Part 3 Creating the first forex strategy – 5 common mistakes when creating strategy

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Forex and CFD Trading

We receive a lot of questions, such as: “Where can I trade Forex (CFD)?” or “What is the difference between binary options and forex?” To help you answer these questions, we have set up this category to share the most relevant information with you.

Although you are on a page dedicated to binary options, I assume that you have heard the term forex, too. What exactly does it mean and what opportunities and options forex offers is something you can read on this page dedicated primarily to beginners. Don’t be afraid; everything will be explained, no previous knowledge is necessary.

What is Forex

Forex (sometimes abbreviated as FX) is a market where currencies are traded. The need to exchange currencies is the primary reason for the establishment of a global foreign exchange market. The word Forex stands for two words: foreign and exchange. So the market is characteristic with the trading of foreign currencies (such as EURO or US dollar).

To keep things simple, imagine that you come to a foreign exchange bureau to buy 20 EUR for 18 GBP. Shortly, the value of EUR falls (meaning that the exchange rate declines to, let’s say, 1 EUR per pound). You go back to the foreign exchange bureau and sell the euro to cash in the 20 EUR for 20 GBP. You in fact made money.

If you had exchanged one million euros, your profit would have bene one million pounds. This is the principle of Forex trading. To keep things simple, we excluded fees paid to the exchange bureau and the difference between sell and buy exchange rate (called spread)

Sometimes the word Forex is (incorrectly) used as a global term for the whole world of CFD trading . What is then the difference between CFD and Forex? It’s simple: Trading CFD may include shares, futures, commodities and currency pairs. This is just a type of trading. As opposed to Forex, which denotes currency pairs only.

For more information read: What is CFD

Basic information about Forex:

  • Each day, more than 5 trillion US dollars is traded on the Forex market, which is why the market is so liquid (There is enough people who sell and buy, making the prices move every single second).
  • Forex is completely constructed on the principle of supply and demand. This means that while you are selling, someone else is buying
  • Forex is open for 24 hours a day 5 days a week, i.e. on business days usually non-stop
  • The most popular currency pair traded globally is EUR/USD
  • Forex enables you to start trading with a few dollars in your pocket via a program or trading platform installed in your PC. So, all you need is a couple of dollars, PC and internet access.
  • Profit (same as loss) is not limited (…or limited by a trading account in case of loss) . This is the biggest strength (as well as weakness) compared with binary options (more about binary options in the article below).

Where to trade Forex

Forex trades are executed through a broker such as AdmiralMarkets, XTB, or plus500. Forex trading is also offered by some binary options brokers e.g. IQ Option.

When choosing the right Forex broker, same as when looking for the binary options broker, you should concentrate on a few aspects such as …:

  • Spread (the bigger, the least profitable)
  • Leverage: For more information read: What is leverage? (article coming soon)
  • Minimum deposit, minimum size of trade
  • Language/s offered by the broker’s platform and customer support

Our proven Forex brokers:

Broker Trading Instruments Leverage Spread Review Open Account
Forex, CFD, Crypto, Shares, Commodities, Indices Up to 1:30 From 2 pips (depends on asset) Review Trade Now! Forex, CFD, Crypto Up to 1:30 1 – 1.3 pips Review Trade Now! Binary options, Forex, Crypto, Digital Up to 1:300 OK Review Trade Now!

How much can I earn on Forex

Average earnings generated on Forex depend on the invested capital and the risk you are willing to take for each won position. Once you learn how to invest and trade, you should be able to increase your initial capital by around 10-20% on a monthly basis. Translated into concrete numbers, if you start with 100 000 USD, you should be able to make 15 000 per month.

All the figures vary significantly depending on your time and experience. Honestly, 20% on a monthly basis is an aggressive target. Conservative traders will be happy if they earn much lower amounts.
Forex trading can become a serious resource of your second income next to your full-time job. As a Forex trader, you are speculating on the changing prices of foreign currencies or, better foreign currency pairs. In the USA, tens of thousands of ordinary Americans use this method for increasing their living standard.
If this article about Forex attracted your attention, don’t hesitate to continue reading our series about Forex to get a more in-depth understanding.

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How to Develop a Trading Plan

Sometimes there is a misconception that you need highly evolved market knowledge and years of trading experience to be successful. However, we often see that the more information we have the more difficult it is to create a clear plan. More information tends to create hesitation and doubt, which in turn allows emotions to creep in. This can prevent you from taking a step back and looking at a situation subjectively.

If you don’t know where you are going, any road will get you there. In trading, if you don’t set out a plan for your trades and develop strategies to follow you have no way to measure your success. The vast majority of people do not trade to a plan, so it’s not a mystery why they lose money. Trading with a plan is comparable to building a business. We are never going to be able to beat the market. In general it’s not about winning or losing, it’s about being profitable overall.

Why a trading plan is important

When trading, as in most endeavors, it’s important to start at the end and work backwards to create your plan and figure out what type of trader you should be. The most successful traders trade to a plan, and may even have several plans that work together. Always write things down. Why? Because it will help you stay focused on your trading objectives, and the less judgment we have to use the better. A plan helps you maintain discipline as a trader. It should help you trade consistently, manage your emotions, and even help to improve your trading strategy. It is also important to use your plan. Many people make the mistake of spending all their time creating a plan, then never implementing it.

Key components to develop a trading plan

  1. Trading plan structure and monetary goals
  2. Research and education
  3. Strategy using fundamental and technical tools
  4. Money and risk management
  5. Timing
  6. Trade mechanics, documentation, and testing

How to build a trading plan

Make sure you do your own research and build a plan according to your needs. Find confidence in what you know. The tools you have selected for your strategy are key, from the type of chart to the specific drawing tools to even the most elaborate of strategies. Test your plan in the beginning to make sure you are on the right track. After you have begun trading, continue testing it regularly. This allows you to measure your success by clearly seeing what works and what does not work. From there you can tweak elements that might be weaker and not contributing to your overall goal. Ask yourself the following questions (The answers to these will assist you in the foundation for your trading plan and should be referred back to regularly to insure that you are on track with your plan.)

Why am I trading?

If your immediate answer is, “to make money” you should stop right there. If the only goal is to make as much money as fast as we can, we are ultimately doomed, because it will never be enough. Managing your losses should be your primary goal. This will create an environment in which profits can be generated.

What is your motivation?

Solid retirement? New career? Spend more time with family and friends?

Ask yourself, “What are my strengths and weaknesses?”

  • How do I maximize my strengths to minimize my weaknesses?
  • An example of a weakness is a need to constantly watch one’s trades. Is your laptop on the pillow, waking you up in the middle of the night to monitor trades? It’s really difficult to make intelligent decisions when you’re half awake.

Is the amount of money I have to trade with sensible to achieve my goals?

Look at things in percentages; remember leverage is a double-edged sword. That is why risk and money management are key.

Deciding what type of trader you are can be tough; especially since the trader you want to be can be very different from the type of trader you should be based on your behaviors and characteristics. Once you have laid out your goals, risk appetite, strengths, and weaknesses it should become apparent which type of trading fits you best. You will notice three columns in the chart; they are labeled short, base and long. Base equals the timeframe charts you spend the majority of your time, if you are not sure, this is the timeframe chart that you keep going back to. Short and long are the timeframe charts that you refer to confirming or denying what is happening in the base timeframe chart. A common mistake traders make is jumping around randomly between chart timeframes.

How to match your goals to a trading style

Once you decide what type of trader you are, you should begin to invest yourself into education and research. Make continual learning a priority, each person’s strategy or methodology is unique and cannot be duplicated. Therefore your plan is most successful when it is based on your individual needs. Evaluate your needs and the effort required. Make sure you understand why you are placing trades. An initial investment maybe monetary but will benefit you over the long-term. Time and research should be continuing investments. Research by way of following current global events and keeping up to date on current analysis tools will help educate you further on all aspects of trading. Ask yourself, “Am I a fundamental or technical trader?”

Creating a strategy using fundamental and technical tools is key, but we first need to learn a little about each of these types. Some traders choose to use fundamental analysis to assist with their trading decisions. This type of analysis is based on the news. News can be considered anything ranging from economic, political, or even environmental events. As a result, fundamental analysis is much more subjective.

Other traders may choose to use technical analysis to drive their trading decisions. This type of analysis is more definitive and relies more on the math and probabilities behind trading. The specific type of analysis used can be an indicator. They could be either leading or lagging. There are very few leading indicators available, which may give an idea of where the market is going to go. Fibonacci is the most popular, but most misused and misunderstood.

After determining some of the types of analysis you will use, it’s time to develop a trading strategy. This can be through fundamental analysis, technical analysis, or a combination of both. It is key that you develop a strategy and include it as a part of your trading plan.

A strategy is a step-by-step systematic approach to how and when we are going to use tools developing a sequence of analysis. Here is what we can expect to see in a trading strategy:

  • The types of analysis tools (fundamental, technical, or both)
  • When and how the analysis tools will be used
  • The timeframes to use the tools
  • The Sequence of analysis
  • High probability trade, description of what to look for
  • Types of orders to use

This sequence will lead us to what a high probability trade looks like visually based on the indicators and analysis we are using. Since we have what we need for our strategy, let’s take a look at the money and risk management side of trading.

Talking about money and risk management can be a difficult step for many people. Trying to determine what your risk tolerance is can be even harder. Ask yourself, “How much money do I really have to trade with?” Be honest with what is truly available to you. One mistake that people make is thinking that trading is an investing or holding activity, and keep depositing money. Trading is not a deposit and hold activity. Liquidation can and does happen when 100% of the total margin requirement of all open positions is no longer met. Those who make money may not have more winning trades than losing; they may just manage their losing trades so the winning ones make them profitable overall. It can be easier to win fewer times and still be profitable. A common characteristic of new traders is to quickly take profits but let losing trades run, consequently they have to maintain a higher risk to reward ratio.

Let’s think in terms of probability. It is helpful to use the 3% rule and always have a cushion. This is an example of the 3% rule in action: 3% on a $10,000 account is equal to $300 risk per trade. Then divide the cost of risk by the account equity, to get the number of losing trades or $10,000/$300 or 33.3 trades. These answers will help you determine if you can meet your goals. It allows you to give yourself room for flexibility. Traders limit their trading and the plan if there is not enough room for the losses. When developing your trading plan and approach it’s important to take other costs into consideration, some may have more of an impact than others, but all contribute to your investment in a trading plan. Assuming we have the right strategy decided and how much equity to risk, let’s figure out timing.

Timing when trading can be everything. When do the markets open? When do they close? What instruments (like currency pairs) am I trading? Some markets are open when others are closed or they may overlap. Here are the open and close times for some of the major markets. More volatility occurs at market opening and closings but also when reports or news are released. The beauty of trading some instruments is the ability to trade them even if the market you physically reside in is closed. The illustration below shows the overlap of markets that are open. Notice the times where more than two markets are open simultaneously. From 8am Eastern Time or 1pm GMT to 12pm Eastern Time or 5pm GMT, it displays the most markets open globally. Picking your times to trade or watch the market maybe easier since there is likely a market open somewhere in the world.

We have reviewed some of the the key components of a trading plan, now it is time to plan the actual trade, and how to stay on track.

  • A checklist is a good reminder of what you are doing (helps to set the path you choose to take, and reinforces why you are trading)
  • Your goal
  • Analysis tools
  • Amount of money to trade
  • Amount you are willing to risk (this could be per trade percent or total amount of equity amount risked at any one time)
  • Risk to reward ratio
  • Timing
  • Types of orders to use for types of trades
  • High probability trades

There is no magic combination but some things to consider when trying to increase your trade probability may help.

  • What timeframes and what instrument, like currency pairs, we are trading.
    • Being consistent with your methods.
  • Winners focus on how much money they could lose as opposed to how much they can win.
  • The most important rule: never get into a trade without first determining when you’re going to get out.
  • Don’t be fooled, a common misconception is that different time frames offer different profits. Always use stop losses. We have yet to see someone who has consistently not used stop losses and made money over time.
  • A bad practice is to go back and say, “What if?” For example, if you got out at the wrong time, your trade goes bad, and you get emotional. If you get out at the right time you become confident, maybe overly confident.
  • Know exactly what a high probability trade looks like, and only take a trade when you see one.

Documentation, this is crucial to our success. If we are not consistent in the way we apply our methodology, it is hard to go back with any degree of accuracy to see if the plan worked. We will never know for sure what the probabilities are in trading but you have a much better chance of being successful if you follow a predetermined plan. We can continue to fine tune and make the strategy as mechanical as possible, removing emotion will keep you on your path.

Before we wrap up, here is a quick review with creating a trading plan.

It’s important to answer the tough questions first, that is what will separate you from the vast majority of those losing money trading.

Make sure you are prepared, continued research and education will be your best weapon in your continued success.

Solid Trading Tips: Creating a trading strategy

One of the most common mistakes new Forex traders do, is that they have no trading strategy. Because of the many appealing characteristics (24 hours, trade both short and long, leverage etc) most of the new traders entering the market are eager to prove themselves in an often egoistic approach. Egoistic in that they believe that they can become very profitable and make a fortune in the short term, but soon enough they end up with a bad psychology which at the end accelerates their loosing pattern. In fact, the most successful Forex traders are people recognized for their humility and discipline. These qualities are acquired trough experience and accepting some simple realities of the Forex market.

The first step towards becoming profitable in the Forex market is to devise a trading strategy/plan. Creating a trading strategy is of paramount importance and is actually very easy.

To create a successful trading strategy, traders should address the following considerations:

1. Reasoning of the trade: Why buy or sell? Which pair?
2. Timing of the trade: Why now? Before economic news releases or after? Day or night?
3. Trading objective: What is the take profit target? What is the stop loss?
4. Money management.
5. Documentation and analysis of the results.

Before entering a trade there should be a good reason. Many times traders are entering a position because of boredom or just to feel the excitement of being long or short. This is a recipe for disaster! You should always buy or sell any pair on a reason that makes sense to you. Whether this reason is fundamental or technical or both, always make sure there is a reason.

What currency pairs will you trade?
This sounds simple, but it is easy to get confused if you don’t define this. From our experience we strongly believe that is best to concentrate on some (not all) major pairs (such as EURUSD, GBPUSD and USDJPY) and don’t waste time with illiquid, choppy pairs.

You also have to determine when you will trade and how often you will trade. Are you going to be a day trader or hold positions for a longer period of time? Your schedule and responsibilities may have some impact on that.

Should you trade before economic releases or after? Should you trade heavily on nights, during UK open and close etc?
It is important to define these basic ideas to begin to form some consistency and discipline.

The second step is to define your trading objectives.
What is your end goal? What is your take profit target and your stop loss limit?
Try to place your take profit and stop loss before entering the trade as you can always change that, if something important happens in the markets in the meantime. Most traders tend to take their profits early while letting their losses run. This is because in the inexperienced traders mindset is very difficult to accept that he/she is wrong.
Placing your stop loss at the time you open a trade will help you create discipline and learn that sometimes you will be wrong. Furthermore, most new traders have completely unrealistic goals. Making big returns in the first year of trading is possible but highly improbable. These unrealistic expectations wipe out a lot of traders before they even had the chance to learn the market. Breaking even in the first year is an admirable goal; many traders do not do that. If a trader makes 20-30% on their initial investment in their first year, that is outstanding.

Money management is probably the most important aspect of trading.
First you have to accept that in trading nobody can have a 100% winning ratio and everybody (even the most experienced traders) are sometimes wrong. Accepting that sometimes you might be wrong is again of paramount importance. The key here is accepting you are wrong before your mistake becomes too big. To do that you need to determine how much equity you have to fund you account. Then you must determine how much risk you are willing to take on each trade. Most experienced traders risk 1-4 % of their account balance on each trade. This may look too low to the new Forex traders, but will definitely help you avoid big losses, create the necessary discipline and keep you in the market in order to get the necessary experience. Also very important is to have a positive percentage of winning trades compared to losing trades and a positive average profit compared to the average loss ratio. If your average loss is two times your average profit that means you need to make 10 profitable trades to cover 5 losing trades. Keep this in mind.

Along with money management, it is vital to keep track of your past trading and results in order to recognize past mistakes and avoid them in the future.
This is just a basic start to having a successful trading strategy in the long run but will definitely help new traders get the discipline required to be profitable in the very exciting Forex market.

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