One of the biggest challenges facing new FX traders is the lack of information around getting started in a market that is especially unforgiving, not only to novice traders but fairly experienced ones as well.
That is why having a trading plan is an essential part of any trader's toolkit, particularly when it comes to taking a position in the most liquid trading market in the world. We've put together some points for you to consider before creating your toolkit.
A common mistake made by a lot of novice traders is to dive straight in, but you shouldn’t enter a trade until it’s been well thought out. When you do, start small – $1 a point at the very most, and slowly but surely build your confidence. There is no such thing as beginners luck in trading – when you start you will lose money on some trades and make money on others.
This is why it makes sense to make mistakes early and ensure they are not too costly. If you start at $10 a point and the market goes against you by 25 points, you will be down by $250 straight away, not to mention the subsequent loss of confidence. That’s an expensive lesson, especially when you consider that when you enter a trade it’s very unlikely the market will move in your favour immediately.
Research a market and decide on whether you're comfortable with the level of volatility. Do you want to try and make a short-term gain, or would you prefer to look for a gradual profit accumulated over time? If you're searching for short-term gains, then you will probably be looking at fairly active markets, with quite a high daily range in comparison to the price spread. A tight bid/offer spread also equates to a reasonable amount of liquidity, which is positive should things go against you, as such fast-moving markets offer a greater opportunity to close a position.
One of the most important rules is to trade with the trend: if the market is going up, place a 'buy' trade; and if it's going down, place a 'sell' trade. It’s probably not a sensible idea to attempt to pick the top or the base. If the market is going up, decide where you want to buy and place your trade, and the same applies if you're looking to sell. You should have a risk-management strategy, with pre-defined stop-loss and take-profit levels. Lastly, you shouldn't trade for the sake of it – being neutral is a position as well.
It can be a sensible idea not to overcomplicate your analysis with a variety of technical indicators, as this can sometimes give contradictory signals, which could lead to cluttered thinking. The basic key questions you should ask yourself are a) is there a trend? (yes/no); b) if there’s a sideways trend – do nothing, with an upwards trend – look to buy, and with a downward trend – look to sell; d) look for support and resistance areas and then decide whether to place a trade.
One of the key tenets of the technical approach is to evaluate the past – the Dow theory works on the premise that 'history repeats itself’. Looking at past price action on an asset can give clues as to how the price will behave in the future, based on previous experience. Human behaviour can be predictable to a degree, given a certain set of circumstances, and this is how the technical approach can work. Market forces dictate price and price is driven by people just like you and me who succumb to the same human emotions of hope, greed and fear as anyone else. Seeing where previous highs and lows have occurred in the past and how the market has behaved previously when at these levels can give clues as to what might happen next, so enabling traders to formulate a number of strategies using 'what if' scenarios.
Money management is a key element to a traders' overall profitability. The urge to take a profit as soon as you see one can lead to many losing money. This can be because traders often tend to run stop-losses until they're executed, but don't do the same thing when making a profit. If you work on the 50/50 basis that you make a profit on 50% of trades executed, then you're unlikely to make an overall profit.
Before placing a trade, think about how much money you're prepared to lose on it. If it's $100, then you should be aiming to make at least $300 profit. This way, based on a 50/50 success rate, you would be making an overall profit. For every element of risk you should be looking to make at least double that on the profit side. Discipline is crucial when things are going well, as well as when they are going badly.
Another common mistake is setting unrealistic stop-loss and take-profit levels on unsuitable markets. A 100-point stop-loss on EUR/USD for example is quite realistic, but might not be very suitable for shares. Use the price ranges over the last few days and months as a benchmark when setting stop-loss levels.
Analyse where you've been making profits and losses by keeping track of all your transactions. Tracking the performance of your trading history allows you to spot patterns where your failures and successes are occurring, so you can cut out the poorer trades and place more of the trades that lead to a profit.
When you start to lose money consistently and nothing seems to be going right, take time out. A monthly float to use as your trading capital is a good idea, because if that float runs out, you should stop trading for the month. Take the time to clear your head and start afresh the following month. And resist the temptation to try and make back lost money by ‘chasing the market’.
Do not overburden yourself with multiple trades – the simplest trades are usually the best ones.
Always be aware of carry costs when running positions overnight, or over multiple days. Selling a high yield currency incurs higher costs than a lower yielding one.
A common trading mistake is to look at an oscillator, decide the product is overbought and trade against the prevailing trend, but this is usually a mistake. Oscillators and moving averages should be used to complement trend, support and resistance analysis.