Thursday, June 29, 2017

Forex Trading: Generating Profits Part 1 – Understanding Leverage, Risk and How to Control Them…

Currency trading in the Forex markets can be an exciting place to be. The leverage these trading instruments provide can create an emotional intensity that is extremely difficult, maybe impossible to fully understand until you have actually entered a trade with real money on the line. The potential rewards of a profitable trade helps feed this excitement… it’s what keeps the never ending revolving door of new traders, with their new accounts, stepping up to the trading desk.

The Good and the Bad Sides of Leverage

Of course, all of us know that leverage is a two headed monster. It is a wonderful thing and life is beautiful when you and leverage are on the right side of the market. But I can assure you that leverage is definitely not all that appealing when you and your hard earned dollars are on the wrong side of the market. Leverage, combined with a traders unwillingness to accept a loss has contributed to the destruction of more accounts then any other combinations.

Know When to Get Out

Learning to admit that your trade has turned against you requires the successful trader to check his ego at the door and recognize the fact that he cannot be right all the time. Learning to be a good loser is essential to surviving as a trader, and if you cannot maintain that discipline, then our friend “leverage” will take care of it for you.

So as a new trader, how do we address this problem and what steps can we take to insure we develop the right skill sets to avoid indecision and another blown up account? There are many important parts that make up a successful trading plan, but one of the first things to understand is “discretionary” trading vs “mechanical” trading.

Discretionary Trading

Discretionary trading seems almost self explanatory in that a discretionary trader does not have a predetermined exit point after he or she has entered a trade. A discretionary trader may have a general profit target in mind as well as a threshold for their max loss, but they enter and exit the market based on an intuitive decision at that point in time. Very few discretionary traders are profitable long term. Fear, anxiety and greed are natural tendencies that tend to fuel bad decisions and end up being nothing more then guesses based on the traders gut feelings.

Mechanical Trading

Mechanical trading can mean many things, but for simplicity sake, a mechanical trading system is a “rule-based” system. This means that the trader has adopted a very specific set of rules that define when a trade is entered, when a trade is exited, a profit target, a max loss per trade, position sizing, stop-loss management, and many other possible variations of requirements depending upon their system. Trading with a set of rules removes the emotional side of trading and replaces it with a clear set of criteria that give the trader the greatest chance for success.

Technical Analysis

Technical analysis is the preferred and most popular method used by experienced forex traders to generate buy and sell signals. To fully appreciate the use of technical analysis it’s important first to have a clear understanding of what exactly it is. Quite simply, technical analysis in the forex markets is the study of price action, primarily through the use of charts for the sole purpose of forecasting future price action.

Technicians hold to the belief that the price action is what reflects changes in supply and demand. When supply exceeds demand then prices must drop and when demand is greater then supply prices will rise. Technicians believe that this recorded data reveals a directional bias by accurately reflecting the bullish or bearish psychology of the currency pair being charted. The tools and methods used in this approach include various indicators, moving averages, oscillators, and chart patterns.

Using the Tools

These tools are generally used in logical combinations to help the technical trader form an opinion on the future direction of price. As an example, a trader may use a moving average combined with a shorter term momentum oscillator to generate buy and sell signals. If the moving average is bullish, and the momentum oscillator is bearish, this tells the technician that the overall trend is up but short term price action is down, signaling a possibly over-sold condition and a good buying opportunity.

Of course the above combination, though a very popular one, is a very simplistic and basic example of how the technical trader can use various indicators and patterns to create their own mechanical or “rule-based” trading system rather then having to rely on the inferior and emotionally draining discretionary approach.

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