on in the market are at a disadvantage, and pure fundamentalists who have no idea of trendlines, moving averages, buy and sell zones, and at least basic price patterns are at an even bigger disadvantage.
What is FA (“fundamental analysis”) and what is TA (“technical analysis”) exactly? OK, I will cut through the bla bla and go straight to it: FA is macroeconomics and TA is the analysis of charts and patterns, along with the identification of sell and buy zones, or supply and demand zones. If you really “want” to avoid one or the other, you must use TA and abandon FA, unless you are a multi-billion hedge fund trading trends (and even then) … But why would you willingly let go of one major element of the market? Lazyness? Yup… the profit killer (there are many others — we’ll get to that).
FA is the study of the economy, financial markets, and the currency of each country. You DO NOT need to be a pro economist like myself to understand the basics, and in fact most “fundamentals” are “contained” in one useful and simple tool: moving averages! Most of the fundamentals can be seen in the 50 period moving averages of H4 and D1 timeframes. If the H4 MA50 is going up-down-up-down with no clear upward or downward trend, the pair is “neutral” and both currencies are more or less “equal” in strength (“fairly” priced and “neutral”) in current market conditions. If H4 MA50 is trending generally up, then the first currency of the pair has the upper hand over the second one, which generally means the “fundamentals” of the first currency are considered stronger by Big Money (hedge funds, large speculators, etc). Same logic if H4 MA50 is trending down.
Above is eurusd H4 chart (each little bar is 4 hours of “price action” — red is down and green is up). I will not explain how to interpret candlesticks as it would be too long in this already-long post. EUR depreciated versus USD in December, appreciated in January, and started to trend down in mid February, with a generally flattening slope in late Feb, perhaps signalling a trend reversal for March 2017 and a gradual takeover by EUR bulls for Spring 2017.
ALL these moves can be explained and even generally followed and clearly understood “as they occur” when you have the knowledge of economics and finance to understand what is going on and see the big picture clearly, but it is not essential to have a deep understanding of all the elements, as they are essentially “contained” in (“priced in”) the moving average.
Isn’t that GREAT?! Price tells you what all the fundamentals are doing: inflation, central bank bias and policy, global capital flows, growth, trade, jobs, credit, tax policy and regulation, politics, mood about risk, asset demand, etc. It’s ALL there in the main MAs! Personally, I like to follow what is happening because I am an economist specifically specialized in currencies, global finance, central banking and macroeconomics, and it does indeed help A LOT, but it is not essential — just know that MAs “contain” the info you need about fundamentals!
The fundamentals that move markets are of 2 categories: 1) what IS happening now and 2) what the big players of the market THINK will happen (expectations): “Successful investing is anticipating the anticipations of others” — John Maynard Keynes in the 1930s.
The market movers for price are what actually happens OR what Big Money thinks WILL happen, as well as things related to actual capital flows due to growth, trade, and prospetity:
- Inflation: more is bullish (the long story is a very long story that I cover in 12-week university courses in international finance or monetary theory, so please just bare with me!!).
- Growth and jobs: more is bullish.
- Credit: more is bullish.
- Taxes: less is bullish.
- Government spending: a big “stimulus program” is bullish, otherwise it has no large effect unless there is a government debt crisis (rare for the 8 currencies mentioned above).
- Central bank stance: a “hawkish” central bank will make the currency appreciate. Sometimes the central bank wants to avoid a currency from appreciating (to help exports) but does not want to cut the policy interest rate (which would weaken the currency) for various strategic and policy reasons (housing or asset bubbles, inflation, and so on), in which case the central bank officials will try to “talk down the currency” by comments and communications (CAD and NZD do this a lot). These strategies have an effect for a few days, but it does not last much more than 1 or 2 weeks if the global forex market feels the currency “should” appreciate.
- Trade: more exports is bullish.
- Global capital: if lots of money from other countries wants to buy financial assets or housing or land in a country, that currency will tend to appreciate… and if lots of global and domestic capital wants to LEAVE the country, the currency could crash due to capital flight!
- Market mood: good mood is bullish, but JPY and CHF are special for this, as they tend to appreciate when global markets start to get nervous (don’t ask why — it’s a long story).
If you get lost in the details, here is a SUPER simple recap to help you: if goods and services and/or assets (stocks, bonds, housing, land, etc.) of a country are highly demanded, then the currency will also be highly demanded and it will tend to appreciate. The other elements exposed above also have a significant impact.
Forex fundamental analysis has to do with “following and understanding what is going on” with these variables and general market mood, along with a grasp of the relative impact and importance of what is happening. It helps to determine your “macro bias” on a pair (buy or sell). You can also “trade the news” in a more profitable way if you have a better grasp of FA.
The advantage of H4 and daily moving averages is that they already contain all the past “fundamentals” of the currency within their trends and directions and they tend to continue in the same direction simply because the macro fundamentals of a country do not (or very rarely) “suddenly change overnight” from bad to good or from good to bad — the process is gradual, and it shows in the news on the various variables discussed above, so the news about fundamentals tend to simply “confirm and reinforce each other” in the same direction, on average, and the general economic context and outlook that influence the currency simply continues in the same dynamic. Currency market forces are more like a transatlantic than a speed boat.
Sometimes the trend weakens (a series of news on the fundamentals that are contrary to the recent past) or picks up more momentum (a series of news about the fundamentals that “add confirmation” to the current trend), and these changes in fundamentals will again show in the moving averages, with increasing, decreasing, flattening slopes, etc. It is important to be able to interpret the movements in the MAs and relate them with what is going on, as it will help you better understand what is happening and it will improve your trading considerably, but remember that all past fundamentals are “in” MAs and all recent fundamentals are “in” price action and “in” recent MA changes in the H1 and H4 charts. Remember this.
News effects are important to understand. Often news come out that have a large one-shot effect and the news is contrary to the general “market sentiment” about the economy. For example, you may see new negative data about jobs or industrial production in an otherwise expanding economy that is doing well. This often creates a short run depreciation of the currency that can last between 1 hour and 1 week, as market participants 1) “over react” to the news, 2) get over it and regroup and see the bigger (positive) picture and 3) the basic strong fundamentals “come back to the surface” such as massive asset demand, large volume exports, large long leveraged positions in the market, etc. Does this “one bad news data point” in an otherwise solidly expanding economy change the entire picture? NO! This is when long positions on this currency are a good trade (once the full negative “tantrum” is over), as the currency’s general bullish momentum will resume, but is “underpriced” (for now) due to the short negative move caused by the “contrary” news. It is thus useful to “understand what is going on” to better grasp price moves and know what is behind them.
However, a series of “contrary to previous general sentiment” CAN change the dynamics overall and indeed cause price to reverse direction or to end a trend — it depends on how many data points “accumulate against the current macro bias” and how long the new direction of the economy will last. This is when a pair goes from bullish to flat or bearish or from bearish to flat or bullish… and you will often “see” this “in the charts” with MA crossovers.
The problem with FA and moving averages for H4 and daily charts is that they contain PAST information but are slow to adjust. Let’s take a real example. CAD was generally bullish in January and February 2017 due to improving fundamentals, as can be seen by this falling usdcad pair (remember: if usdcad goes down, it means usd is “depreciating” versus cad, or equivalently, cad is appreciating versus usd) …
The pattern of CAD appreciation was quite generalized (in most cad pairs) in Jan and Feb 2017. Then in late Feb, rumours started to circulate that the Canadian Federal Government was going to significantly increase taxes on capital gains! This instantly made Canadian assets LESS attractive to global capital and there was a very quick response, as you can see with the swift upward move of usdcad on the far right of the chart (depreciation of cad versus usd) … and this swift depreciation of cad was generalized in all cad pairs.
This example tells us that the trend of moving averages gives us a general signal, but they do NOT give us timely information about what is going on “right now” … to understand what is going on now, you can look directly at price and see how it is moving by itself and relative to the main MAs. I also like to follow the main news so that I really understand what is happening, which helps me in my trading biases and my entries, exits, etc. But you can also simply look at price and “notice” that CAD is depreciating a LOT, without necessarily knowing why. Chart analysis will help you do this.
I will say it now: I am a fan of the COMBO of FA with quality chart analysis with only MAs and pure price action, using simple trendlines and resistance/support zones and basic candlestick patterns that I don’t have place to discuss in a blog post that is already too long… but I prefer no “technical indicators.” Sometimes I look at RSI or CCI, but honestly, I find indicators useless and confusing, as they simply show price in another form… I say just “look at the chart” and understand what’s going on instead of trying to avoid the effort of understanding what is going on with obscure “indicators” that will make you blind instead of helping you — they are like cruches that keep you from full autonomy: free yourself of them and “see” the matrix!
I can’t cover all the details of good TA or FA in a blog post, but in general, in TA, you want to look at price dynamics, MAs, and price relative to MAs. You absolutely MUST identify the main buy and sell “zones”: places where the pair finds lots of “buyers” (buy zone, or “support”) and lots of “sellers” (sell zone, or “resistance”), you must be able to interpret trapped shorts or longs, “see” how much bull/bear momentum there is just by looking at price, etc.
The 2 blue lines there in this H1 audusd chart are “support” or “buy zones” … notice how the drop of price stops cold when it hits those regions. This is because there are massive amounts of buy orders waiting at those levels. The same principle applies for sell zones. Notice I am using the word “zone” and not “value” — they are not extra super precise points, they are fuzzy zones of a few pips distance. R/S zones on daily timeframes are more “significant” (solid and hard to “puncture”, but also wider). When they are broken, they often flip: sell zones become buy zones and buy zones become sell zones. There are specific reasons for this, but I don’t want to write an ebook here! Some are very solid, for example 100 for usdjpy is a very solid support and parity is quite solid for usdcad.
Now you may be tempted to say “oh cool, well I just have to wait for price to “bounce off” S/R levels and I will make money.” It’s not that simple, because 1) R/S values ARE punctured regularly, especially on lower timeframes and 2) you will get “fakeouts” during which it SEEMS that price will bust through, only to come back and hit your stop loss.
You also get a LOT of “stop hunting” around those R/S areas. Stop hunting occurs when the broker sees 5000 stop loss orders all within 10 pips… he pushes the price in the desired direction to hit the stops and profit from your loss, AND get a better entry price for the following move.
You need to properly interpret price moves in the lower timeframes (H1) and put them in the bigger context (H4 and D1 trends, even the weekly chart, market mood, etc.).
Forex trading strategiesFirst, what timeframe to use?
The eternal question. Trade the ones that work for you. If you work and you do not want to (for now) do full time forex trading, focus on the daily, H8, H4 charts and use lower leverage. If you want to trade full time and you are willing to watch your screen constantly, you can trade shorter timeframes. I trade centered on H4, using H1, H4, and the daily, but I also keep an eye on the weekly to have the “big picture” in mind. The longer the timeframe, the wider the stops you need to have and the lower the leverage. Longer timeframes have less market “noise” and are less erratic. There is almost no logic in the 1 minute or 5 minute charts, but some DO make money off of these charts. It’s really up to you. If you want to enter and exit 10 trades per day, use H1 and below. If you prefer to analyze the charts, follow the market news a bit, and take a bit of time, then trade H4, H8, or the daily.
When you enter a trade, you must have some “target” in mind and some point where you should exit at a loss if the market goes against you. These are TP (take profit) and SL (stop loss) orders, which you typically set upon placing your buy or sell order. These can be changed at any point during the trade.
It is worth mentioning that trading is all about probability. You want to tilt probabilities “in your favour” ideally more than 50%. This is not totally true, but for retail traders it essentially is the brutal reality. Some traders who can take many losses (those who are well capitalized) can be “wrong” 70% of the time and STILL be profitable: 7 losses of 20 pips and 3 profits of 60 pips = +40 pips (which can be 400$ or 4000$, depending on your trading account size and leverage). The problem is that most retail traders like you and I do not have the capital or the mental fortitude to withstand a system with a 30% success rate (and a 70% fail rate!), so for all practical purposes, we will say that you as a retail trader should aim to have a better-than-50–50 success rate, with average losses at least a bit lower than average gains. This is called your “edge” (what makes you profitable). You NEED an edge and this is what will consume all your time and energy if you are serious about one day becoming good and profitable at currency trading. A System does NOT have to be complicated. Do NOT buy systems from others — they will work randomly and you will eventually lose money. There is no way around it: you must find YOUR system and style, and that is a lot of effort and mental energy. Period.
As a retail trader, you typically want something like a 60% or 70% win ratio with equal or slightly smaller losses than profits: 3 losses of 20 pips + 7 wins of 20 pips = +80 pips.
Some push for a “profit-to-loss ratio” of 2:1 or whatever, setting stop losses at say 20 pips and profit targets at 40 pips. That is fine, but that means you are placing your stop loss twice as close to the entry price as will be the profit target, and that does NOT guarantee a winning strategy, because it increases the probability of hitting the stop loss. The probability of hitting your stop loss is determined by 2 things: 1) the quality of your entries and 2) the distance between the entry price and your stop loss. The better you are at entries (i.e. price goes “in your favour” almost right upon entry most of the time), the smaller your stops can be, but the compromise is always there anyways.
Returning to probabilities…
The expected profit of any trade is given by:
E(profit) = p(loss) + (1-p)(profit), where “p” is the probability of hitting your SL. The closer your SL is to your entry point, the higher “p” will be. You can tilt p in your favour (lower it) by becoming the king of entries, but that takes time and dedication, and lots of focus. Just know that it’s not as simple as it is sometimes presented with the 2:1 or whatever win-to-loss ratios for setting stops.
Suppose I set my stop loss at 20 pips and my profit target at 40 pips. If there is not enough “air” between your stop loss and profit target relative to the normal movement of price on your holding period, the probability of hitting your stop loss is too high… EVEN if you have a good entry, which should “tilt the odds” in your favour (i.e., increase the probability of moving AWAY from your stop loss shortly after entering). Until you become extremely good at entries and have “tight” entries after which price goes in your favour almost immediately, use low leverage and small amounts. Beware of stop hunting around R/S values and round numbers. You must also set logical profit targets: not “on the other side” of major R/S values, as this reduces the probability of hitting them! Note that I talk a lot about entries, but I think EXITS are even more important and considerably harder to master, so put as much effort on exits as you do on your entry strategies.
Your trading system must have rules to force you into discipline and tilt the probabilities in your favour, on average. Among your biggest enemies are emotions, overtrading, fear, and greed. My personal weakness is greed — I have a tendency to “overstretch” winning trades. I have simple rules. For example, I never trade against the direction of H4 MA50, I never short JPY or CHF, I always wait for a “retest” of R/S levels in H1 before entering for a bounce or a breakout, I never trade “against’ the current H1 candlestick (if it is “up” even a bit, I do not short, even if it has a clear “bearish tail” on a solid resistance), I rarely trade against the COT report, if price makes a huge move and I did not catch it, I WAIT for a retracement before entering (if it is still “logical” to do so based on my understanding of what is going on and based on my rules), I try to enter on a “wave” (always in the same direction as where H4 MA50 is pointing recently) … I have a few other rules, but as you can see, they are simple and clear and quite restrictive! That gives me an edge.
Look at this H4 chart of usdjpy of early 2017:
Notice the 2 clear phases of down “waves”: one at the very start and one at the end, when price is below MA50 and ends an “up move” and prints a bearish candle … THAT is an entry signal for me. I exit when I see signs of exhaustion (dojis) or other market information, which often happens after 3 waves. These waves were noticed by Ralph Nelson Elliott a long time ago and were called “Elliott Waves”, but you do NOT have to study the (sometimes ridiculously overcomplicated details) of “Elliott Wave Theory” to trade them, as long as you understand what is going on in the market and you know how to “read” a chart with price action and moving averages!
Why do prices move in waves? There are 3 main reasons.
Let’s take a downtrend for discussion. Sellers enter the trade and price goes down. They are happy because they are in profit. They decide to exit their shorts once key levels are reached and they “take profit”, which removes sell pressure and tilts the power towards buyers for a while … if the down move is driven by strong fundamentals, the sell pressure eventually returns and sellers re-enter, thus creating a second wave, etc. That’s the first reason.
The second reason for waves is massive forex market orders, in the billions, which are often driven by actual fundamentals such as asset demand, trade, etc. Suppose for example that a large US mutual fund wants to buy huge amounts of Canadian bonds denominated in CAD or that a huge US importer wants to buy CAD to buy Canadian export goods. They need to buy a huge amount of CAD and if they do so too quickly, they will cause the price of CAD to spike and they will inflict on themselves a high price to pay now and in the near future! This means that super large orders come in waves: they buy 4 times 500 million instead of once 2 billion. These 4 large orders (but not mega orders such as 2 billion) create waves while they pass through the market and bring CAD buyers (and USD sellers) along with them, thus pushing usdcad down. When the short-term effect dissipates, the temporary removal of their large orders along with profit taking (traders exiting positions) moves the price in the opposite direction. These waves can sometimes last a long time when they are driven by strong fundamentals, such as massive global carry trades.
The third reason is strangely related to the second one: if you have a large buy order, you want to enter at a LOW price, right? What to do? You first push the price down with a mega SELL to “bring sellers into the market and add to the down move” … this moves the price down… once the price is low, you go with your large buy order at this better (lower) price. Get it? Large players DO “manipulate” the market in the short run, but they do not change the general direction of a pair in the longer run, simply because the global market is way too big for any one player to fudge it for a long time in any significant way.
Look at this daily chart of eurnzd for 2016 and early 2017:
First, notice the waves. Second, notice the 1-year downtrend. Why? Returns on German and most zero-risk Euro Area 10 year bonds were zero, while they were 3% in New Zealand. There were thus massive leveraged borrowings in Euros that were “exchanged” for NZD (sell EUR, buy NZD) to benefit from the different returns, and this depreciated EUR versus NZD… and the wave structure is still there. There is ALWAYS a wave in some timeframe. Sometimes it’s “horizontal”, which means the market is ranging up and down, other times it is trending strongly like this. Massive carry trades occur in specific macro conditions and they can also “unwind” massively in specific conditions, creating an opposite trend.
Trends and long term trades
As strange as it may seem, I generally recommend to NOT trade “against” the main trends (H4 or D1 — I prefer H4, as it is more timely), EVEN for day traders. Why? Because you must understand what is “behind” that little innocent chart you are looking at: BILLIONS… hundreds of billions of dollars of exchanges on many pairs, driven by large players like banks, hedge funds, multinationals, pension funds, mutual funds, sovereign funds, huge central banks, mega trade orders triggered by computers, etc. Do NOT go “against” these massive players, even if your holding period is 2 hours! Because, on average, in the long run, price moves WITH the market and those moves will have greater amplitude, and your “edge” will have an extra edge to it — the entire market! As long as the trend is not flattening, do NOT suppose it is ending and just go with it without question when it respects your other criteria.
How much time should you let your position open? It can be a few minutes to several weeks. Both approaches have pros and cons. The longer your open position will be, the more exposed you are to “news effects” and weekend gaps and large price fluctuations. This means you must use less leverage. Enterering a long-term trade STILL can be “fine tuned” right down to the H1 chart: you analyze the pair and you think a long-term uptrend will soon start — a trend that you think will go for 500 pips. This is done with the weekly and daily charts and often some FA. Then you drill down to find a good “entry” for your long-term trade. You identify that “today” is a good general setup for entering long. But you don’t just enter and leave it there, because a bad entry could cause a 100-pip drawdown or more before price starts to go in your favour, so you want to “fine tune” the entry by drilling down to H4 and H1… the tighter your entry point, the less of a “starting” drawdown you will have to endure.
When to exit is a long story as well, but if you are holding long-term positions, it will typically be due to the breaking of a trendline or MA. You must also move your SL strategically during the life of the trade, but not putting it too close so that you stay “in” your position. This could last a long time. You can also set a simple trailing stop. For example, if you entered correctly and you expect 500 pips of profit, you may set a trailing stop of 100 pips after the trade has moved +100 pips in your favour.
Exiting losers and psychology
I would dare say that most traders are “right” in their trades… at some point. “Probably” price will go in the direction you thought it would … at some point… the issue is that you can’t wait 3 weeks and tolerate huge drawdowns while you “wait” for price to go in your favour! This is why I say: if your analysis is correct and you trust your system, KEEP TRYING… but don’t be stubborn! What do I mean? Suppose you think eurusd is going down. OK. Now suppose your max tolerance drawdown is 20 pips. If you enter and price moves against you, EXIT for now, wait a bit, try again later with a better entry… yes, you will pay the spread every time you “try”, but you will be happy if price really moves opposite to what you thought… and you are proven totally wrong by orders of magnitude! Yes, this also means that you may exit and price goes in your initially planned direction… well if you stick around and watch the chart, you can simply re-enter once it clearly “moves” in your direction… or you will simply miss that move… SO WHAT? I PROMISE: there will ALWAYS be a next profitable trade! Remember this. Write it in red and bold.
People who want to catch all possible moves suffer from emotional control and a scarcity mindset. I PROMISE: in forex trading, there are ALWAYS plenty of good setups coming in the next days, weeks, and months. ALWAYS. Remember this and do NOT aim to “catch all the big moves” … that is THE way to lose money. In fact, I would say that you need a system that will keep you OUT of the market most of the time! THAT is what will discipline you and put some stucture, logic, and order in your trading.
You enter a trade and it goes against you. Your general tolerance for a trade is about -20 pips, after which you consider the loss to be too much and the trade a probable fail. Initially it goes to -8 pips… then -15… then -28… Your brain and ego seek escape: avoidance and denial start to make their way… “it will turn around any time soon” … -33… “I am sure it will soon turn.” This is gambling… Then it becomes real, and you do not WANT to realize the huge loss. You stretch the denial and you enter hoping and wishing mode… disconnected from reality. STOP.
CUT. LOSERS. BRUTALLY… turn away and never look back… remember: there are thousands of future good setups in the coming weeks, months, and years! Chill! You are losing nothing at all.
If you are not yet “tight” with your entry strategy, but you ARE generally good at understanding the market and knowing “where it is going”, on average, here is a typical approach you could have for a small retail trader with anywhere between zero and 10k in a trading account.
On the same pair and for the “same trade”:
Scenario 1: correct direction, bad first 2 entries
Try 1: bad entry… cut loss at -8 pips total (including spread) …
Try 2: bad entry… cut loss at -12 pips total (including spread) …
Try 3: goes almost immediately in planned direction for +55 pips.
Net: +35 pips. This is really one trade with a loss of 20 pips and a profit of 55 pips.
Scenario 2: incorrect direction
Try 1: bad entry… cut loss at -8 pips total (including spread) …
Try 2: bad entry… cut loss at -12 pips total (including spread) …
Try 3: bad entry… cut loss at -10 pips total (including spread) … and stay out!
Net: -30 pips. This is really one trade with a loss of 30 pips and a profit of zero.
Scenario 3: correct direction AND good entry
Try 1: goes -7 (including spread) … and immediately goes to a net of +55 pips.
Net: +55 pips. This is one trade with net +55 pip profit.
As you can see, I am a fan of “3 strikes you’re out” … if you fail after 3 tries, either you seriously suck at entries and you need to work on your entry strategy OR you are fine with entries, but you are simply wrong about where price is going, given your chosen chart and open position timeframe. Notice how important it is to cut losing trades fast and to let winners run and “mature” to capture as much pips as possible. Of course, don’t overdo it, because you may do the worst of all: turn winners into losers, which is not recommended… but the classic “you can’t go broke taking profits” is not totally true, because if you “take profits” too fast (small profits), they will not compensate for the losses! Also obvious is that the better you are at entries AND at good “anticipation” of future direction, the more profitable you will be, which is trivial, but still good to explicitly mention, and this requires good entries, good exits, good money management, solid emotional control, and a good understanding of FA and TA.
People who tend to be anxious and nervous, insecure, and hesitant will have a harder time with forex trading, especially the shorter timeframes. You need a system with clear rules that constrain you and keep you from 1) overtrading and “chasing the market” 2) hesitating to the point of over analysis and paralysis 3) not cutting losers 4) taking profit too fast, and many other problems. FOREX traders need to work on inner calm, centeredness, focus, balance, clarity of mind and spirit, mental and physical health and fortitude, a strong mental and emotional core. May I recommend rock climbing! It helps a lot. But whatever way you take, find ways to work on these aspects of your life, as they are solid foundations for good, sane, and happy trading.
I will stop here even if there is a LOT more to discuss! A LOT! But this is not an ebook and is already a very long post! At least it gave you a few useful tips, I hope. My mission is to help you, and I hope that is what I did with this (long!) post. Like and share!