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Prior to answering this key question, let us clarify the difference between a trader and an investor: From a top-down perspective, there are many elements where both do the same: Participating in the financial markets with assets like stocks, commodities, currencies, treasuries and their derivatives: Futures and options. However, there are behavior differences, where the action of the one is very different to the other: The investor usually takes a longer-term perspective and mostly only makes money when an asset bought, increases in market value. A trader focuses on participating in the short-term price moves of assets and mostly uses methods and trading instruments, which allow making money when prices move up or down. Successful traders and investors manage the following challenges: Challenge-1: Finding assets with a future perspective price move. Challenge-2: Applying a method of protecting profits. Challenge-3: Managing risk. Given the circumstances that some assets have price developments: With-, separate from, or against the markets, makes Finding Assets with a price move potential a key challenge. When those are found, the second challenge is to define how far their price move will reach to realize profits or find forms of protection prior to a potential reversal price move. In general, there are two basic methods to identify trade- or investment potentials: Fundamental Analysis: Where you equate financial and other business factors of an observed asset to decide for its future perspective. This is the arena of smart people working for the big investment firms, constantly analyzing the world’s markets and finding assets to invest in. As a private investor; however, if we try to replicate the same; we are facing a hard time in keeping up with the information base and point of view of institutional investors. Their managers have contact to the world leaders of business and politics and use pre-information constantly to their benefit. Technical Analysis: If applied right, a sound chart analysis helps you to spot and follow the action of institutional money moves with a trading system which equates the happening in price, volume and volatility for identifying asset in supply or demand, for you to trade along with the referring price moves. Given the magnitude of more than 40,000 investment instruments in the US-markets only, you might want to find a service, helping you to identify assets with institutional attention, fundamentally or technically. Protecting Profits The equation to consider is: Protecting Profits = Making Profits. A common saying is: “You trade with the trend until it comes to an end”. However, there are two fundamentally different ways of making and keeping profits: Way-1: You find a systematic to trail a critical price level along with the price move of an asset and when the price direction reverses to this level, you either exit your trade or you apply a method of profit protection against a potential counter price move. Way-2: You define positive trade exit price levels by equating the minimum and maximum expected price move from trade entry. When those critical price levels are reached, you either exit or you apply a form of protection to assure that the gains you made cannot disappear from your account. Check the graphics below for examples: Trail Your Stop (Way-1) Approximate Min and Max Price Expansion (Way-2) Managing Risk Managing risk builds the foundation for successful trading or investing. Only when you are able to prevent major draw downs in your trading/investing account, you will be suited for staying long-term in the trading/investing business. If the foundation of your trading system/plan is not standing on solid ground, your temple of success will quickly fall: Always be aware that there is no risk-free trade and the higher you put your return expectation, the higher the risk will be to accept a trade or investment. At the end of the day, a million dollars is a million dollars; however, if you are able to build up a trading plan, where you keep a constant low risk, while producing constant returns from multiple trades, you are better on than aiming for a onetime high return with an associated high risk: Imagine a trader with a $20,000 account, if he aims for a onetime return $10,000 and an associated risk of $10,000. When he fails, 50% of the account holdings are gone and the trader needs a 100% return on the remaining capital to just breakeven. Instead, if he is striving for a $1,000 return/trade with an associated risk of $1,000, he has a much higher probability to being long-term successful, as long as he constantly finds and trades assets with high-probability trade setups. The key question arises: How to define an appropriate risk in relation to the considered return? Our recommendation is to consider two risk levels: The minimum risk is the one you need to accept to allow for a price move in the desired direction, considering the natural price distribution of the asset to trade: Finding this price level prevents that you will be stopped out even so the price moves in your desired direction. If you continuously experience being stopped out and afterwards you see the price taking off, your risk tolerance was too narrow. Best is when a computer programs measure the statistical volatility of an asset at the time to trade, giving you a clear-cut approximation, where to put the stop- or trade adjustment level. Aside from this, you can surely pick a major support or resistance level where the price haltered in the past, at which your base hypothesis of the directional price move will no more have validation when it is surpassed. In addition to the minimum risk, you need to decide for a maximum risk to allow for accepting a trade, with the implication: When the maximum risk level is touched, a trade adjustment is necessary, which can be released or enforced, depending on the continuation of the price development. If your experience from the past was: Small gains, small gains and big losses, your risk tolerance was too wide and you face the danger to drain your account by either having no trade adjustment or stop level or an inappropriately wide risk tolerance, which is not in relation to the potential reward of the trade you entered. For any trader, if the relation from the maximum risk to the expected return is not in your favor, just do not accept the trade. Price levels, where the prices remained for a longer period in the past, can be used to define maximum risk levels. However, you can also help yourself finding those levels by letting your computer build the associated volume-price-relations, so you can see on the chart where the critical price levels are. Prepare for your trading success by installing the elements of asset selection, profit protection and risk management. The knowledge how to apply those instruments to your benefits is not widely accessible, however with the help of this article, you can check and balance where you stand today and how you can create your trading future by gaining the necessary knowledge and obtaining the referring instruments, helping you to develop yourself into the trader or investor you want to be.
Approach to trading is all too often a one-dimensional activity. "I will look to buy at X and take profit at Y" might be said approach. Now I know many will understand the idea that an entry is an entry, but trade management is probably much more important to your bottom line. However, I know for new traders at least and perhaps some who have been around for a while longer, the method of exiting a trade is frequently overlooked. The reason for this is simply that if you can't pick a trade, how are you gonna manage it? You have to find a decent way to select your trades before you can appropriately manage them. Anyway, once a trader has a way to select a trade which in a good number of cases gets them onside, there is another issue. How to exit the trade. Not just where your targets are. But more importantly, where you abandon ship when things aren't looking terribly promising. This is perhaps one of the most important aspects that a trader needs to address if they either A) do not wish to or B) are unable to take multiple "scales" on exit (to scale = to close a small portion (or enter a small portion) of a trade). How many times do you see what looks like a decent entry turn and run against you? Does this need to happen in order for you to remain in a trade when it would turn out to be a good one? The market is always testing. Testing balance, testing imbalance. If for example you take a continuation trade, it tests the last known extreme before continuing or balancing/reversing. If the market struggles to extend through that point, isn't it sound logic that there is still opposing interest and so a deeper counter rotation might be necessary? If this is the case, wouldn't it make sense that your position is potentially under threat? Simply exiting at this point doesn't necessarily make sense to me, although if you were from the scaling camp, then you might take something off when presented with this situation. Either way, you should be on alert. Alert that if then, counter trend activity increases and prices thrusts against you, there is a good chance that you'll be seeing a retest of at the very least, the location of the attempted point of continuation. The next thing to point out, which every risk conscious trader must be aware of, is when you take a trade what is the accuracy and quality of your trade "location"? Is it close to where the market turned? Is the turn close to where you had expected a possible turn to materialise? Was the turn well received? I.e. did it move effortlessly away from the area or was it a struggle? With this, you will have a better idea of how swiftly and decisively you will need to act. Finally, if activity does then reverse and give you a clear signal to exit, you have the chance to cover before the market forces you to by your risk plan. i.e. when your stop is hit. I trade in a certain way and by no means is what I am describing suitable or even relevant for everyone. However, I'd suggest to all traders to look at some sort of early exit method as a contingency plan as turning many small losses into small winners can make a big difference to your bottom line.
The Myth of Risk Reward This article today is going to cover one of the biggest myths that Forex traders world over believe in. A lot of traders have many false beliefs when it comes to trading, full stop. However this particular myth hurts traders substantially. The myth we will look at more closely today is Risk Reward. I get numerous emails from traders asking the same question, “Shouldn’t we always aim for 2/1 Risk Reward on each trade” or in other words, should they aim to target a minimum of double their risk per trade they put on. Risk Reward is only half the Equation The problem with traders targeting a random amount such as 2/1 Risk Reward is they are only working out half of the equation. Traders who have a win rate of 25% can be profitable and traders that have a win rate of 85% can be profitable. What will be different for each of these two traders is what Risk Reward they will need to target to be profitable. As traders go for the bigger Risk Reward trades, their win rates, I guarantee will come down substantially, as opposed to the trader that takes profit regularly and should have a much higher win rate. A trader that only wins 25% of their trades is going to need a large Risk Reward each winning trade just to stay in the game. This trader can take many losing trades as long as they have a large Risk Reward trade to make up for their losses. Another trader that averages 85% win rate will need a much smaller Risk Reward per trade as they are not sustaining the same amount of losses as the trader with only a 25% win rate. It does not matter whether you are the trader that has a high win rate or a trader with a low win rate, the goal is being profitable over the journey. For this to be possible the trader needs to work out more than just the random number that they need to target as their Risk Reward for each winning trade. Traders need to work out what trader they are, and the win rate they average. From this number they can then work out what Risk Reward they need minimum per trade to be profitable. This will be different for everybody. I myself like to have a high win rate and bank consistent profits. I personally found that when I began increasing my trade size, I no longer wanted to take large hits to my account and wait for the big Risk Reward trades to cover the losses. Instead I adopted an approach where I bank profits regularly, and because of this, to remain profitable, I need a much smaller Risk Reward per trade as my win rate is high. The Market Does Not Care What You’re Minimum Risk Reward is The main problem with traders entering trades and then setting their targets based on what Risk Reward they want to receive on each trade is, the market does not give two hoots where a traders minimum Risk Reward is. All the market cares about is “supply and demand” and “support and resistance levels”. Traders who set random levels based on Risk Reward will find themselves being stopped out regularly. This is because the market does not care about what Risk Reward you need. If the market hits a supply or demand zone it is going to change direction. Use the Market for Guidance The best way to take profits in the Forex market is to let price be your guide. Price is giving us clues all the time and traders can manage trades according to what the price is telling them. Forex School Online specialises in helping traders learn how to manage trades. The reason Forex School Online concentrates so closely on managing trades is because other educators fail in this area. Even a monkey can open winning trade. I could flip a coin right now and place a winning trade off the toss decision. That does not mean I will be profitable over time. To be profitable over time a trader needs to be able to manage trades consistently and with the same method every time. Without consistency your results will remain all over the place. If you want to find out how you can learn a method for managing trades rather than just setting random Risk Reward targets, the Forex School Online membership is for you. Inside the members area you will be taught a method that you can use for each and every trade using price as guidance. Safe trading, Johnathon Fox Learn Price Action Trading