No investment plan is foolproof. The vagaries of the markets mean that there is no sure-fire system for making money each and every time. If there were, everybody would be doing it, and you would have something like a perpetual motion machine – fun to think about but impossible in real life. This is especially true in Forex investing. While many years of back analysis and observation of how multiple factors affect price movements can be helpful, you probably know in your gut that Forex is as much art as it is science. This said though, there are certain rules you can follow that will help you avoid common pitfalls and increase your chances for financial success.
Stay on Top of Things
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Nothing is worse than being ahead by a substantial amount only to watch it all go the other direction in a few short minutes. Since the Forex markets can move very quickly, you need to stay on top of things to make sure this doesn’t happen to you. But how can you do this practically? Since you will occasionally need to go get a cup of coffee, use the restroom, or make a snack, you need a tool that will automate this process so you don’t have to spend every minute with your eyes glued to a computer screen. Also, since it can be tempting to try to ride the tide of a loss, hoping for a reversal, you need a tool that will help you keep to your pre-established exit point. This is where the trailing stop comes in.
What is a trailing stop? Optionsxpress.com explains:
A “trailing” stop order is a stop order that moves along with a favorable movement in a security. Trailing sell stop orders will move upward a defined distance as long as the security moves upward. Trailing buy stop orders will move downward a defined distance as long as the security moves downward.
The trailing stop is different than a fixed stop order in that the stop point is adjusted continuously based on the security’s current value. Take the case of a stock, for example. Say you bought George’s Carpets (GCPT) at $20 a share six months ago with a GTC trailing stop of 10%. GCPT has been steadily increasing in value, with occasional small retractions. However, none of these retractions were more than 10% of the peak price. Last week though, after hitting a high of $40, it then dropped to $36. This would trigger the trailing stop order automatically, selling your position and locking in your profits.
Stay on the Left
What do we mean by this? You need to use logic. Check your right-brain tendencies at the door; there is no place for them here. It can be a terrific thrill when you are riding a winning position, but a single bad loss can wipe out your profits and capital. If you stay on the left side of your brain, using logical reasoning and pre-established entry and exit points and sticking to them, you have a much better chance of staying ahead of the game and profiting.
Use the 2% Rule
Risk management is key to Forex trading. A widely accepted risk-management technique is called the 2% rule. This means that we will never risk more than 2% of your trading account on any transaction. At first, this may seem very conservative. After all, for a $10,000 account, this means we are only risking $200. But don’t forget that our goal is to make more money than what we are losing, even if that amount seems very small. As TheBull explains,
1 or 2% of your trading capital is kept at a small amount to avoid a string of losses that could wipe out your entire trading capital. Losses are always going to occur, but limiting the losses and preserving your trading capital are vital for staying in the game.
If your wins outpace your losses, your account will grow, and that 2% will grow as well. Since this increase is exponential in nature, it won’t take as long as you might at first think. If you are successful, pretty soon that $10,000 account and $200 risk will turn into a $100,000 account with a $2000 risk. On the other hand, think of the advantages. If you limit yourself to 2%, you would have to make a string of 10 bad trades to lose 20% of your account value.
Don’t Pit Lions Against Lions
Sound military doctrine is based often on overwhelming force. If a country wants to be assured a military victory, it will wait until there is overwhelming force on its side before committing to a particular engagement. Carrying that analogy over to Forex: You want to make sure that you are pitting a lion against a sheep, not a lion against a lion. Make sure that the currencies you are trading always consist of pairing a strong with a weak currency.
Use Both Forms of Analysis
Some Forex traders tend towards technical analysis, others fundamentals. As a general rule, fundamentals are good at determining overall trends that will cause the market to move in a certain way over the long haul. When you look at these, you talk about such things as intrinsic value, and look at indicators to determine the overall health of a currency. Technical analysis doesn’t particularly care about this; it centers on the idea that past performance indicate future performance, and that looking at the way pricing and volume fluctuates in the past is a good way to determine where a given security will move at a given time. But a good trader will not stick exclusively with only one of these two methods. He will use both to his advantage. One technique is described by investopedia.com:
A rule of thumb is to trigger fundamentally and enter and exit technically. For example, if the market is fundamentally a dollar-positive environment, we’d technically look for opportunities to buy on dips rather than sell on rallies.
While no investment plan is foolproof, following these five rules will lower the chance of you behaving like a fool. Educate yourself, plan carefully, and execute logically.
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