Forex trading is more art than science. One of the advantage of forex trading is the use of leverage. However, leverage is a double-edged sword that can maximize the profits with limited funds; it can also expose the traders to increased risk of blowing out the account. Many professionals have suggested basic rules for successful forex trading. Half of the trading is about strategy and another half is about risk/money management.
1. how much maximum to risk on one trade?
This number is 2% – 5% suggested . For beginners, this number may be 2%. The 2% rule ensures that the loss is only 20% even after 10 consecutive losing trades and it would only require to make 80% profit to break even. Some people risk maximum of 2% if the trade is with the trend, 1% if it is against the trend (trade reversal or trade retracement)
2. know the risk-reward ratio
Some trade setups are restrictive and high probable, there is few entry opportunities. The risk-reward rule can be loose. Otherwise reward-to-risk ratio should be at least 1:1. Risk must be determined before enter the trade with stop loss and only adjust (can use trailing stop) after hitting the most close profit target. This practice can prevent one losing trade to wipe out the profit from multiple consecutive winning trades. A reward-to-risk ration of 2:1 would suggest that the trader only need to be right with the trend or direction 35% of the time to breakeven.
3. secure winning trade – set partial profit target
Never turn a winning trade into a loser. Partial profit target (usually the amount risked) can be set in advance; and adjust the remaining position’s trailing stop to breakeven point.
4. use discipline and strategy
Discipline keeps one indifferent and strategies (rule -based trading strategy) screen out the noise signal from the technical indicators and increase the probability of a profitable trade and decreased probability of a trade being stopped out.
Kathy Lien’s book “Day Trading and Swing Trading the Currency Market” provide some rule-based trading strategies including both short-term (on the minutes chart) and mediate-term (day chart) trade setups, both fundamental trading strategies and technical trading strategies.
5. determine the time horizon of the trading strategy
A strategy that works on daily chart may be far less accurate on minutes charts
6. identify the trading environment – trending or range bound
Many technical indicators can be used together to identify the market environment. Short-term traders should use daily chart to define the trading environment. This practice may help prevent entering into a breakout trade when market is range bound and entering into a reversal trade (based on overbought and oversold technical signals) when market is trending.
7. what is the difference of “scaling in” and “adding to the loser”
“Scaling in” is the practice of adding more positions to the initial trade to get a better average price of the trade. The initial trade is only a part of a larger total intended lot. Scaling in either lower (for long position) or raise (for short position) the average price of the trade. And the stop is the same for all the entries. The multiple entry is planned in advance. “Adding to a loser” has gone beyond the point of the risk when the market go in the opposite direction and is the common mistake traders make result in margin call of the accounts
8 concentrate on the majors
Currency majors has large trading volume, less volatile market environment. Some cross currency pair are synthetic and are converted from majors.