Many novice FOREX traders are enticed into the trading arena by the allure of easy money. FOREX websites make such alluring claims as 'risk-free' trading, 'high returns' 'low investment', and so on. While these claims have a grain of truth in them,
the reality of FOREX trading is a bit more complex.
There seems to be two common mistakes that many beginner traders make - either trading without a strategy and letting emotions rule their decisions - or both. After opening a FOREX account it is tempting to dive right in and start trading. Watching the movements of EUR/USD for example, you may feel that you are letting an opportunity pass you by if you don't enter the market immediately. You buy and watch the market move against you. You panic and then you sell, only to see the market recover.
This sort of undisciplined approach to FOREX trading is guaranteed to lose you money. FOREX traders need to have a rational trading strategy and not to allow emotions to rule their trading decisions.
To make rational trading decisions, you, the FOREX trader, must be well-educated in market movements. You must be able to apply technical studies to charts and plot out entry and exit points. You must take advantage of the various types of orders to minimize your risk and maximize your profit.
The first step to becoming a successful FOREX trader is understanding the market and the forces behind it. Who trades FOREX and why? Who is successful and why are they successful? This knowledge allows you to identify successful trading strategies and use them as models for your own.
There are 5 major groups of investors who participate in FOREX:
- Governments,
- Banks,
- Corporations,
- Investment Funds, and
- Traders.
Each group has varying objectives, but the one thing that all the groups (except traders) have in common is external control. Every organization has rules and guidelines for trading currencies and can be held accountable for their trading decisions. Individual traders, on the other hand, are accountable only to themselves.
This means that the trader who lacks rules and guidelines is playing a losing game. Large organizations and educated traders approach the FOREX with strategies, and if you hope to succeed as a FOREX trader you must play by the same rules.
Money Management
Money management is part and parcel of any trading strategy. Besides knowing which currencies to trade and recognizing entry and exit signals, the successful trader has to manage his resources and integrate money management into his trading plan. Position size, margin, recent profits and losses, and contingency plans all need to be considered before entering the market.
There are various strategies for approaching money management. Many of them rely on the calculation of core equity. Core equity is your starting balance minus the money used in open positions. If the starting balance is \\$10,000 and you have $1000 in open positions your core equity is $9000.
When entering a position try to limit risk to 1% to 3% of each trade. This means that if you are trading a standard FOREX lot of \\$100,000 you should limit your risk to $1000 to $3000 - preferably $1000. You do this by placing a stop loss order 100 pips (when 1 pip = $10) above or below your entry position.
As your core equity rises or falls you can adjust the dollar amount of your risk. With a starting balance of \\$10,000 and one open position your core equity is $9000. If you wish to add a second open position, your core equity would fall to $8000 and you should limit your risk to $900. Risk in a third position should be limited to $800.
By the same principle you can also raise your risk level as your core equity rises. If you have been trading successfully and made a \\$5000 profit, your core equity is now $15,000. You could raise your risk to $1500 per transaction. Alternatively, you could risk more from the profit than from the original starting balance. Some traders may risk up to 5% against their realized profits ($5,000 on a $100,000 lot) for greater profit potential.
