Foreign exchange (forex or FX) traders participate in the global currency market, buying one currency and selling another in the hope of making a profit. The forex market is the largest financial market in the world, stretching across time zones and operating 24 hours a day during the trading week. The most recent global data shows that in 2022, global daily trading reached levels of $7.5 trillion.
While the rise of online forex brokers and trading platforms have made forex trading more accessible to non-professional traders, even hobbyists can improve their trading through a variety of strategies. The best traders hone their skills through practice and discipline. They also perform self-analysis to see what drives their trades and learn how to keep fear and greed out of the equation. These are the skills any forex trader should practice.
Key Takeaways
- The foreign exchange market is the largest in the world by trading volume, and online brokers have made it more accessible.
- Traders of all levels can use trading strategies to streamline their methodology, minimize risk, and analyze the results of their trades.
- Calculating expectancy can help forex traders determine how effective their trading methodology is and whether their system needs to be adjusted.
- Methodologies and analysis that minimize emotional trading will lead to more stable outcomes in the long term.
Identify Your Trading Style
Before you begin forex trading, develop clear goals and ensure your trading method is capable of achieving these goals. In forex trading, there are three main styles of trading.
- Day trading: If you can’t stomach going to sleep with an open position in the market, then you might consider day trading, which involves buying and selling assets within the same day.
- Swing trading: If you’re willing to give your trades a small amount of time, you might be a swing trader who holds assets for a few days or weeks to capture short-to-medium-term gains.
- Position trading: If you have funds you think will grow over time, you may be more of a position trader, which means buying and holding a position until it appreciates.
Each trading style has a different risk profile, which requires a certain attitude and approach to trade successfully. The trading style you choose should match your personality and comfort level.
Select a Forex Broker and Trading Platform
Choosing a reputable broker is of paramount importance, and spending time researching the differences between brokers will save you money and stress in the long run. Each forex broker will have different trading policies and a preferred way to go about making a market.
- Over-the-counter (OTC) market: Assets are traded over a broker-dealer network, rather than through a centralized exchange.
- Spot market: Financial instruments are traded for cash for immediate delivery; sometimes called physical market or cash market.
- Exchange market: A centralized market that all trades must pass through; may be in-person or digital.
Your broker’s trading platform should be suitable for the analysis you want to do. For example, if you like to trade off Fibonacci numbers, be sure the broker’s platform can draw Fibonacci lines.
Develop a Trading Methodology
Before you enter any market as a trader, decide how you will make decisions to execute your trades. Determine what information you will need to enter or exit a trade. For example, you may choose to:
- Monitor underlying economic fundamentals
- Track major news in different countries and economies
- Rely only on technical analysis
Whatever methodology you choose, it should be both consistent and adaptive. You need to be able to keep up with the changing dynamics of the market.
Determine Entry and Exit Points
Many traders, especially those with less trading experience, may be confused by conflicting information that occurs when looking at charts in different timeframes. What shows up as a buying opportunity on a weekly chart could show up as a sell signal on an intraday chart.
If you are taking your basic trading direction from a weekly chart and using a daily chart for time entry, be sure to synchronize the two. In other words, if the weekly chart is giving you a buy signal, wait until the daily chart also confirms a buy signal. Keep your timing in sync.
Calculate Your Expectancy
Expectancy is the formula you use to determine how reliable your system is. It allows you to analyze how the profit you made from your winning trades compares to the losses from your losing trades.
Take a look at your last ten trades. If you are new to forex trading, test your system through paper trading and monitor those results. Determine if you would have made a profit or a loss. Write these results down.
You can calculate your expectancy as:
Expectancy = (% Won * Average Win) – (% Loss * Average Loss)
This will give you a sense of how well your methodology is working and whether you need to tweak your system to make more reliably profitable trades.
Although there are a few ways to calculate the percentage profit earned to gauge a successful trading plan, there is no guarantee that you’ll earn that amount each day you trade since market conditions can change.
Example of Expectancy
Imagine you have made ten trades, six of which were winning trades and four of which were losing trades. The six winning trades made $2,400, while the four losing trades lost $1,200.
- Your percentage of winning trades would be 6/10 = 60%.
- Your percentage of losing trades would be 4/10 = 40%.
- Your average win would be $2,400/6 = $400.
- Your average loss would be $1,200/4 = $300.
Using the above formula, we can calculate your expectancy as:
Expectancy: (.60 * $400) – (.40 * $300) = $120
In other words, using your current methodology, you can expect to earn an average of $120 per trade.
Manage Your Risk
Anytime you engage in forex trading, or any other kind of speculative investing, your money is at risk. Therefore, the money you use should not be needed for regular living expenses.
Experienced traders come up with ways to manage or mitigate risk, particularly by being systematic about the type of trading they engage in. They also focus on the long-term outcomes of their trades, rather than obsessing over every small loss or change. This attitude can help traders accept small losses and help you avoid emotional trading decisions, which often backfire. By focusing on your overall trading activity, and accepting small losses rather than constantly counting your equity, you will be much more successful.
You can also employ strategies to understand the risk level you are willing to take, as well as set guards in place to minimize the total losses you might incur.
Risk-Reward Ratio
Before trading, determine the level of risk that you’re comfortable taking on each trade and how much can realistically be earned. A risk-reward ratio helps traders identify whether they have a chance to earn a profit over the long term. This ratio is expressed as:
Potential loss / Potential gain
A risk-reward ratio of 1:10 suggests that an investor is willing to risk $1 in order to earn $10. A risk-reward ratio of 1:2 suggests that an investor is willing to risk $1 in order to earn $2.
For example, if the potential loss per trade is $200 and the potential profit per trade equals $600, the risk-reward ratio would equal 1:2.
If ten trades were placed and a profit was earned on just four of the ten trades, the total profit would equal $600 x 4 = $2,400. As a result, six of the ten trades would’ve lost money at $200 each, which equals $200 x 6 = $1,200 in total losses. In other words, a trader would earn a profit on the ten trades despite being correct only 40% of the time.
Knowing how much risk you are willing to take on for how much potential reward can guide you toward profitable trades that fit your strategy.
A very low risk-reward ratio could indicate that a trade is riskier than it first appears. As a result, many experienced traders are cautious about engaging in trades with abnormally low risk-reward ratios, as a low ratio alone doesn’t guarantee a smart or profitable trade.
Stop-Loss Orders
Although it’s important to have a winning trading strategy on a percentage basis, managing risk and potential losses is also critical so that they don’t wipe out your entire account. Risk can be mitigated through stop-loss orders, which exit the position at a specific exchange rate. Stop-loss orders are an essential forex risk management tool since they can help traders cap their risk per trade, preventing significant losses.
Using the example above, imagine the trader had a very wide stop-loss order for each trade, meaning they were willing to risk losing $1,200 per trade but still made $600 per winning trade. One loss could wipe out two winning trades. If the trader experienced a series of losses due to being stopped-out from adverse market moves, a far higher and unrealistic winning percentage would be needed to make up for the losses. A more narrow stop-loss order can prevent this level of risk.
Perform Weekend Analysis
On the weekend, when the markets are closed, study weekly charts to look for patterns or news that could affect your trade. Perhaps a pattern is making a double top, and the pundits and the news are suggesting a market reversal.
This is a kind of reflexivity where the pattern could be prompting the pundits, who then reinforce the pattern. You’ll make your best plans, however, if you are able to analyze this news rationally and objectively before the trading week opens. Wait for your setups and learn to be patient.
Keep a Printed Record
A printed record is a great learning tool. Print out a chart and list all the reasons for the trade, including the fundamentals that sway your decisions. Mark the chart with your entry and your exit points.
Make any relevant comments on the chart, including emotional reasons for taking action.
- Did you panic and either enter or exit a position?
- Did you get too greedy and take on too much risk?
- Were you full of anxiety while making certain trades?
Learning to objectify your trades will help you develop the mental control and discipline to execute according to your system instead of your habits or emotions.
Is Forex Trading Good for Beginners?
Foreign exchange trading is generally not suitable for beginners due to its complexity and high levels of risk. Because exchange rates fluctuate quickly due to economic data or world news, traders must be ready to quickly enter or exit a position. New traders can learn and develop strategies for forex trading by engaging in paper trading or working with very small levels of capital.
What Are the Pros of Forex Trading?
The foreign exchange market is open 24 hours a day, five days a week, and trades more volume than any other global market. It is also more decentralized than stock or bond markets, and traders can quickly amplify their gains.
What Are the Cons of Forex Trading?
Forex markets are less regulated than other markets and not suitable for beginner traders. Successful forex trading depends on an advanced understanding of both global and local economic factors, as well as technical indicators. High levels of leverage are not uncommon and can quickly lead to steep losses.
Where Should I Place a Stop-Loss Order?
You can employ multiple stop-loss points depending on how long you intend to hold a position while trading. Key trendlines are good reasons to set a stop-loss order. Always allow a margin of error when placing a stop; obvious stop-loss points may be tested and trigger others, which could end up briefly surpassing the exact stop-loss level you’ve placed. A good margin of error in currency trading is 15-20 pips.
The Bottom Line
The foreign exchange (forex) market is the largest in the world by trading volume. It operates 24 hours a day, five days a week, and is accessible through a variety of online brokers and trading platforms. Experienced traders use a variety of strategies to maximize their profits and minimize risk, including developing a set methodology, calculating expectancy, and regularly analyzing the results of trades to determine whether any given system is working.
Forex traders of all levels can make use of these strategies to minimize risk, develop systems, and avoid emotional trading decisions. However, as with other forms of investing, risk can never be fully eliminated from forex trading.
