Are you looking to start trading the forex market but have been reluctant to do so because you are not sure whether forex trading can be a profitable venture?
Based on statistics it has been shown that 96% of forex traders lose money in the market. Although this is true, forex trading can still be profitable if you have the right skills, risk management and mindset in place.
There are plenty of people who actually make a living from forex trading. However, it takes a lot of effort, time and experience to be profitable in the forex market. Forex trading should be treated like every other business venture that you take and not just some ”get rich quick scheme”.
If you don’t treat the forex market seriously then you are setting yourself up for failure.
So, if you want to find out more about what it takes to be profitable in the forex market keep reading.
Why Trade The Forex Market ?
The forex market or foreign exchange market is the biggest financial market. The forex market is even larger than the New York Stock Exchange with an average trading volume of $5.1 trillion daily.
In comparison to the New York Stock Exchange that has an average trading volume of $2 – $6 billion daily. Although $2 – $6 billion are large numbers, however, these numbers pale in comparison to the forex market.
So, what does this mean in the context of forex trading? Well, it simply means that there is plenty of opportunities to make money every day.
Additionally, when you are trading the forex market you are actually trading by the margin. Trading by the margin simply means that you are paying a small percentage of the overall purchase value,
This means that you are able to generate more profit but at the same time, you are also susceptible to losing more money. So basically it is like a double-edged sword.
However, there are ways to trade the forex market which will offset the disadvantage of trading by the margin. We will touch more on this in later sections so continue reading.
The Trifecta of Forex Trading
In order to be profitable in forex trading or just trading, in general, there are 3 aspects that you need to take into consideration before starting your forex trading journey.
These 3 aspects are:
Trading mindset also referred to as trading psychology is one of the 3 aspects that you need to have in your trading arsenal.
Why is it important to have a good trading mindset?
Well, trading mindset refers to the emotional state that every trader goes through when trading any form the financial market. With a weak trading mindset, a trader would tend to overtrade, revenge trade or even break their trading plan.
To illustrate the importance of having a good trading mindset, let’s take a look at a simple example. In this example let’s assume that you have a good trading plan and your trading plan has the ability to make a profit of 50% annually.
However, with a weak trading mindset, you may not be able to achieve that 50% profit. With a weak trading mindset, you may pass on a good trade out of fear even though based on your trading plan you should have taken that trade. Then the next day seeing that the trade going well you may feel pain for missing out on the trade.
Through this pain of missing out, you end up taking the trade when it is way above your trading setup (based on your plan) which then reverses against you and you end up making a loss. Then out of fear of loss you end up passing on a good trade setup again and the cycle continues in a loop.
In the example above, we can see that with a weak mindset we tend to let the market dictate our actions and end up getting caught in a loop of bad trades that are driven by emotions.
How do we break the loop?
Well, to break the loop the first thing you need is to have a good trading plan which will talk more about in the next section. Secondly, you have to practice mindfulness,
Although conventional wisdom that is widely passed on in the trading community, mentions that we need to block out our emotions when we are trading. I think that it makes more sense to have good mindfulness rather than blocking out out emotions.
Blocking out our emotions although in theory may seem like it makes sense, in reality, we as humans are emotional creatures and it is hard or impossible to block out our emotions entirely.
The best thing to do is practice mindfulness as our mind tends to wander and think negatively or just go out of focus. Through the practice of mindfulness, we learn to shift back our focus to the trade at hand and stay focus.
So, how do we improve mindfulness?
You can improve mindfulness, through meditation like breathing meditation, etc. There is plenty of books or classes on mediation out there where you can learn from and practice them daily. You want to be able to feel the fear but take the trade anyway and focus on your trading plan.
Having a winning trading plan is important because even though you have a good trading mindset but your trading plan is not a profitable one then you will still lose in the market.
So, there are 3 things to need to understand when you are going to choose or come up with a trading plan.
1.Understanding The Type Of Trader You Want To Be
There 3 main trading styles out there which you can choose from which are:
Swing Trading (Medium Term Trading)
•Timeframe – Daily.
•Typically hold onto a position for days or even weeks before taking profit
Day Trading (Short Term Trading)
•Timeframe – 1-hour or 15-minute.
•Focuses on taking a position and closing them within a day and not holding them overnight.
•Timeframe – 5-minute or 1-minute.
•Scalping focuses on taking multiple profits on small price change in hopes that it exceeds your loss.
(Note: It gets harder to trade as the timeframe becomes smaller because price movements are more volatile with smaller timeframes.)
2.Coming Up With A Trading Plan
It is important to understand the type of trader you want to be so that you can come up with a trading plan or learn a trading plan that is specifically catered to the type of trader you are as different styles of trading utilizes different strategies.
Strategies use for scalping are not viable when you are swing trading.
There are 2 things you need to consider when you are coming up with a trading plan:
1.Trade setup – Entry strategy
2.Exit – Exit strategy
So, your trading setup may consist of a double bottom (chart pattern) in confluence to a candlestick reversal such as a bullish engulfing. Plus maybe a stochastic indicator to further support your analysis.
An exit strategy would determine where you take profit and determines when your trade is a loss which could be based on support and resistance. For example, take profit when the price hits a certain resistance or cut your losses when price breaks 30 pip below the support.
It’s hard to come up with your own trading plan when you are new, so it’s better to take a trading plan that is already working from others and just copy them. As you get better and more knowledgeable with trading you can come up with your own plan.
To ensure that your trading plan works whether it is taken from other traders or you coming up with your own plan. It is best to backtest that trading plan on past price movements to find out it works or not.
There are plenty of programs out there that will help you with backtesting your trading plan (i.e soft4fx). The purpose of backtesting is to understand that there are times where your plan will make multiple losses but ultimately you want to find out whether the trading plan is profitable overall (over the course of 5/10 years).
Understand that trading is a statistics game, what do I mean by that? Well, in forex trading just like any other business ventures there is no such thing as a 100% win rate/success.
Losing is part of the forex trading game. As mentioned before you have the ability to lose more than the capital that has been deposited into your trading account when trading the forex market which is why it is important to have good risk management.
As a rule of thumb, you only want to risk 1% to 2% of your capital for every trade that you take. That way you do not lose your whole capital in 1 trade and give yourself room to make more losses.
What do I mean by making room for more losses?
As an example, let’s say based on your backtest you are able to determine that your win rate is 50%. Just like flipping a coin just because it has a 50% chance of getting heads or tails doesn’t mean that when you flip a coin 10 times you will get 5 heads and 5 tails.
You might get 6 tails and 4 head or other forms of variations. This is why you want to have good risk management so that even if you are on a losing streak you are not kicked out of the market.
How does risk management help with profitability?
With a win rate of 50% and only taking a trade when the profitability ratio is 2:1 or any number above 1 like 1.5:1. In this example, I will be using a profitability ratio of 2:1.
So, with a win rate of 50% and only taking a trade when the potential profit exceeds the potential loss by 2. If you make 10 trades that resulted in 5 wins and 5 losses, assuming that when you make a loss you lose $100 and when you win you make $200.
So, 5 loss = $500 and 5 wins = $1000. Overall with a 50% win rate you are still able to make a profit of $500.