5 Pitfalls To Avoid For Sucessful Forex Trading
Contents Page Legal and Copyright 3 Introduction To The 5 pitfalls 4 Pitfall 1- Unlimited Losses 6 Pitfall 2-Forex Brokers Closing Our Accounts 8 Pitfall 3-Unprofitable Trading Systems 10 Pitfall 4-Small Profits 12 Pitfall 5-Emotional Trading 14
Legal and Copyright 2012 by Dean Watt, All Rights Reserved worldwide under the Berne Convention. May not be copied or distributed without prior written permission. All information provided in this ebook is for your information only. You are responsible for your own trading activity and I take no responsibility for any financial gains or losses that you incur.
Introduction to the 5 pitfalls Many people start trading forex to earn lots of money. This money has the potential to grow so large that they can achieve financial freedom. This combined with working for themselves is a draw for many. This dream of freedom is a powerful one and this inspires many to start trading forex. Armed with little knowledge and lots of enthusiasm would be traders rush to open there trading accounts. Currencies pairs are chosen and time frames selected. The patterns on the screen are trying to tell us something but... what? The market keeps on ticking up and down, up and down. It feels like a living breathing animal as we try to understand its movement. We buy. Our trading account starts to move with the flow of the market. First we are elated as we start to make profits. Suddenly despair as our account starts to drop. 10, 20, 50 into the red. The faster the market moves the more emotions we feel, falling, falling, falling into the red... How can we get out of this mess? Thankfully the market turns... hopefully we can get out of this trade without losing too much. 40, 30, 20 our brain screams to close the trade to avoid a bigger loss. Another part of pushes us to keep going as we believe we can make some money. We are trading... we never know which way the trade will go. Sometimes we win others we lose. Despite this emotional roller coaster we always want open another trade. The lure of the market keeps drawing us in. This time we will make some money. Over and over again we trade. Soon we notice that the money in our accounts are dropping. A little at first, then the slow, slow decline... until our accounts are empty. This is our struggle when we learn to trade. We have followed the trading guides. We've looked for pendants, flags and triangles. These are patterns in discipline called technical analysis also known as chart-ism. Charts are used by technical analysts to read the market
The market is made up of humans and we are emotional beings. These emotions show up as patterns on the charts. Technical analysts believe these patterns are as repeatable as our emotions are. By identifying these patterns a chartist tries to predict the markets next move. Maybe we have used moving averages, MACD and stochastic indicators. These indicators are used with charts to show when the market is overbought and oversold. An indicator can also tell us when to open and close our trades. Despite using these indicators we have still lost money. Why do we keep losing money? What have we done wrong? This is what this ebook is all about. I want to share with you the 5 unknown pitfalls, and offer my thoughts on how we can use this to help deepen our understanding of trading...
Pitfall 1 - Unlimited Losses We all see the warnings from our forex broker that trading is risky. We should only trade with money that and we can afford to lose and we don't know what this means. The notion of risk is often misunderstood; we think that the money in our trading account is all we can lose. Despite this being a substantial risk to us. This is not the risk our forex brokers are telling us about. Our forex broker's are offering us a leveraged product. This means that we are borrowing money from our broker to open our trades. When a trade really goes against us we can incur a massive loss. Every time we open a trade we have the potential to increase or decrease our accounts. This happens every time the market moves even a pip. (A pip is the fourth decimal place on our broker price charts.) The more the market moves the greater the potential for us to win or lose money. Let s say we have a trading account of $5,000 and we have opened 2 trades. Each of these trades is opened with our forex broker for 1 standard lot (100,000 units of currency) and we are currently trading at $10 for every pip moved. When we open our trade our forex brokers must be paid a deposit. This is so we can have access the credit the broker is offering (leverage). Let s say we need to deposit $1,000 to open this trade. This leaves us only $4,000 to manage our open trades. This figure of $1,000 deposit would depend on our lot size and the size of the broker leverage used. When the market moves 100 pips at $10 a pip our account would either be $6,000 or $2,000. 100 pips x $10 a pip x 2 trades open = $2,000 profit or loss. A 100 pip movement is an average move in the forex market each day. This is how fast money can be won or lost in forex.
Example We want to trade an interest rate decision by a central bank. The interest rates have continued to climb for 40 months in a row, the currency pair we wish to trade continues to rise. This is because everyone is putting money into the trade creating a trend. We believe that this trend will continue so we open 2 trades to capture this movement. We open each trade for 1 standard lot (100,000 units of currency) and each pip moved equals $10. A surprise rise in interest rates causes the market to drop. The smart money is leaving the trade. As the trade turns the speculators are now driving the market and are selling the trade. The market starts to drop...100, 150, 200 pips. This is a very small drop in the market but our account has been wiped out...we have lost $4,000 in minutes. At this point our forex broker will shut down our account. This is called a margin call. However if the market is moving quickly they may not be able to close our trades when our account balance reaches zero. If the market had moved 4 pips between the order to close our account and the execution of this order. We would owe our forex broker $40... Not much we may think... NOW imagine if the execution order fails and our trades remain open. Now our potential for loss (and liability) becomes unlimited. If the market continues its reversal we will keep on losing money. A simple use of a stop loss (an order given to our brokers to close our trade at a set level in the market) is all that is needed to stop this risk. This happens because we have set a point where we know our trade should have been closed. If the execution order failed we would be able to show the broker where our trade would have been closed. This is like insurance which protects us from unlimited losses. Without using a stop loss we have no such insurance. In my 15 Minute Forex Formula I not only use stop losses for all of our signal providers. I tell you exactly where to set them. Now you don't need to guess your stop losses. I give them to you.
Pitfall 2 Forex Broker Closing Our Accounts When we trade forex we have to open a trading account. In this account we deposit our trading funds. The amount of these funds dictates how big we can trade and how often. By misunderstanding the lot size and the frequency we trade causes our second pitfall. Having your account closed by your forex broker. Why can your forex broker close your account? Forex is traded in units of currency and 1 standard lot it is 100,000 units. For a retail trader that has no leverage it would take over $100,000's to open 1 trade of 1 standard lot, with $100,000 just for the deposit. This makes it nearly impossible for a small retail trader to trade the forex market. So forex brokers offer account leverage to their retail traders. This can be as low as 1:1 or as high as 500:1 and it is this leverage that allows a retail trader to trade forex. Leverage multiplies the money in our accounts by the amount of leverage taken. So 500:1 will mean we can control 500 times the amount of money in our trading account. With leverage we are effectively multiplying our money and this can be either good or bad. Used correctly leverage will make us more profits for less investment risk. Used incorrectly it can close our trading accounts. Our biggest risk is when we open trades that are too big for our account. This means small changes in the market will wipe us out. We simply don't have the number of trades in our account to ensure our survival. When we do this we are over trading... This happens when we are risking too much money per pip. If we lower the cost per pip we can extend the number trades that we have in our accounts. This then gives us the breathing space to for our system to earn money. Over trading also happens when we have too many trades open at the same time. When we combine this with over-trading we will lose money. It is only a matter of time before a margin call happens and our trading accounts are closed. When we trade large lot sizes and open too many trades we mistakenly believe that we will earn money quickly. If we open lots of trades we could earn a 200% return
every month. We hope we can turn a $500 account in $10,000's We do this because we all subconsciously know that to make money we must have money to start with. We know that a reasonable return on a reasonable amount of money would be all we would need to become rich. However in our rush to earn the money needed to make us rich we take too many risks. So instead of money pouring into our accounts... we go bust. All our trading capital has been lost. By making sure that we are not over-trading is the fastest way to increase our trading accounts. Now we can always open a trade. We always have enough capital in our account to keep us trading... Now we can compound our returns. This compounding is an effective way to increase our accounts. By keeping control of our lot size and the number of trades we are taking we stop our pitfall. Our accounts now have enough money to weather a draw down. We can now protect ourselves from our broker by not over trading our account. In my 15 Minute Forex Formula I have built a proven risk management strategy. This easy step by step system is designed to stop you over-trading. It will tell you what lot sizes to use to keep you from over trading your account. By spending 15 minutes a day updating your lot size you can compound your profits. This will help you reach your trading goals.
Pitfall 3 Unprofitable Trading Systems There are many different ways to trade the foreign exchange market. We can choose to open and close trades with manual trading. We can use automated trading robots to open and close for us. Another way we can make money is to follow signal providers. Each method has it's pro's and con's and which one we choose depends on how we wish to trade. No single method is better than the others; we only need to choose the style of trading which suits us. This is a personal choice and finding our style is an important first step towards profitability. Once we have identified the correct method for us, we need to know if the system we are using will make us money. Trading is not just about opening and closing trades for a profit. It's about having a repeatable system that when followed makes more money than it loses. The system does not have to be complicated to make money but it must have an edge. It like counting cards at blackjack... The system (counting cards) turns a slight edge for the house into a slight edge for us. This small edge is enough to make us rich We use this principle in our forex trading. Knowing if our system has an edge will tell us if our system will make any money or not. If we do not know if our system has an edge how can we be sure that we are not trading a system that will lose us money? To understand if our system has an edge we need to create a repeatable trading plan. In this plan we describe our trades before we need to use them. In this way we have a record of why we are taking our trades. Knowing our entry and exit strategy, we can record and measure our trading, to find out if our trading systems have this edge we first need to test it. Once tested we can measure our system to see if it is profitable. When using automated systems we can back test to get historical simulations. This shows us how our system would have performed in the past. When we look at our results we need to answer one question. Does our system make money? If our system is not making money we need to change to a system that does. Back testing our trading system will show us if our system will money over the long term.
When we open a manual trade we need to use a different system. We need a paper based system to keep records of our trades. Print off a copy of the trade and write the facts of the trade on the copy. We write the opening price, buy or sell, stop loss positions, the exit strategy. We can now keep track of our open trades. We close our trade when our stop loss is hit or we decide to close our trade. When we close our trade we make another print out. This time we have the closing part of the trade. From this we can see how well we are trading. Because we can record our results we can see if our trading has given us our edge. By recording trades as they happen stops us retro fitting our trading results. This gives us the accuracy needed to tell us if our trading system is profitable. We need to collect at least 2 to 3 months (100 trades or so) worth of trading results. This gives us a clear understanding of our trading results and our profitability. If after testing we have discovered that our system does not make money. It's time for us to change. If we are profitable then we can use this testing procedure to improve our trading. Once we have a system that has a statistical edge. We can trade this system for the long term. We know that as long as the system edge remains we will make money. In this way we can keep ourselves safe. We are no longer wasting our time on a system that will never make money. My 15 Minute Forex Formula provides signal providers with this positive edge. The edge indicator is available from my website. This is always updated so you can be sure your signal provider has a system that will make you money.
Pitfall 4 - Small Profits. When we use a indicator based trading strategy we may be missing out on extra profits. A good indicator will tell us when to open and close our trades. We can then use this to run our historical tests. These tests tell us if our indicator has an edge. Through testing we can monitor our edge and we can keep track of our systems performance. If we developed a system that produces a stable 20% profit per year, most of us would be happy. This stability would then allow us to grow our money over a number of years. However we have to be aware that we may only be making a linear profit. A linear profit is a slow way to increase our account. By back testing our indicator we can work out the historical return for our system. If we produce a 20% return per year, and our trading account holds $10,000 we would make $2,000 per year profit. $10,000 + $2,000 =$12,000 + $2,000 =$14,000 + $2,000 =$16,000 +$2,000 =$18,000 + $2,000 =$20,000 As long as our system retains its edge we could expect to double our money in 5 years... This is too slow. The best way to maximise our trading profits is to use compounding. This will allow us to grow our trading accounts much faster. How can we use compounding to increase our profit margins? When we use a linear system we are using a fixed lot size to produce the return. This means that the risk we are taking per trade is being reduced as our trading account increases.
The number of trades we have available to us will increase as our account grows and this will reduce our trading risk. We could use this strategy as it will keep reducing our risk. The trade off between this extra safe method is the slow accumulation of profits. When we know that our system will survive and make money. We need to change the linear return to a compound one. To do this we need to understand our lot size. We can increase our lot sizes as we make more money. What we want to do is keep the lot size in proportion to our account size. When we increase our lot size the amount of profit available also increases. By keeping our lot sizes in proportion to our account we can compound our profits. Let s assume that our system is still producing a return of 20% per year and we can now compound our return. $10,000 X 20% = $2000 profit $12,000 x 20% = $2,400 profit?14,400 x 20% = $2,800 profit $17,280 x 20% = $3,456 profit $20,736 x 20% = $4,147 profit This would give us a return of $24,883 in 5 years. We have gained an extra $4,883 on top of the linear profits without taking on any more risk. In my 15 Minute Forex Formula it is easy to compound your profits. My easy to use calculators will help you increase you lot sizes correctly when trading account grows. This will ensure you are always compounding your money. The quickest way to increase your wealth.
Pitfall 5... Emotional trading When we trade we open ourselves up to the market. Controlling the emotional pull that the market has on us is perhaps the most difficult part of trading. It makes us second guess ourselves. We know that our trading system must have an edge to make money, and when we control our trading risk we know that we can survive a draw-down. The trading plan is the method we use to create an edge in our system. A fully tested trading plan should get results similar to our back-tested results. This is because we are working with probability. If we have a system that will make money, why do we find it so hard to stick to our trading plan. Trading is difficult and our emotions have a big impact on the decisions we make. This can lead to snap decisions which could lead to unprofitable trading. Our trading plan helps us to keep our perspective. We know from testing our system that our trading plan has an edge. We can be confident that the system will make money. This is why the urge to deviate from our trading plan is madness. We must always remind ourselves that our system only has an edge when it is traded according to our plan. By understanding this we can reassure ourselves when times are tough. Only a carefully monitored trading system tells us when it is profitable. It will also tell us when it's not. Having a system that tells us when to stop trading helps following our trading plan easier. By sticking to our trading plan we can stop the final pitfall of emotional trading. In my 15 Minute Forex Formula you do not have to worry about developing a trading plan. I have provided signal providers who do this for you. Just keep track of the providers system edge and you will know when its time to switch signal providers. My automated system gives you the confidence as you know that your not overtrading. You can compound your profits for maximum return, and track your signal providers to ensure continued profitability. Giving you the peace of mind you need when trading.