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Forex, now even more prominent:
Why Trading Forex Now
Beats the Stock Market
Thursday, November
5, 2009
A Special Note from
The
Tycoon Report:
As a free
investor-education newsletter, we are always on the lookout
for opportunities to round out your education with different
strategies and approaches. Today, we are pleased to
introduce you to Profits Run Founder Bill Poulos, who will
be talking with you today about the forex market. Visit the
link at the end of this article to get even more information
on forex.
Why Trading Forex Now Beats the Stock Market
You've likely heard the term "forex" lately -- it is
becoming the hottest market today, attracting more and more
traders around the world.
As the stock markets continue to meander, I believe that the
strong trends in the forex market will continue ... which
means this is one of the best times to engage the foreign
currency markets as an added investment vehicle to your
portfolio.
Over the past few years, I've had the opportunity to teach
thousands of new and experienced traders the pitfalls of
trading foreign currencies and to help them discover the
right way to attack these markets.
Today, however, I want to share with you the key reasons you
should take advantage of the potential that exists in
trading foreign currencies and, going forward, I'm going to
share more-detailed strategies with you.
What is Forex?
Forex stands for "foreign exchange" and is the trading of
one currency against another.
At its simplest, trading foreign currency involves two
currencies that are traded simultaneously, called a "pair."
For example, the EUR/USD pair, trades the Euro against the
U.S. dollar. In this example, a buyer of this pair would
"buy" the Euro and simultaneously "sell" the U.S. dollar.
Forex trading takes place through major banks,
market-makers, and brokerage houses around the world, who
together create a marketplace for trading currencies on a
near-24/7 basis.
The forex market is almost always "open"; it is the 7-Eleven
of the trading world. It is the largest financial network in
the world, with a daily average turnover totaling trillions
of dollars.
Until recently, the foreign-exchange markets were dominated
by the big brokers and major banks around the world.
Today, the "little guys" have gotten in on the action -- and
the growth in currency trading has increased from $1.9
trillion to nearly $3 trillion in that short space of time.
(That's the average daily turnover in the markets -- a 50%
growth in turnover.)
Why Should You Trade Forex?
First, the forex markets are highly liquid (in the major
pairs) and have a strong tendency to "trend" regardless of
what is happening in other markets (i.e., stocks,
commodities, bonds).
This liquidity also creates constant volatility -- and the
volatility is where the ability to profit from those trends
happens. The greater the volatility, the greater the profit
potential. (Be advised, however, this also means the greater
the risk.)
Second, the stock markets have been beaten down, rallied,
fallen, rallied again -- and there are strong indications
that another "fall" is coming. The uncertainty in these
markets is unnerving for buy-and-hold investors and traders
alike.
In the forex markets, however, traders don't have to worry
about "bull" or "bear" markets -- the currencies are always
in a trend (whether up, down or sideways). And frequently,
when one set of pairs is trending one way, another set of
pairs can be trending the opposite way.
In addition, there are no restrictions to selling short a
pair like there are for short-selling stocks.
Furthermore, the financial upheaval driven by the credit
crisis and the massive government responses I believe means
that investing or trading in the stock markets will never be
the same -- but these same events are helping to create even
greater opportunities in the forex markets.
As interest rates are cut or raised, economies grow or slow,
jobs are gained or lost -- each of these factors impacts the
future value of a currency pair. As these and other economic
factors change, they affect the swings in volatility.
Forex trading is not without risk -- and, frankly, most
people approach the forex markets completely wrong. I
believe the current economic and financial conditions make
this one of the best times to take on forex trading, but
only if done correctly.
How Most Traders Incorrectly Approach Forex Trading
While doing research on the current state of the forex
trading landscape, I discovered something surprising:
Losing forex traders appear to be enamored with "winning
percentages" when selecting a forex trading method.
The irony in that statement should be obvious -- if the
"winning percentage" of the forex method is so important,
how can these traders still be net losers?
Because, I believe, winning percentage is the wrong concept
to focus on. In fact, I find winning forex traders look for
methods that have winning percentages closer to 50%-60%.
And, they also have one more "secret" that losing traders
DON'T have. ...
The difference will probably surprise you -- and it's a big
difference, too. The answer should have been obvious, but it
isn't for most traders.
Ask yourself this question: How is it possible that a forex
trading system that wins 90% or more of the time can end up
a net loser?
The answer?
Losing trades. BIG losing trades.
Here's what I've discovered many of those systems (or
robots) that claim 90% winning trades aren't telling forex
traders:
When their systems "win," they are making a high number of
very small gains.
But when their systems "lose"? They wipe out all of the
gains ... and a good percentage of the trader's account
balance, too.
Still, traders flock to these automated systems because,
after all, something winning "almost" 100% of the time must
be good, right?
Not really, no.
See, what most traders don't get is that the reward-to-risk
ratio in those high-win percentage systems is upside-down.
Traders risk too much capital for too little profit
potential.
That's poor risk management, and it leads to one becoming a
"losing" trader.
Let me illustrate an example, using a "typical" robot (or
automated) trading system,making five trades:
Trade 1
-- gains 8 pips on 20 mini-lots ( $160)
Trade 2 -- gains 8 pips on 20 mini-lots (
$160)
Trade 3 -- gains 8 pips on 20 mini-lots (
$160)
Trade 4 -- loses 80 pips on 20 mini-lots (-
$1,600)
Trade 5 -- gains 8 pips on 20 mini-lots (
$160)
Note that pips are smallest units of measurement in
which currencies are traded.
This is standard practice for automated systems out there
that don't employ risk management. They set stop-losses that
are far too wide given the reward ratio. Here it's 10-to-1
(risking $10 to win $1 -- does that make sense?)
Say you had a starting account balance of $10,000 -- at the
conclusion of these five trades, your account balance would
be $9,040.
That's a 9.6% loss, even though you "won" 80% of your
trades!
We haven't factored in lot or position size yet, either. I
would expect it to be obvious that the trader above is
taking on far too much risk.
Keep in mind, too, that when trading with an automated or
robot method, you are unlikely to be able to stop that
80-pip loss unless you happen to be watching it unfold.
Of course, that robot is supposed to make you money "while
you sleep" -- isn't it? (That’s what they promise, anyway.)
The bottom line is this: If you aren't managing risk in
every single trade, from determining the correct lot and
position size to the right points for your stop-losses and
your exit strategies, you will NEVER join the elite 5% of
successful forex traders.
Here’s the Forex ‘Secret’
Let's illustrate a "winning" trader using a forex trading
method (not a robot), who only wins on 60% of their trades,
and see if you note right away what their "secret" is:
Trade 1
-- gains 43 pips on 10 mini-lots ( $430)
Trade 2 -- loses 30 pips on 10 mini-lots (-
$300)
Trade 3 -- gains 29 pips on 10 mini-lots (
$290)
Trade 4 -- gains 19 pips on 10 mini-lots (
$190)
Trade 5 -- gains zero pips on 10 mini-lots
( $0)
Again with a starting account balance of $10,000 -- this
trader would have made a 6.1% gain ($610 net), as opposed to
the first trader's nearly 10% loss.
Yet, this trader only "won" 60% of the time. What happened?
This trader "broke even" on 1 of the 5 trades. No gain. No
loss.
What the "winning" trader does is eliminate risk as quickly
as possible, thereby ensuring infinite reward (until they
liquidate their position).
To do this, these traders take aggressive action to move
their initial stop-losses up to the breakeven point from the
outset of a trade, set an initial profit target and -- once
they are able to eliminate the risk side in the trade --
they will manage the profit side of the trade by scaling out
in stages at predetermined profit points.
In this way, once the trader has been able to "erase" the
risk side, they can focus solely on the profit side -- with
the worst case scenario being a "zero-gain" trade (or,
breaking even).
Now, you may not be able to eliminate risk in every single
trade, but breaking even on just 1 in every 5 trades can
have a significant and positive impact on your account
balance.
The chart below illustrates the mistake of focusing on
winning percentage where risk is ignored (Traders A & B), as
opposed to managing risk FIRST and taking profit second
(Trader C).
So, don't let yourself be fixated on the "winning"
percentage of a trading method. As you've just seen, that
doesn't guarantee you can be a net winner.
Instead, put risk first and profit second. I think you'll be
surprised at the results.
Optimal Profit Strategy for Forex Traders
As we’ve just shown, when it comes to trading forex, traders
typically focus on when to enter the trade, but pay too
little attention to protecting their initial position AND
too little attention on how to manage and exit the trade.
This is a critical mistake, yet it is one of the simplest
concepts in trading.
It should go without saying that -- as soon as you enter the
market with a new position -- an initial stop order should
be entered to protect the position against an adverse move
in the market, or an exit strategy should be employed to
cover the trade if the market closes adversely.
If such a move occurs, as is often the case, you want your
position liquidated and to be out of the market with a
minimal loss.
The consequences of failing to do this are simple: You will
not be successful at trading.
In fact, every trade you put on, you should plan to lose, so
that you are sure to place your stop-loss order or cover the
trade on an adverse close.
Otherwise, what would have been a small loss turns into a
big loss, turning the entire risk/reward ratio against you.
That being said, where should you place your stop-loss?
The short answer is, “Where you don’t expect the market to
go,” or, more specifically, where the assumption in putting
on the trade is no longer valid.
For example, if a long position was entered into after an
uptrend or breakout market traded back down to support, an
initial stop could be entered below the recent low.
Why? Because if the market does go there, support (as
defined by that low) would have failed, and there is no
longer any reason to be long the market -- so get out!
Don’t wait around for it to come back in your favor, because
the odds are against it.
If the market goes in your favor once the initial stop is in
place, then you need a set of rules that will allow you to
exit the market profitably.
This poses a real dilemma.
If you exit too soon, you may secure a small profit, but
miss out on all those big moves that occur (and the big
profits that go with them).
On the other hand, if you wait too long to exit, the market
might reverse and take away all of your open profits and
even put you into a loss position.
So, what do you do? Well, the first thing is to
realize that there is no method that can forecast whether or
not a particular move will:
-
Go
against you immediately
-
Go up
only a little before going back down
-
Go up
a lot in your favor
For example, after you enter a long trade in an uptrend,
there’s absolutely no way to predict what will happen next
(contrary to what the so-called “gurus” tell you).
Because of this, you absolutely need an exit strategy,
because the risk of loss is significant no matter how
carefully you plan your entries and exits.
The 'Optimal Profit Exit Strategy'
The following is the very best exit strategy that I believe
possible when trading the forex markets. I call it the
Optimal Profit Exit Strategy.
It’s a strategy that scales out of a trade in two steps.
This strategy is first and foremost about taking an initial
profit as soon as appropriate, thereby “taking some money
off the table” and reducing the risk in the trade at the
same time.
Here’s an example from two recent moves in the EUR/USD -- in
both cases, I applied my Forex Profit Accelerator method to
identify the potential trade, and my Optimal Profit Exit
Strategy to show how to manage the trade while its ongoing.
Optimal Profit Exit Strategy in action:
PT1 = Profit Target 1 (your first exit
point)
PT2 = Profit Target 2 (your second exit
point)
PT1 in the chart above exits 1/2 of your
position at a pre-determined profit target. The profit
target is modest, but enough to make the trade worthwhile,
and the specific level is also dependent on the overall
method being used.
Once that initial profit target is hit, you should move the
initial stop up for the remaining 1/2 of the position to the
lowest low of the past three bars for an uptrend trade, or
the highest high of the past three bars for a downtrend
trade.
As you can see, in the example above (from my Forex Profit
Accelerator method), the first trade would have exited PT1
with a profit of 135 pips (or $1,350 on a standard lot
trade) and the second trade would have exited PT1 with a
profit of 130 pips (or $1,300 on a standard lot trade).
You’re now out of 1/2 of the trade (in each instance) with a
very nice profit and, at the same time, you are prepared to
ride the market as far as it wants to go in your
favor for the remaining 1/2 of your position.
PT2 allows you to continue to ride an
existing market trend with the remaining 1/2 of your
original position, but you protect it by a trailing
stop always based on the lowest low of the past three bars
(for an uptrend trade).
As the market continues to move up, you would move the stop
up with it. This locks in a significant portion of the
remaining open profit but also gives the market enough room
to trade down a bit without shaking you out of the trade if
it moves higher.
As the example chart shows, this added profits of 243 and
191 pips, respectively, to the winning trades -- an
additional $2,430 and $1,910.
With this strategy, you should be prepared to take advantage
of the market after entering a trade no matter what it does.
And that’s a big deal.
Good Trading,
Bill Poulos
Founder
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