They get into the “guts” of the method only looking for that big, mysterious, slap-your-forehead, jaw-dropping “secret” which will suddenly unlock the mysteries of the Forex universe and make them Master and Commander of every Forex pair. All too often, they find themselves completely disappointed or the “guts” reveal something they’d already heard about (but had not practiced). Amateur traders will then dismiss the method as ‘too simple’.

Or, the amateur trader will look for that complicated formula, cryptic combination of indicators and all too often what they actually discover is a set of simple indicators working together in an uncommon way, and they say, “Well I could have done that!” — and they become disappointed or frustrated, because they wrongly assume that any method MUST BE complex, it can’t possible be SIMPLE! So, they shelve the method or return it and complain that it’s “not complicated” enough.

This is a serious mistake – because the amateur trader will then repeat this error method after method and they will never take the time to learn and understand the full process of trading.

Don’t make this mistake. Understand that most trading methods out there are not complicated. They weave a smaller set of rules together in a simple manner (simple enough that anybody can apply them) but apply them in an uncommon way. Complex systems are for computer geeks and big banks — if you can’t understand something, you can’t possibly apply it.

Never skip ahead when learning a powerful new method for trading Forex. Make certain you learn the setup, entry and exit rules (which should exist in a good trading method); that you learn how to protect your trade with stops; and that you learn how to apply your method on a timely basis (be it hourly, daily or weekly) to get the most out of the method and to learn how all facets of what you learn work cooperatively to make you a better trader.

Remember, Simple but Powerful — using just a few indicators or rules applied in a non-textbook approach — is the key to getting an edge in the markets.

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Let’s assume the current bid/ask quote for the EUR/USD is 1.3802/05 and you want to take a long (or Buy) position because you believe the Euro will gain on the Dollar.

We’ll also assume that you are only buying 1 Standard Lot.

When you buy this pair, you are actually buying 100,000 Euros for $138,050 US Dollars. Using leverage, at 100:1, you would need to have an initial margin deposit of $1,381 for this trade to take place.

Let us then assume that the Euro indeed gains on the Dollar and trades now at 1.3865/68 and you decide to sell and take your profits. You would sell you 1 Standard Lot at a profit of 60 pips (1.3865-1.3805).

When you sell this pair, you are selling 100,000 Euros for $138,650 US Dollars. Since you bought the 100,000 Euros for $138,050 and sold them for $138,650, you made a cash profit of $600.

If on the other hand the Euro went down to 1.3775/78 and you sold at 1.3775, you would have a loss of 30 pips, or $300. ($138,050-$137,750).

When using margin and leverage, it is imperative that you employ sound risk management rules to ensure that your account equity never falls below margin requirements — if it does, your position will be automatically liquidated and you will sustain a significant loss.

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The dirty secret in the Forex markets is that most people OVERTRADE. This happens because forex traders are widely taught that the only way to succeed in the markets is to Day trade. The dirty ’secret’ is that if a forex trader can’t make money trading forex on an end-of-day basis, the forex trader is unlikely to be any more successful day trading forex.

In fact, growth among retail forex traders is accelerating — these are people who currently have ‘day’ jobs. There is no likelihood that these traders have the time to watch the forex markets 24 hours a day. What happens if the traders fall asleep and miss putting in a protective stop order? Or miss an entry point?

I advocate trading forex on an end of day basis to eliminate the stress and time pressure to make instant decisions on order entry, immediate placement of stop orders, and constant ‘watching’ of the markets.

Combined with utilizing technical indicators, end of day trading allows forex traders to spend more time looking at the ‘big picture’ — is there really a trend? Is my method ‘right’? Are my numbers and calculations correct? And, they can do so in the quieter trading hours following the New York close (5:00pm Eastern Time).

Here’s a brief example:

Using a recent chart of the EUR/USD pair, from March 2009, shows a strong move from the 1.2600 range to 1.3000 — a 400 pip gain, which took about 7 days to complete and should have been captured by a good end of day trading method. However, that same chart shows more extreme fluctuations as the price ranged sideways in a 200 pip channel — if a forex trader is trying to day trade in that channel, the trader can quickly find themselves on the wrong side of a trade in more extreme short term volatility.

Forex traders who do not have the time to commit to managing their trades and monitoring the markets are precisely the traders for whom an end-of-day forex trading method based on technical analysis is best suited.

That concludes this four part series. Next time we’ll start looking at some more basics of Forex Trading

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As you already are aware, there are two primary forces acting in the Forex markets: fundamental data, which include such indicators as balance of trade data, money supply, interest rates, economic and financial reports, etc.; and technical data, which include such indicators as moving averages, average directional movement, stochastics, etc.

So, why should a forex trading method be focused on technical indicators?

First, attempting to trade on fundamental data requires you to be available on a real-time bases at whatever hour of the day or night that the news impacts the markets, and, you must be able to act on that news before (predictive) or at the instant thousands of other forex traders do (reactive), otherwise, you will have missed your opportunity.

Trading on fundamentals, as well, is less about the actual data itself and more about the market’s reaction to that data.

Technical analysis, however, allows the trader more time to make a smart decision. Utilizing technical indicators means the fundamentals are already reflected in the price of the market at any given instant.

While this means you are working more often with slightly lagging indicators, the advantages to using a forex trading method based on technical analysis mean that you spend less time identifying potential trades and when you have identified a trend and look to enter a trade, you have much more data to support the trend’s existence than if you are simply trading on the ‘news’.

Furthermore, by using technical analysis and applying it through a trading method, you can trade the markets on your own terms, when you want to trade and how you want to trade them, without needing to grasp the minute details of what fundamental reports ‘really’ mean.

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Today, I want to add to that by talking about risk management. This is perhaps the area where 95% of Forex traders make mistakes and lose money. Managing risk is about reducing your losses AND about protecting trade capital by employing specific strategies to accomplish each of these simultaneously.

What do I mean by that and why is it important?

First, most Forex traders make simple trading mistakes: they take too large of a position and expose themselves to serious and steep losses should the markets move against them. Second, they fail to protect their ENTIRE account by allowing ONE trade to put their full account balance at risk.

Here’s a quick and perhaps extreme example:

Suppose a forex trader has a $10,000 account balance. The forex trader takes a 5 standard lot forex trade on the EUR/USD pair. The forex trader now has at least $5,000 ‘margin’ at risk (or 50% or more of the forex trader’s account balance).

For every 1 point that this forex trade moves against the forex trader, the trader loses  1/2% of the total account balance. At first glance, that may not seem like a steep loss. However, should the Forex trade move a total of 50 pips against the Forex trader, and the trader subsequently exits the position, the forex trader’s total loss would be an INCREDIBLE $2,500! (25% of the trader’s account balance). This is poor risk management and it frequently leads to complete wipeouts of Forex trading accounts.

How did we calculate that loss? 1 pip for the EUR/USD pair is equal to $10 (on a standard lot trade). A 50 pip loss equals a monetary loss of $500; and remember our example forex trader had traded 5 standard lots — for a whopping loss of $2,500!

Instead, any trading method should teach you very specific guidelines for incorporating money management and risk management into every forex trade you take.

Money Management should involve the distribution of a forex account among the various trades a forex trader takes. For example, forex traders should never trade their entire account on a single trade, and should rarely have more than a few open positions. By utilizing multiple positions, the forex trader distributes the risk among each of the forex trades they have taken.

Risk management should involve the maximum risk in any SINGLE Forex trade, and should limit the impact of a losing Forex trade on the trader’s account balance.

Here are two quick examples:

Money Management: A theoretical forex trader takes 4 separate one lot trades on four separate pairs. Assuming here that each of the pairs have a pip value of $10 on a standard lot, then the total amount of the account being margined across all four trades is about 40% (it may be higher depending upon the actual pairs traded. With proper stop loss management, however, in conjunction with risk management, it is UNLIKELY that the forex trader would incur a complete 40% loss.

Carrying forward to risk management: In each of the theoretical forex trades above, the forex trader risks no more than 2% of the trader’s total account balance on each forex trade. That means a maximum loss of $200 per forex pair traded if ALL FOUR trades are stopped out. Total loss in this case would be $800 — a much more recoverable scenario than the $2500 in the first forex trade example.

Furthermore, Risk Management has the capacity to make loss recovery easier. For example, in the first case, where the Forex trader lost $2500, the trader would need a nearly 250% gain on their next trade to recover the lost value on the first trade.

In the second example, however, the forex trader would need only an 8% gain.

A second part of Risk Management not typically discussed in poor trading methods is protecting gains. Though this begins as a discussion on Exit Strategy rules, it is also an element of risk management. Once a forex trade turns profitable, it is imperative that the forex trader manage the gains with smart stop loss management. The worst thing a forex trader can do is allow a profitable position to reverse and become a losing position. Thus, managing risk extends to the protection of gains on a forex trade, just as it does protecting against deep losses on a forex trade.

Therefore, in considering any trading method for use in your Forex trading, you must ensure that risk management is not only discussed, but clearly explained in conjunction with the use of the trading method. If risk management is not present, unclear, or not specific to the trading method, you should avoid using that trading method.

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I’ve developed a simple set of rules to follow when evaluating a Forex Trading method, course, system or program and today I want to share them with you.

First and foremost, any Forex trading method you consider must be complete. By complete, I mean the Forex trading method must teach you the following:

1. The precise conditions under which you can consider a Forex trade to be entered into. These are known as the “setup” conditions and refer to the technical indications (usually) that a Forex trade possibility exists.

2. The exact point at which you would enter into a Forex trade (price). This refers to the Entry Point (or Entry Rules) and means the price at which a Forex trade would be executed.

3. Rules for establishing initial and ongoing Stop loss marks for an open Forex trade. As part of Risk Management, it is imperative, especially in Forex, to have Stop Losses ALWAYS in place. If a Forex trading method or Forex trading system does not teach or define these, you should abandon it — without effective stop loss management you can be easily wiped out in a single Forex trade should the Forex market move against you.

4. The exact points and an effective strategy for exiting a Forex trade. Unlike stocks, you will rarely, if ever, find yourself holding a Forex pair position in the Forex markets for extended periods of time. Therefore, it is also important that a method teach you a strategy for exiting a Forex trade once that trade has become profitable.

Combined, these four elements will help you to eliminate chance by streamlining your Forex trading decision making process. Without any of these, no forex trading method, system or program should be considered because in each individual case, forex traders will be exposed to steep losses or taking poor Forex positions. Keep in mind, not every setup will execute into a Forex trade, nor should every Forex trade be taken. Combined, these rules will help to protect you both in evaluating a method for its use and in executing the method when trading Forex.

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