Traders who are new to the forex market are often overwhelmed with the amount of information they need to assimilate. From understanding how the markets work, to understanding their trading personality and style, planning their approach to the market and of course learning how to place and manage their trades.
If you are that situation in this section we’re going to look at how to pull all this information together in a logical sequence of events, and the place to start is with you.
After all, it is you who will be responsible for all your trading decisions, it is you who will develop, design and follow your trading plan, and it is you who will ultimately decide how much time, effort and money you want to invest in your trading business.
Your trading business
Trading after all, is a business. A little different perhaps from many other types of business, but a business nevertheless, and provided you follow sound business principles and have a sound business plan to follow in the form of a trading plan, then you have a better chance than most of becoming a consistently successful forex trader.
Business is about making money, which is the sole purpose of trading. We are not in this business for pleasure, or for the thrill of trading, and whilst it is enjoyable, the objective is very simple – it’s about making money and nothing else.
The place to start therefore is in analyzing your own personality so that you have a clear picture of your strengths and weaknesses. This will help to guide you in the right direction, whilst also perhaps having to accept that maybe trading is not for you.
Your trading personality
There are many online personality tests available, some are good and some not so good. I advise that you look to spend a minimum of $100 on a good personality test. It will provide you with some excellent feedback, and will answer key questions about your relationship to money, handling loss, planning, attention to detail, discipline, patience and all the other attributes which are part of the psychological make up of every trader.
This in turn should start you thinking about what might be the best trading strategy to suit your temperament and your personality.
Some people prefer to trade using the shorter term tick charts or time charts, scalping many times a day, and taking a small number of pips on each trade. They never hold a position overnight or at the weekend.
Other traders prefer to trade the longer term trend, holding positions for days, weeks or even months as they follow the longer term trends of the markets, looking for bigger moves but with fewer positions. Another group of forex traders will only trade the news, waiting to enter the market as each new economic release appears, and trading in the currency pairs affected by the news.
Forex traders generally fall into one of three categories:
- The intraday scalper
- The swing trader
- The position trader
Which of these you choose to be will ultimately depend on your personality and also the time you have available during the trading day.
The intraday scalper
The day trader will generally aim for a quick turnover rate, trading many times during the day, and generally using the ultra short or very short time frames such as the 1 minute, 5 minute or 15 minute charts.
Alternatively professional day traders will tend to concentrate on the tick charts which provide the purest form of data. Typically day traders will tend to approach the market using a technical bias, and concentrate on the more volatile currency pairs to make their profits. Although fundamental news plays a part, these traders are typically looking for positions which last from seconds to minutes and no longer.
The longer term trend is unimportant to the day trader, as he or she is simply looking to profit from the next few minutes of price action, so counter trend trading is often the norm as markets pull back or retrace during a longer term trend or rally.
The swing trader
The swing trader takes a more cautious approach, tending to hold positions for several hours or perhaps a few days in order to benefit from a turn in the market. Unlike the day trader, the swing trader is trying to identify those reversal points which can be so profitable, where the market reverses and trends in the opposite direction.
Timing for the swing trader is the key, and success is based on identifying when a currency is over bought or over sold, something the amateur forex trader finds difficult to achieve with any degree of consistency. Just like the day trader, the swing trader bases their analysis on a more technical approach.
The position trader
The position trader takes the longest view of the market, and will base their trading decision on the daily, weekly or even monthly charts.
Instead of considering short term market moves, this style of forex trader will look at a longer term plan. As a result, the position trader will place greater emphasis on the long term fundamentals. In particular they consider the outlook for longer term interest rates, inflation and growth, although the longer timeframe technical patterns will also play asignificant role.
Whether you choose to be a day trader, a swing trader or a position trader will ultimately depend on your personality. There is no right or wrong way to trade the forex markets. It’s simply a question of matching the right approach for your own personality, so that you have the greatest chance of success.
Each approach requires different skills and disciplines, and those that are best suited to a position or swing trader, may be wholly unsuitable for a day trader. This is why it is so important that you start with a personality test to find out more about yourself and the inherent traits you have. In other words, play to your strengths, not your weaknesses.
Risk on or risk off?
The next step is to learn how the markets really work. The biggest misconception is that the forex markets trade in isolation, that currencies ebb and flow on their own. They do not.
The markets are driven by fear and greed in equal measure, what professional traders call risk on, or risk off appetite, and it is this market mood which is the key, as it signals the flow of money from one market to another.
So for example when equity markets are rising, then investors traders and speculators are prepared to take on more risk, as they are buying a riskier asset class.
This in turn is likely to be reflected in strength in the euro. The euro is currently considered to be a risk currency, and therefore both will tend to rise or fall together.
Commodities and the US dollar are also closely linked with a weak dollar resulting in higher commodity prices, which in turn are likely to trigger inflation and higher interest rates in due course.
In addition, as all commodities are generally priced in dollars, then a strong dollar will cause commodity markets to fall, and a weak dollar will generally see these markets rising.
Economic releases (news)
Whilst the relational markets are important, the fundamental news flow is relentless, and is often the trigger for volatile moves in the market once the data has been absorbed. It is important to realize that while many of these numbers are only statistics, and therefore subject to manipulation by governments, politicians and financial institutions alike.
However, whether we like it or not, they do form the basis for much of the monetary policy decision making by the central banks and others, so they have to be taken seriously.
All fundamental data will fall into one of several categories, and depending on which sector of the economy the data relates to, this in turn will dictate the importance of the release, and the consequent effect on the market.
For example, any numbers which relate to employment, unemployment, jobs created or jobs lost, will always be considered to be extremely important, as they indicate whether the economy is expanding, contracting or simply stagnant. If an economy is expanding, then this will signal demand from consumers, with further jobs likely to be created in the future, with subsequent inflationary pressures then controlled through interest rate increases.
As a result this is likely to be seen as positive news for the currency.
Naturally not all jobs related data or markets have equal weight, and an employment number for the US, the world’s largest economy, will carry more weight than for a smaller member state in the EU. Equally, employment data from a future powerhouse nation such as China, will have a major impact on the markets, not so much directly on the Chinese currency itself, but on virtually every other currency around the world, since a slowdown in China, is likely to affect world demand globally.
Each release and each item of news has to be seen in the context of both the local market as well as the global picture.
Finally, to understanding how the markets work, we need to develop our chart reading skills, generally referred to as technical analysis.
Whilst this may sound clinical and clear cut, technical analysis is far more of an art than a science. The price chart combines all the views of all the traders, speculators and investors from around the world, and encapsulates these views into one simple price bar or candle, which then gives a visual picture of the state of the market at any point in time.
The technical chartist is then able to apply their analytical skills to interpret where the market is likely to move in the future.
All other indicators are based on historical data and have little bearing on the future. However volume is ‘predictive’ as it signals what the market is intending to do.
As such it is the primary indicator of choice for all serious traders. Until now, volume was not available to forex traders in the spot market. The true supply/demand relationship, has been hidden from view. Now with the MT4 platform and others we have the perfect tool in the form of tick volume.
Having grasped an understanding of how the markets work the next step is to learn the mechanics of trading, and in particular those key skills of assessing risk and money management. Trading is all about trading risk, and not about trading a market.
Every decision we take as a forex trader is essentially posing the same question:
“On the balance of probabilities, what is the likelihood of a successful trade?”
In entering and managing our positions, this is where we need to learn how to define and manage the risk on each trade, as well as how to calculate the correct position size so that our losses are kept small, our profits are allowed to run, and the percentage risk on each trade is kept within our trading rules.
As a general rule of thumb the maximum percentage of total trading capital at risk on each position should be no more than 1% and preferably less.
Whether you have $1,000 or $100,000 in your trading account makes no difference. It is the percentage that is important, not the amount of money in your account.
The last piece of the jigsaw is the one that most traders avoid: the trading plan. Failing to develop and write a coherent and simple plan is where most forex traders fall down. It is one of the cornerstones of trading success. Without a simple trading plan with well defined rules to follow on each and every trade, then your trading will be reduced to that of one based on pure emotion( which is essentially gambling).
Your trading plan should be simple, with clear and concise rules which you then follow on each and every trade. Fear is the traders biggest enemy.
Without a plan, fear will rule your trading decisions. Whether it is the fear of a loss, the fear of losing a profit or the fear of missing a trade. With a plan your fear is managed for you by your trading rules, removing the emotion and stress from your trading, allowing you to get in, stay in, and then get out when you have taken your profits off the table.
As forex traders we never ever stop learning. It’s a constant and evolving process of acquiring and absorbing knowledge, which we then apply to our own analysis day in and day out.
It takes time, effort and hard work to keep ahead of the markets, but by applying the above principles, these will provide the solid foundations on which the rest of your forex trading career is built.