The most important step for a forex trader is to begin on a solid foundation of a good education. This is key to preserving capital and ensuring the long term survival and ultimate success of the Forex trader.
The key to a good forex education is to get a great Mentor. A Mentor is defined as a wise and trusted counselor; someone who has already proven themselves and can hold your hand and guide your footsteps as you walk along the path to success. Market Traders Institute, http://www.markettraders.com/landings/forexIQ/forexIQ.aspx?id=THEFOREXMOM(Blog), have been excellent mentors for me. They have provided me with a solid foundation for understanding the forex.
The easiest way to begin your forex education is to read my posts in this order:
1. Introduction to the forex
2. Candlestick Formations
3. Forex Trading Strategies
When a currency is in the middle of a consolidation range (even on small time frames), enter a trade to buy AND a trade to sell. Set your limits a little before the outer edge of the consolidation. Be sure to account for the spread and difference between a bid and ask chart when setting your limits.
Time the entrances for each direction so the pip spreads are cancelled out. Thus you have a completely zero hedge until one of them limits out.
Enter in the middle, one order selling, one order buying, set the limits for each to just inside the recent consolidation, get paid as it swings both ways.
If you enter at the edge, you may only take a loss as the market decides to leave the consolidation. If you enter in the middle, you will most certainly capture something. At most you risk only 1/2 of the consolidation range. If the market leaves the consolidation range after you enter, your loss would only be the difference between your limit for one trade and the stop loss of the other.
Trading plans can be as simple or complex as you want it, but the most important thing is that you actually HAVE a plan and you FOLLOW the plan. With that said, here are some of the essentials that every trading plan should have.
1. A trading system
This is the heart of your trading plan. This system should be one that you have thoroughly backtested, and have traded for at least two months on a demo account.
Include all the necessary information about your system such as: time frames you use, criteria for entries and exits, how much you risk during each trade, which currency pair(s) you trade and how many lots you trade.
Example: I am an intraday trader and I trade off of the 10 minute charts. I enter when there is a moving average crossover and all my indicators support the direction. I only trade the EUR/USD and I risk no more than 2% of my account on each trade. For now, I trade 5 mini lots and will increase my lot size according to my 2% money management rules.
2. Your trading routine
This is a crucial part of your plan because it will determine three very important things: when you will analyze the market and plan your trades, when you will actually watch the market to take trades, and when you will evaluate your actions during your trading day.
3. Your mindset
Ask any trader out there and they will all tell you that one of the hardest things to do when trading is to take out your emotions from it. This section of your trading plan will describe what frame of mind you will be in when you are trading.
- I will see what is on the charts and not what I want to see.
- No matter how biased I am towards a direction, I will make sure to trade only what my eyes see and not what my feelings tell me.
- I will not get “revenge” on the market if I lose on a trade.
- I will not beat myself up if I make a losing trade. Instead I will take it as a learning experience and move on.
4. Your weaknesses
Yes, we all have our weaknesses. We just don’t like talking about them. But ask yourself this, “How will you ever get better, if you don’t admit to what you need to work on?” This section will be an objective way to keep track of things that you need to work on in order to become a better trader.
- I tend to overtrade. Whenever I lose on a position, I get upset and immediately try to get “revenge” on the market.
- I tend to exit early on trades.
- I don’t stick to the rules of my system every time
- I don’t stick to my money management rules every time
5. Your goals
“To make a lot of money” is not a good goal. Sit down and really think about what you want to accomplish as a trader. Do you want to trade for a living? How much return can you realistically expect from trading based on your knowledge and experience? Your goals don’t even have to be about making money. Maybe you would like to be more disciplined or gain more confidence. These goals can be personal. What do YOU want to get out of this? Use these goals as your motivation when times get tough. These goals will be your vision, and you must always keep your eyes on the prize!
6. Your trading journal
This will be a valuable tool to helping you become a better trader. Make sure you log all your trades and why you took them. Later down the road you can look back and evaluate your trades and see how you are progressing. I’ve looked back at my trade journal and have seen just how much I’ve grown as a trader. My first entries were very basic and as I’ve progressed, my trades make more sense to me now. I’ve gained a lot of confidence throughout my career and by looking back at my trades, I’ve really been able to evaluate myself and see if I am getting closer to my goals. This tool will help you tremendously in the long run, so take a few minutes each day and log your trades. You’ll be happy you did!
The simplest way to test your system is to find a charting software package where you can go back in time and move the chart forward one candle at a time. When you move your chart forward one candle at a time, you can follow your trading system rules and take your trades accordingly. Record your trading record, and BE HONEST with yourself! Record your wins, losses, average win, and average loss. If you are happy with your results then you can go on to the next stage of testing: trading live on a demo account.
You can create a spreadsheet, or table in a word processor to record your results. Since I am a programmer, I created a webpage to record mine into a database.
Trade your new system live on a demo account for at least two months. This will give you a feel for how you can trade your system when the market is moving. Trust me, it is a lot different trading live than when you’re backtesting.
After two months of trading live on a demo account, you will see if your system can truly stand its ground in the market. If you are still getting good results, then you can choose to trade your system live on a REAL account. At this point, you should feel very confident with your system and feel comfortable taking trades with no hesitation. At this point, YOU’VE MADE IT!
Another option would be to create an automated trading system using Meta Editor on a Meta Trader Platform. If you can program, or have a friend who can, this is a very powerful tool. You can use the strategy tester to then test it during different time levels and on different currencies.
Step 1: Time Frame
The first thing you need to decide when creating your system is what kind of trader you are. Are you a day trader or a swing trader? Do you like looking at charts every day, every week, every month, or even every year? How long do you want to hold on to your positions?
This will help determine which time frame you will use to trade. Even though you will still look at multiple time frames, this will be the main time frame you will use when looking for a trade signal.
Step 2: Find indicators that help identify a new trend.
Since one of our goals is to identify trends as early as possible, we should use indicators that can accomplish this. Moving averages are one of the most popular indicators that traders use to help them identify a trend. Specifically, they will use 2 moving averages (one slow and one fast) and wait until the fast one crosses over or under the slow one. This is the basis for what’s known as a “moving average crossover” system.
In its simplest form, moving average crossovers are the fastest ways to identify new trends. It is also the easiest way to spot a new trend. Another way would be to use trendlines. Of course there are many other ways traders’ spot trends, but moving averages are one of the easiest to use.
Step 3: Find indicators that help CONFIRM the trend.
Our second goal for our system is to have the ability to avoid whipsaws, meaning that we don’t want to be caught in a “false” trend. The way we do this is by making sure that when we see a signal for a new trend, we can confirm it by using other indicators.
There are many good indicators for confirming trends, but I really like MACD, Stochastics, and RSI. As you become more familiar with various indicators, you will find ones that you prefer over others, and can incorporate those into your system.
Step 4: Define Your Risk
When developing your system, it is very important that you define how much you are willing to lose on each trade. Not many people like to talk about losing, but in actuality, a good trader thinks about what they could potentially lose BEFORE thinking about how much they can win.
The amount you are willing to lose will be different than everyone else. You have to decide how much room is enough to give your trade some breathing space, but at the same time, not risk too much on one trade. You’ll learn more about money management in a later lesson. Money management plays a big role in how much you should risk in a single trade.
Step 5: Define Entries & Exits
Once you define how much you are willing to lose on a trade, your next step is to find out where you will enter and exit a trade in order to get the most profit.
Some people like to enter as soon as all of their indicators match up and give a good signal, even if the candle hasn’t closed. Others like to wait until the close of the candle.
In my experience, I have found that it is best to wait until a candle closes before entering. I have been in many situations where I will be in the middle of a candle and all my indicators match up, only to find that by the close of the candle, the trade has totally reversed on me!
It’s all really just a matter of trading style. Some people are more aggressive than others and you will eventually find out what kind of trader you are.
For exits, you have a few different options. One way is to trail your stop, meaning that if the price moves in your favor by ‘X’ amount, you move your stop by ‘X’ amount.
Another way to exit is to have a set target, and exit when the price hits that target. How you calculate your target is up to you. Some people choose support and resistance levels as their targets. Others just choose to go for the same amount of pips on every trade. However you decide to calculate your target, just make sure you stick with it. Never exit early no matter what happens. Stick to your system! After all, YOU developed it!
One more way you can exit is to have a set of criteria that, when met, would signal you to exit. For example, you could make it a rule that if your indicators happen to reverse to a certain level, you would then exit out of the trade.
Step 6: Write down your system rules and FOLLOW IT!
This is the most important step of creating your trading system. You MUST write your trading system rules down and ALWAYS follow it. Discipline is one of the most important characteristics a trader must have, so you must always remember to stick to your system! No system will ever work for you if you don’t stick to the rules, so remember to be disciplined. Oh yea, did I mention you should ALWAYS stick to your rules?
When developing your system, you want to achieve 2 very important goals:
- Your system should be able to identify trends as early as possible.
- Your system should be able to avoid you from whipsaws.
If you can accomplish those two things with your trading system, we GUARANTEE you will be successful. The hard part about those goals is that they contradict each other. If you have a system in which its sole purpose is to catch trends early, then you will probably get faked out many times.
On the other hand, if you have a system in which its sole purpose is to avoid whipsaws, then you will be late on many trades and will also probably miss out on a lot of trades.
Your task, when developing your system, is to find a compromise between the two goals. Find a way to identify trends early, but also find ways that will help you distinguish the fake signals from the real ones.
Always remember these two goals when you create your system. They will make you a lot of money!
I found this out the hard way as I tried to program automated trading systems. I would be want to capture lots of pips, but I found myself with huge losses. Then when I was more cautious in the trading so I could avoid being stopped out, I missed most of the trades and ended up entering the trades so late I was stopped out! Finding the right balance is the key. You will ALWAYS incur some losses.
Market Hours reference
New York Stock Exchange (NYSE Euronext)
NASDAQ Stock market
London Stock Exchange (LSE)
Frankfurt (FSE) Borse Frankfurt, Deutsche Borse Group
Shanghai Stock Exchange (SSE)
Australian Securities Exchange (ASX)
Swiss Exchange, SWX — $1,318
Nordic Stock Exchange Group OMX — $1,296
Borsa Italiana S.p. A., ISE — $1,123
Bombay Stock Exchange Limited — $1,005
KRX Korea Exchange — $1,001
NSE National Stock Exchange of India Ltd
ÌÌÂÁ(Moscow) & MICEX
JSE Securities Exchange South Africa
TAIWAN Stock Exchange
The stock makes its initial move upwards. This is usually caused by a relatively small number of people that all of the sudden (for a variety of reasons real or imagined) feel that the price of the stock is cheap so it’s a perfect time to buy. This causes the price to rise.
At this point enough people who were in the original wave consider the stock overvalued and take profits. This causes the stock to go down. However, the stock will not make it to its previous lows before the stock is considered a bargain again.
This is usually the longest and strongest wave. The stock has caught the attention of the mass public. More people find out about the stock and want to buy it. This causes the stock’s price to go higher and higher. This wave usually exceeds the high created at the end of wave 1.
People take profits because the stock is considered expensive again. This wave tends to be weak because there are usually more people that are still bullish on the stock and are waiting to “buy on the dips”.
This is the point that most people get on the stock, and is most driven by hysteria. You usually start seeing the CEO of the company on the front page of major magazines as the Person of the Year. People start coming up with ridiculous reasons to buy the stock and try to choke you when you disagree with them. This is when the stock becomes the most overpriced. Contrarians start shorting the stock which starts the ABC pattern.
Now the pattern forms a gartley and retraces before returning to it’s trend. When you see this change, look for gartleys and crowns. Remember, crowns is the same thing as Head & Shoulders (close enough).
Select your preferred time frame and then go up to the next higher time frame. There you make a strategic decision to go long or short based on the direction of the trend. You would then return to your preferred time frame to make tactical decisions about where to enter and exit (place stop and profit target). Adding the dimension of time to your analysis gives you an edge over the other tunnel vision traders who trade off on only one time frame.
There is obviously a limit to how many time frames you can study. You don’t want a screen full of charts telling you different things. Use at least two, but not more than three time frames because adding more will just confuse the geewillikers out of you and you’ll suffer from analysis paralysis and go crazy.
We like to use three time frames. The largest time frame we consider our main trend, the next time frame down as my medium trend and the smallest time frame as the short-term trend.
You can use any time frame you like as long as there is enough time difference between them to see a difference in their movement. You might use:
- 1 minute, 5 minute, and 30 minute
- 5 minute, 30 minute, and 4 hour
- 15 minute, 1 hour, and 4 hour
- 1 hour, 4 hour, and daily
- 4 hour, daily, and weekly and so on.
When you’re trying to decide how much time in between charts, just make sure there is enough difference for the smaller time frame to move back and forth without every move reflecting in the larger time frame. If the time frames are too close, you won’t be able to tell the difference which would be pretty useless.
Long-term Traders will usually refer to daily and weekly charts. The weekly charts will establish the longer term perspective and assist in placing entries in the shorter term daily. Trades usually from a few weeks to many months, sometimes years.
- Don’t have to watch markets intraday
- Fewer transactions means less paying of spreads
- Large swings which require large stops
- Usually 1 or 2 good trades a year so patience is required
- Bigger account needed to ride longer term swings
- Frequent losing months
Short-Term Traders use hourly time frames and hold trades for several hours to a week.
- More opportunities for trades
- Less chance of losing months
- Less reliance on one or two trades a year to make money
- Transaction costs will be higher (more spreads to pay)
- Overnight risk becomes a factor
Intraday Traders use minute charts such as 1-minute or 5-minute. Trades are held intraday and exited by market close.
- Lots of trading opportunities
- Less chance of losing months
- No overnight risk
- Transaction costs will be much higher (more spreads to pay)
- Mentally more difficult due to frequency of trading
- Profits are limited by needing to exit at the end of the day.
Shorter time frames allows you to make better use of margin and have tighter stop losses. Larger time frames require a bigger account so you can handle the market swings without facing a margin call.
The strength of support and resistance at the different pivot levels is determined by the number of times the price bounces off the pivot level.
The more times a currency pair touches a pivot level then reverses, the stronger the level is. Pivoting simply means reaching a support or resistance level and then reversing. Hence, the word “pivot”.
If the pair is nearing an upper resistance level, you could sell the pair and place a tight protective stop just above the resistance level.
If the pair keeps moving higher and breaks out above the resistance level, this would be considered an upside “breakout”. You would also get stopped out of your short order but if you believe that the breakout has good follow-through buying strength, you can reenter with a long position. You would then place your protective stop just below the former resistance level that was just penetrated and is now acting as support.
If the pair is nearing a lower support level, you could buy the pair and place a stop below the support level.