Frequent guest blogger, Bill Poulos, presents his latest article below which looks deep into a number of major issues within the Forex markets, as well as provides a number of excellent tips for you to use on a daily basis. Please check out Bill's site here, and as always he's excited to read and respond to your comments so let's not let him down.
Recent events have brought the dollar back into focus – both as it continues to slide, and as it made an unusual, event-related rebound last week. Because of that, many traders, my students included asked me for my take on why Forex traders are struggling right now.
I believe there are three reasons that are deeply affecting traders of foreign currencies. They are:
• Overexposure on trades
• Little or no attention to risk management
• Stuck in a black hole cycle of dependency
Let me elaborate:
Overexposure on trades
Too many forex traders frequently turn a profit into a loss, or worse yet, a small loss into a bigger loss.
How does this happen?
I believe first that traders right now are desperate for profits. The markets (whether currencies or equities) are still unsettled and acting in unorthodox (or uncharted) ways. Consider the dollar's surprise rebound upon the news of the Dubai debt collapse on Friday. Or, that market pros are still unable to explain the continued rise in the Dow and S&P despite the lack of strengthening fundamental data.
Combined, these 'weird' events are wreaking havoc with many traders, especially in the currency markets.
That desperation is causing many traders to stay in trades LONGER than they should. Thus they are overexposing themselves on their trades. This is true of both day traders and end of day traders – they’re hoping for a move to go in their favor, rather than trusting their trading rules to tell them what to do. And that is a recipe for trading disaster.
Forex Tip #1: If a trade moves against you, get out of the trade. Whatever the original premise for that particular trade event was, it no longer exists, and therefore, you are no longer in a valid trade setup.
The most difficult step to take as a trader is to accept that loss and move on – I know, because I’ve done it, too. No trader is immune to that reaction.
But the longer you hold a loser, the greater your loss will likely become – and that’s a bad thing.
For the past ten years, I’ve consistently reminded my students of the importance of risk management and recently began teaching a concept I call a ‘Free Trade Strategy’. At its simplest, the concept is to move your stop loss to BREAK EVEN as soon as you can. This does require some learning and timing, but once many of my students began to practice it, they instantly had a stronger feel for ‘when’ to do that.
Why is this important?
Aside from accepting a small loss, traders will, I believe, frequently have an opportunity to either get out of a trade at break even or slightly better with more aggressive risk management tactics when the markets move against their position.
The sheer volume of the foreign currency markets demands that higher aggressiveness – more traders, more money, and more volatility are controlling the markets today. Trends can change too fast and if traders aren’t taking simple steps to protect themselves, they’ll too often end up on the losing side of a trade.
Day traders especially must walk a fine line balanced between profit-hunting and risk protection – it’s not an easy task. So while the idea may not be new, I just don’t see enough traders taking action to protect themselves in this way.
Here’s a quick example:
If you’ve entered the EUR/USD at (for simplicity) 1.4000, on a long position, with an initial stop loss at 1.3980 which of the following steps would you take if the market moved UP 20 pips to 1.4020:
- No action, let the market run
- Sell out and take the 20 pips gain
- Sell half the position at 1.4020, move the stop loss to 1.4010 and let the remainder run
- Move the stop loss to 1.4010, let the market run
Do you know what most of the traders I talk to do?
Nothing. They let the market run. Any of the last three options locks in a profit – and that’s a GOOD thing. Is it a small profit? Yes. But if a trader selected option 1, and the market turned and hit their stop loss, they’ve now lost 20 pips, versus these results:
- Option 2: 20 pip gain
- Option 3: 30 pip gain
- Option 4: 10 pip gain
(I’m assuming spreads in these gains for mathematical simplicity; it’s more important to draw the point at this juncture).
As you can see, it’s far better to grab a gain than to let a trade turn into a loss. Now, here’s the critical part – I get a lot of feedback about how ‘easy’ that looks…and a lot of admissions that traders just don’t do it.
Folks, these markets are too quick for many of us – if you don’t have the time to dedicate to managing your trades in this way, you shouldn’t be in the markets. If you’re serious about improving your Forex trading, however, learn to accept smaller gains from time to time. They are far better than constant losses, or once-winning trades that turned into losing trades. It’s your choice what to do.
The Black Hole
I’ve stumbled onto this concept only recently and it was a real eye-opener. It’s one of those things that you ‘sense’ is out there, but can’t quite put your finger on it. Not until now that is.
I believe most of the forex market components, be they system sellers, brokers, news outlets are creating a cycle of dependency for traders. That is, traders come to believe they cannot function without these things.
This is still a major trend that has been taking place in Forex over the past year; a trend which I believe will continue to grow and is only likely to STEAL your money from you.
If you've been curious about trading Forex, or if you've been attempting to trade Forex with little to no success YOU will be the target of this trend.
What am I talking about?
Forex robots - or - automated trading systems that continue to flood the market right now. You've probably seen them or heard about them, and you can easily pick them up for about $97...here are a couple of terrific examples, dedicated to the dependent traders:
The creators of these systems will tell you time and time again they have "cracked" some imaginary Forex code, or they are former "insiders" or they're going to "reveal" how they "legally rob the big banks".
And naturally, because they have such big hearts, they want to share these secrets with you.
Now I'd like to share a secret with you:
They don't work.
Truth is, we'd all like to find that secret program or code that never fails to make money in the markets, whether we're trading Forex or Stocks or Options, and, we'd want a system that wouldn't require a single moment of our time -- just load it up and watch the deposits rack up in our bank account.
Do you honestly believe this happens?
If you take nothing else away from the recent disaster on Wall Street, learn from this: Major investment houses lost billions of dollars last year -- two, Bear Stearns and Lehman Brothers, went belly-up. While it's true that their demise was caused in the real estate and derivatives markets...don't you think that if such an amazing, effective and profitable program existed (one that never failed to make money) that they would have been using it?
Major banks around the world trade foreign currencies -- how is it that many of them are also recording record losses? Shouldn't they be profiting mightily from these 'expert' programs? Wouldn't the capital they had to bring to bear have created huge sums of money for them?
In a word: No.
If such a 'perfect' never-lose system existed (which in a financial sense is really a cross between the Holy Grail and Utopia) our markets would always move systematically in the same direction; and, everybody would be using it.
Obviously that isn’t the case. The reason is simple: automated systems fail after constant, extended exposure to the Forex markets.
Three key reasons these systems fail:
- Automated systems respond to technical indicators in the market without regard to what drives the markets.
- They are designed for extreme short term trading and are easily wiped out when markets move against them. The best profits are actually made in longer moves (not 10 minute moves).
- Robots are robots and not human beings. Markets are driven by psychological factors more so than any other. Technical and fundamental indicators and their impact on a Forex pair or stock issue (or any other instrument) are NOTHING MORE THAN the psychological RESPONSE to current and future conditions. Robots cannot account for those factors and cannot respond to fast changing emotional indicators or responses (fear and greed).
By the time they do, most traders have been wiped out.
What REALLY happens to traders who buy automated systems is this:
They buy one. It works for a few days or weeks, and then it fails -- fails again and fails again and the trader becomes frustrated and jumps to another black box program, which may work for a short period, but it, too, then fails. So the trader again jumps to another automated program ... see the pattern? The trader never realizes that the systems are not a fault.
The trader is at fault. And he or she becomes dependent upon such systems and continues to hunt for the elusive Holy Grail -- they fall into that Black Hole of dependency.
Let’s take a quick look at something –
If this magical software really could turn $200 into $30K in a week...
...that means the second week it can take that $30K and turn it into $4.5 million. Then in week three it can take that $4.5 million and turn it into a whopping $675 million.
I could choose to let it ride one more week to create numbers so big neither you nor I could even comprehend them... but hey, why be greedy? (Actually at those rates, you could corner the USD market in about 7 weeks.)
Here's the real 'insider's code' -- the true 'secret weapon' --
Think about this: nobody has yet created a computer that can emulate the human brain (oh, they've come close...in chess). We can process an incredible amount of data from multiple sources in ways a computer cannot -- AND, we can apply a psychological understanding of our response to that data, which a computer cannot yet do.
That's why black box systems don't work over the long haul. Sure, a system can be curve-fitted for back-testing purposes -- but as we all know, past performance is not indicative of future returns.
So what does work?
Simply put: I believe Trading Methods work. Automated Systems do not. Methods allow you to pull together a stream of data (from simple to complex) and draw a more robust and complete picture. A trading method allows the trader to remain IN CONTROL of his or her own money at all times. A trading system requires a trader to be OUT OF CONTROL.
If you don't have control of your money, you are at risk of total loss. Turning your Forex trading over to an automated system means no control.
Learn from different trading methods that teach you how to trade Forex (or any market) -- not systems that do it for you. You'll remain in control of your trading activities, be able to maintain control of your exposure to the markets, manage your risk appropriately and, I believe you'll be surprised at how quickly you can outperform your own expectations.
Good Trading to all,