Today's post is from an old friend, frequent blogger (see previous posts), and trading expert Bill Poulos from Profits Run. With Bill focusing a ton of his time on Forex, and with the Forex market getting so much attention, I wanted to ask Bill to come and give us some of his latest insights into what he's found. The article below is a great one, and if you have time I'd highly recommend checking out his new "Risk Eraser" technique video!
You've likely heard the term Forex lately -- it continues to be the hottest trading trend today. That's a trend I believe will continue but today, I wanted to take a few moments to point out why as well as how you can best take advantage of trading foreign currencies without being taken advantage of.
Just a couple of years ago, the foreign exchange markets were dominated by the big brokers and major banks around the world. Today, the 'little guys' have gotten in on the action -- and the growth in currency trading has increased from $1.9 trillion to nearly $3 trillion in that short space of time (that's the average daily turnover in the markets - a 50% growth in turnover).
But why should you trade Forex?
First, the Forex markets are highly liquid (in the major pairs) and have a strong tendency to 'trend' regardless of what is happening in other markets (stocks, commodities, bonds).
That liquidity also creates constant volatility -- and the volatility is where the ability to profit from those trends happens. The greater the volatility, the greater the profit potential.
Second, the stock markets remain beaten down. Yes they've rallied, fallen, and rallied again -- but there are strong indications that another 'fall' is coming. The uncertainty in these markets is keeping them from a specific direction, or trend. In the Forex markets, however, traders don't have to worry about "bull" or "bear" markets -- the currencies are always in a trend (whether up, down or sideways).
Furthermore, the financial upheaval driven by the credit crisis and the massive government responses means investing or trading in the stock markets will never be the same - but these same events helped to create even greater opportunities in the Forex markets.
Forex trading is not without risk - and frankly, most people approach the Forex markets completely wrong. The current economic and financial conditions make this one of the best times to take on Forex trading, but only if done correctly.
And the correct way to trade Forex is to manage Risk first and Profit second.
It's an entirely new approach to trading - and quietly becoming the best secret weapon for Forex traders because it gets them out of trades that go wrong and helps them limit the downside risk on every trade. This approach also changes the win/loss ratio for forex traders by incorporating 'break even' trades -- just a 20% reduction in converting losing trades to break even trades can have a huge impact on your capital!
But it's clear that many new and inexperienced forex traders simply do not know how to manage risk at all in their trades -- and the result is the same: they wipe out their accounts.
Here's what I see happening: Forex has grown in popularity so quickly that many traders who are new to forex trading wade into the waters, open an account and begin putting on trades without any real thought or planning.
It should be obvious that the problem with this thinking is little to no understanding of how to approach trading foreign currencies, nor the significant risks to capital that it poses. What new traders do is trade first and learn second. Their trading is always done from the mindet of 'profit, profit, profit'.
And the result of that mindset is startling losses in account balances. Hey, let's be honest, trading on a demo account is never the same as trading with real money. You do not apply the same emotional control, the same trading principles or rules, you'll take greater risks with the demo account and play too safe with the live account (often to your own loss).
Reverse your thinking: learn first, trade second. In fact, across the board, the need to reverse people's mindsets about forex is what is needed. Learn the right way to trade first, and THEN take that knowledge to the market and trade with it.
As part of that learn first scenario - the NUMBER ONE element to trading forex that new, inexperienced or unsuccessful traders should learn is how to MANAGE RISK FIRST in every single trade.
By learning to manage risk FIRST, traders will find their trading transformed as they are able to approach forex trading with an entirely different mindset, a plan for erasing risk and a solid set of rules by which to trade.
But first, here's a queston: What is the purpose of a trade? To maximize gain and minimize risk - it IS that simple.
Maximizing gain does not mean you exit a trade at the absolute 'Top' - it does mean that for the duration the trade is on, you have a set of rules that determine where you'll exit for profit.
Minimizing risk means more than just setting that initial stop loss -- you MUST manage your stop losses throughout the duration of a trade.
When forex traders enter a trade they must protect their capital first and think profit second. When their position starts trending up, they can take the right action to protect their capital AND their profits.
That action is the aggressive managment of stop losses from the OUTSET of the trade. What traders usually do is set an initial stop and leave it there until they decide to exit the position, whether at a profitable point or not.
This is a serious mistake!
What successful forex traders are doing now - the secret weapon - is moving that initial stop to a break even point once their position has begun trending in their favor and then moving it again once they have hit a series of profit targets.
In fact, most successful forex traders ASSUME they'll lose on every trade. They perform this psychological trick to make sure their risk strategy is always top of mind!
Once a trade turns in their favor (much to their surprise), the first step they take is to get themselves into a break-even trade situation; followed by scaling themselves out of the trade at pre-determined profit targets and aggressive stop loss management to maximize their profits on the trade.
They think risk first, profit second.