Foreign exchange trading, while potentially very profitable, carries a high level of risk. It may therefore not be suitable for all investors -- especially those without much knowledge or experience.
Before investing, you should carefully weigh the risks. As with any investment, you could lose money. Do not invest money you cannot afford to lose.
In addition, the leveraged nature of foreign exchange trading means market movements will have an effect on your deposited funds. This may work against you as well as for you. You could lose your initial margin funds and be required to deposit additional funds to maintain your position. If you fail to meet a margin call within the time prescribed, your position will be liquidated and you will be responsible for any resulting losses.
You should seek advice from an independent financial advisor if you have any questions or doubts.
Thursday, September 27, 2007
Foreign exchange trading, while potentially very profitable, carries a high level of risk. It may therefore not be suitable for all investors -- especially those without much knowledge or experience.
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Account - Record of all transactions.
Account Balance - Same as balance.
Accrual - The apportionment of premiums and discounts on forward exchange transactions that relate directly to deposit swap (Interest Arbitrage) deals, over the period of each deal.
Adjustment - A change made in the internal economic policies to correct a payment imbalance or in the official currency rate.
Agent - An individual employed to act on behalf of another (the principal).
Aggregate Demand - The sum of government spending, personal consumption expenditures, and business expenditures.
All or None - A limit price order that instructs the broker to fill the whole order at the specified price or not at all.
Appreciation - An increase in the value of an asset.
Arbitrage - The purchase or sale of an instrument, and simultaneous taking of an equal and opposite position in a related market, to profit from small price differentials.
Ask Rate - The lowest price at which a financial instrument is offered for sale (as in bid/ask spread).
Ask Size - The amount of shares being offered for sale at the ask rate.
Asset Allocation - Investment practice that distributes funds among different markets (cash, forex, stocks, bonds, commodity, real estate) to achieve diversification for risk management purposes.
At Best - An instruction given to a dealer to buy or sell at the best rate that can be obtained.
At or Better - An order to deal at a specific rate or better.
Attorney in Fact - Someone who is allowed to transact business and execute documents on behalf of another person (holds power of attorney).
Back Office - The departments and processes related to the settlement of financial transactions (i.e. written confirmation and settlement of trades, record keeping).
Balance - Amount of money in an account.
Balance of Payments - A record of a nation's claims of transactions with the rest of the world over a particular time period. These inlcude merchandise, services and capital flows.
Balance of Trade - The value of a country's exports minus its imports.
Base Currency - The currency in which an investor or issuer maintains its books; the currency that other currencies are quoted against. In the forex market, the US Dollar is normally considered the 'base' currency for quotes, meaning that quotes are expressed as a unit of $1 USD per the other currency quoted in the pair.
Basis - The difference between spot price and futures price.
Basis Point - One hundredth of a percent.
Bear - An investor who believes that prices/the market will decline.
Bear Market - A market distinguished by a prolonged period of declining prices, usually accompanied with widespread pessimism.
Bid - The price a buyer is prepared to purchase at; the price offered for a currency.
Bid/Ask Spread - See spread
Big Figure - Dealer phrase referring to the first few digits of an exchange rate. These digits rarely change in normal market fluctuations, and therefore are omitted in dealer quotes, especially in times of high market activity. For example, a USD/Yen rate might be 107.30/107.35, but would be quoted verbally without the first three digits; i.e. "30/35".
Bonds - Tradable debt securities issued by a borrower to raise capital. They pay either fixed or floating interest, known as the coupon. As interest rates fall, bond prices rise and vice versa.
Book - In a professional trading environment, a book is the summary of a trader's total positions.
Bretton Woods Accord of 1944 - An agreement that established fixed foreign exchange rates for major currencies, provided for central bank intervention in the currency markets, and set the price of gold at US $35 per ounce. The agreement lasted until 1971.
Broker - An individual or firm that acts as an intermediary, putting together buyers and sellers (for a fee or commission).
Bull - An investor who believes that prices/the market will rise.
Bull Market - A market distinguished by a prolonged period of rising prices. (Opposite of bear market).
Bundesbank - The central bank of
Cable - Slang for the British Pound Sterling.
Candlestick Charts - A chart that indicates the trading ranges for the day as well as the opening and closing price.
Capital Markets - Markets for medium to long term investment (usually over 1 year).
Central Bank - A government or quasi-governmental organization that manages a country's monetary policy a prints a nation’s currency. For example, the
Chartist - An individual who uses charts and graphs and interprets historical data to find trends, predict future movements and perform technical analysis.
Clearing - The process of settling a trade.
Close a Position (Position Squaring) - To eliminate an investment from one's portfolio by either buying back a short position or selling a long position.
Collateral - Something of value given to secure a loan or as a guarantee of performance.
Commission - The fee a broker charges for a transaction.
Confirmation - A document exchanged by counterparts to a transaction that confirms the terms of said transaction.
Contagion - The tendency of an economic crisis to spread from one market to another.
Contract (Unit or
Convertible Currency - A currency which can be exchanged freely for other currencies at market rates, or gold.
Cost of Carry - The cost associated with borrowing money in order to maintain a position. It is based on the interest parity, which determines the forward price.
Counter Currency - The second listed Currency in a Currency Pair.
Counter Party - The participant, either a bank or customer, with whom the financial transaction is made.
Country Risk - The risk associated with government intervention (does not include central bank intervention). Examples are legal and political events such as war, or civil unrest.
Credit Checking - Due to the large size of certain financial transactions that change hands, it is essential to check that the counter parties have room for the trade. Once the price has been agreed the credit is checked. If the credit is bad then no trade takes place. Credit is very important when trading, both in the Inter-bank market and between banks and their customers.
Credit Netting - Arrangements that exist to maximize free credit and speed the dealing process by reducing the need to constantly re-check credit.
Cross Rates - An exchange rate between two currencies.
Currency - A country’s unit of exchange issued by their government or central bank whose value is the basis for trade.
Currency Risk - The risk of incurring losses resulting from an adverse change in exchange rates.
AUD - Australian Dollar
CAD - Canadian Dollar
EUR - Euro
JPY - Japanese Yen
GBP - British Pound
CHF - Swiss Franc
Day Trading - Opening and closing the same position or positions within the same trading session.
Dealer - Someone who acts as a principal or counterpart to a transaction; places the order to buy or sell.
Deficit - A negative balance of trade (or payments); when expenditures are greater than income/revenue.
Delivery - An actual delivery where both sides transfer possession of the currencies traded.
Deposit - The borrowing and lending of cash. The rate that money is borrowed/lent at is known as the deposit rate (or depo rate).
Depreciation - A decline in the value of a currency, usually due to market forces.
Derivatives - Trades that are constructed or derived from another security (stock, bond, currency, or commodity).
Devaluation - The deliberate downward adjustment of a currency's value versus the value of another currency, normally caused by an official announcement.
Economic Exposure - The risk on a company's cash flow, stemming from foreign exchange fluctuations.
Economic Indicator - A statistic that indicates current economic growth and stability issued by the government or a non-government institution (i.e. Gross Domestic Product (GDP), Employment Rates, Trade Deficits, Industrial Production, and Business Inventories).
Efficient Market - A market in which the current price reflects all available information from past prices and volumes.
End Of Day (or Mark-to-Market) - Traders account for their positions in two ways: accrual or mark-to-market. An accrual system accounts only for cash flows when they occur, hence, it only shows a profit or loss when realized. The mark-to-market method values the trader's book at the end of each working day using the closing market rates or revaluation rates. Any profit or loss is booked and the trader will start the next day with a net position.
Estimated Annual Income - Projected yearly earnings.
Euro - The currency of the European Monetary Union (EMU) which replaced the European Currency Unit (ECU).
European Central Bank - The Central Bank for the European Monetary
Exchange Rate Risk - See Currency Risk.
Federal Deposit Insurance Corporation (FDIC) - The regulatory agency responsible for administering bank depository insurance in the
Federal Reserve (Fed) - The Central Bank of the
First In First Out (FIFO) - Open positions are closed according to the FIFO accounting rule. All positions opened within a particular currency pair are liquidated in the order in which they were originally opened.
Fixed Exchange Rate - An official exchange rate set by monetary authorities for one or more currencies.
Fixed Interest - The agreed interest rate remains constant for the term of the deal.
Flat (or Square) - To be neither long nor short.
Floating Rate Interest - As opposed to a fixed rate, the interest rate on this type of deal will fluctuate with market rates or benchmark rates.
Foreign Exchange (or Forex or FX) - The simultaneous buying of one currency and selling of another in an over-the-counter market.
Foreign Exchange Risk - See Currency Risk
Forex - Foreign Exchange.
Forward - A deal that will commence at an agreed date in the future.
Forward Points - The points (pips) added to or subtracted from the current exchange rate to calculate a forward price.
Forward Rate Agreements (FRAs) - Transactions that allow one to borrow/lend at a stated interest rate over a specific time period in the future.
Front Office - The trading room and other main business activities.
Fundamental Analysis - Thorough analysis of economic and political data with the goal of determining future movements in a financial market.
Futures - A way of trading financial instruments, currencies or commodities for a specific price on a specific date in the future. Unlike options, futures give the obligation (not the option) to buy or sell instruments at a later date. They can be used to both protect and to speculate against the future value of the underlying product.
FX - Foreign Exchange.
G7 - The seven leading industrial countries, being the
Going Long - The purchase of a stock, commodity, or currency for investment or speculation.
Going Short - The selling of a currency or instrument not owned by the seller.
Gross Domestic Product - Total value of a country's output, income or expenditure produced within the country's borders.
Gross National Product - Gross domestic product plus income earned from investment or work abroad.
Good 'Til Cancelled Order (GTC) - An order to buy or sell at a specified price. This order remains open until filled or until the client cancels.
Hedge - An investment position or combination of positions that reduces the volatility of your portfolio value. One can take an offsetting position in a related security. Instruments used are varied and include forwards, futures, options, and combinations of all of them.
High/Low - Usually the highest traded price and the lowest traded price for the underlying instrument for the current trading day.
"Hit the bid" - Acceptance of purchasing at the offer or selling at the bid.
Inflation - An economic condition where there is an increase in the price of consumer goods, thereby eroding purchasing power.
Initial Margin - The required initial deposit of collateral to enter into a position as a guarantee on future performance
Interbank Rates - The Foreign Exchange rates at which large international banks quote other large international banks
Interest Rate Swaps - An exchange of two debt obligations that have different payment streams. The transaction usually exchanges two parallel loans; one fixed, the other floating.
Interest Rate Swap Points - Interest rates may be determined by a simple rule using the bid and offer spread on an fx rate. If the rate quoted is in foreign (non US) terms and the offered price is higher than the bid, then the interest rate in that nation is higher than the rate in the base nation for the particular time in question. If quoted in American terms, the opposite is true. Example – USD/ JPY quoted 105.75 to 105.65. Because the offered price is lower than the bid, then you know that rates are lower in
Intervention - Action by a central bank to effect the value of its currency by entering the market. Concerted intervention refers to action by a number of central banks to control exchange rates.
ISDA (International Swaps and Derivatives Association) - The body that sets terms and conditions for derivative trades
Kiwi - Slang for the
Leading Indicators - Economic variables that are considered to predict future economic activity (i.e. Unemployment, Consumer Price Index, Producer Price Index, Retail Sales, Personal Income, Prime Rate, Discount Rate, and Federal Funds Rate).
Leverage - Also called margin. The ratio of the amount used in a transaction to the required security deposit.
LIBOR - Stands for
LIFFE - The
Limit Order - An order to buy at or below a specified price or to sell at or above a specified price.
Liquid and Illiquid Markets - The ability of a market to buy and sell at ease with no impact on price stability. A market is described as liquid if the spread between the bid and the offer is small. Another measure of liquidity is the presence of buyers and seller, with more players creating tighter spreads. Illiquid markets have few players, hence, wider dealing spreads.
Liquidation - To close an open position throgh the execution of an offsetting transaction.
Liquid Assets - Assets that can be easily converted into cash. Examples: money market fund shares, US Treasury Bills, bank deposits, etc.
Long - A position to purchase more of an instrument than is sold, hence, an appreciation in value if market prices increase.
Margin - Customers must deposit funds as collateral to cover any potential losses from adverse movements in prices.
Margin Call - A requirement from a broker or dealer for additional funds or other collateral to bring the margin up to a required level to guarantee performance on a position that has moved against the customer.
Mark to Market (or End Of Day) - Traders account for their positions in two ways: accrual or mark-to-market. An accrual system accounts only for cash flows when they occur, hence, it only shows a profit or loss when realized. The mark-to-market method values the trader`s book at the end of each working day using the closing market rates or revaluation rates. Any profit or loss is booked and the trader will start the next day with a net position.
Market Maker - A dealer who supplies prices and is prepared to buy or sell at those stated bid and ask prices. A market maker runs a trading book.
Market Order - An order to buy/sell at the best price available when the order reaches the market.
Market Risk - Risk relating to the market in general and cannot be diversified away by hedging or holding a variety of securities.
Maturity - The date a debt becomes due for payment.
Mine and Yours - To announce that a trader wants to buy he/she may say or type Mine. This would also be known as taking the offer. To sell he will use Yours. This would be known as `hitting the bid`.
Money Markets - Refers to investments that are short-term (i.e. under one year) and whose participants include banks and other financial institutions. Examples include Deposits, Certificates of Deposit, Repurchase Agreements, Overnight Index Swaps and Commercial Paper. Short-term investments are safe and highly liquid.
Net Position - The amount of currency bought or sold which has not yet been offset by opposite transactions.
Net Worth - Amount of assets which exceed liabilities. May also be known as stockholders equity or net assets.
Off Balance Sheet - Products such as Interest Rate Swaps and Forward Rate Agreements are examples of 'off balance sheet' products. Also, financing from other sources other than equity and debt are listed.
Offer - The price, or rate, that a willing seller is prepared to sell at.
Offsetting Transaction - A trade that serves to cancel or offset some or all of the market risk of an open position.
One Cancels Other Order (O.C.O. Order) - A contingent order where the execution of one part of the order automatically cancels the other part.
Open Order - An order to buy or sell when a market moves to its designated price.
Open Position - A deal not yet reversed or settled and the investor is subject to exchange rate movements.
Options - An agreement that allows the holder to have the option to buy/sell a specific security at a certain price within a certain time. Two types of options – call and put. A call is the right to buy while a put is the right to sell.
Order - An order is an instruction, from a client to a broker to trade. An order can be placed at a specific price or at the market price. Also, it can be good until filled or until close of business.
Overnight - A trade that remains open until the next business day.
Over The Counter (OTC) - Used to describe any transaction that is not conducted over an exchange.
Pegging - A form of price stabilization; typically used to stabilize a country’s currency by making it fixed to the exchange rate with another country.
Pips (or Points) - The term used in currency market to represent the smallest incremental move an exchange rate can make. Depending on context, normally one basis point (0.0001 in the case of EUR/USD, GBD/USD, USD/CHF and .01 in the case of USD/JPY).
Political Risk - Changes in a country’s governmental policy, which may have an adverse effect on an investor's position.
Position - A trading view expressed by buying or selling. It can refer to the amount of a currency either owned or owed by an investor.
Premium - In the currency markets, it is the amount of points added to the spot price to determine a forward or futures price.
Price Transparency - Every market participant has equal access to the description of quotes.
Profit /Loss or "P/L" or Gain/Loss - The actual "realized" gain or loss resulting fromtrading activities on Closed Positions, plus the theoretical "unrealized" gain or loss on Open Positions that have been Mark-to-Market.
Quote - An indicative market price; shows the highest bid and/or lowest ask price available on a security at any given time.
Rally - A recovery in price after a period of decline.
Range - The difference between the highest and lowest price of a future recorded during a given trading session.
Rate - The price of one currency in terms of another, typically used for dealing purposes.
Realized and Unrealized Profit and Loss - One using an accrual type accounting system has an “unrealized profit” until he sells his shares. Upon the sale of one’s shares, the profit becomes “realized.”
Re-purchase (or Repo) - This type of trade involves the sale and later re-purchase of an instrument, at a specified time and date. Occurs in the short-term money market.
Resistance - A term used in technical analysis indicating a specific price level at which a currency will have the inability to cross above. Recurring failure for the price to move above that point produces a pattern that can usually be shaped by a straight line.
Revaluation Rates - The revaluation rates are the market rates used when a trader runs an end-of-day to establish profit and loss for the day.
Risk - Exposure to uncertain change, the variability of returns significantly the likelihood of less-than-expected returns.
Risk Capital - The amount of money that an individual can afford to invest, which, if lost would not affect their lifestyle.
Risk Management - To hedge one's risk they will employ financial analysis and trading techniques.
Rollover - The settlement of a deal is rolled forward to another value date with the cost of this process based on the interest rate differential of the two currencies.
Round trip - Buying and selling of a specified amount of currency.
Settlement - The finalizing of a transaction, the trade and the counterparts are entered into the books.
Short - To go 'short' is to have sold an instrument without actually owning it, and to hold a short position with expectations that the price will decline so it can be bought back in the future at a profit.
Short Position - An investment position that results from short selling. Benefits from a decline in market price because the position has not been covered yet.
Spot - A transaction that occurs immediately, but the funds will usually change hands within two days after deal is struck.
Spot Price - The current market price. Spot transaction settlements usually occurs within two business days.
Spread - The difference between the bid and offer (ask) prices; used to measure market liquidity. Narrower spreads usually signify high liquidity.
Square - Purchase and sales are in balance and thus the dealer has no open position.
Stop Order - An order to buy/sell at an agreed price. One could also have a pre-arranged stop order, whereby an open position is automatically liquidated when a specified price is reached or passed.
Support Levels - A term used in technical analysis indicating a specific price level at which a currency will have the inability to cross below. Recurring failure for the price to move below that point produces a pattern that can usually be shaped by a straight line.
Swaps - A swap occurs when one currency is temporarily exchanged for another, then the currency is held and exchanged later after a fixed period of time. To calculate the swap take the interest rate differential between the two underlying currencies, thus it may be used for speculative purposes to exploit anticipated movement in the interest rates.
Swissy - Market slang for Swiss Franc.
Technical Analysis - An effort to forecast future market activity by analyzing market data such as charts, price trends, and volume.
Tick - Minimum price move.
Ticker - Shows current and/or recent history of a currency either in the format of a graph or table.
Tomorrow Next (Tom/Next) - Simultaneous buying and selling of a currency for delivery the following day.
Transaction Cost - The cost associated with buying or selling of a financial instrument.
Transaction Date - The date on which the trade occurs.
Turnover - The volume traded, or level of trading, over a specified period, usually daily or yearly.
Two-Way Price - Both the bid and offer rate is quoted for a Forex transaction.
Unrealized Gain/Loss - The theoretical gain or loss on Open Positions valued at current market rates, as determined by the broker in its sole discretion. Unrealized Gains' Losses become Profits/Losses when position is closed.
Uptick - A new price quote that is higher than the preceding quote for the same currency.
Uptick Rule - In the
US Prime Rate - The interest rate at which US banks will lend to their prime corporate customers.
Value Date - The date that both parties of a transaction agree to exchange payments.
Variation Margin - An additional margin requirement that a broker will need from a client due to market fluctuation.
Volatility - A statistical measure of a market or a security’s price movements over time and is calculated by using standard deviation. Associated with high volatility is a high degree of risk.
Volume - The number, or value, of securities traded during a specific period.
Warrants - Warrants are a form of traded option. They are the right to purchase shares or bonds issued by a company at a specific price within a specified time span.
Whipsaw - A term used to describe a condition in a highly volatile market where a sharp price movement is quickly followed by a sharp reversal.
Yard - Another term for a billion.
As you can see, the buying and selling of currencies is necessary as it supports trade between countries in today's global marketplace and, as the major world currencies often work against one another, will continue to be. There is so much money to be made from currency transactions.
The major players in the market today are buying and selling in single deals and they are often running into many millions of dollars. The smaller players (as usual), like the brokerage houses and individual brokers, are often trading in single deals that consist of as little as one hundred thousand dollars.
Nowadays, you can join this market and, providing you take the time to learn everything that there is to know of the currency markets and have a little bit of capital to invest, you can have a great time and earn a very reasonable income from your trading efforts when you do it online.
As you have learned here you will not be able to trade on your own and will need to use a broker, but many brokers will allow you to open an account online and start trading with anywhere between $250 and $1,000. Many of them will let you try a free demo just to let you get the nag of it.
Forex trading is not for everybody but its major advantage is that it is a highly liquid market that does not involve the commission payments and paperwork which many people find a problem like with other forms of trading. It is, however, a technical market and you should not try it unless you are absolutely ready to take the time to learn the basic principles that make up this currency market and become competent
in the use of some of the tools at your disposal.
It is not necessary to become an expert in these markets to profit from them. With a little time and effort you can quite easily gain enough of an understanding of the currency markets to start making money online and off and, eventually you will be surprised at just how quickly you can become quite an expert.
This guide has given you all of the knowledge you need to make money if you really want to. All you have to do is follow the advice mentioned here and do your research. Next thing you know, you will be earning steady income from the forex trading market in no time at all!
If you do not know whether your trading system is positive expectancy then it makes no sense for you to be trading it in the first place. Expectancy is calculated using the profit or loss on each trade; divided by the initial risk, and then taking the average of this number of a series of trades. Systems that have positive expectancy will make money most of the time and those with negative expectancy will lose money.
Successful traders only trade systems when the odds of success are in their favor so that they know that making money is the final result of accurately implementing the system and not just pure luck.
Some trading systems can offer you only marginal profitability, and trading implementation costs (commission, spread, and slippage) can be the difference between making a profit and making a loss.
With the simple availability of modern electronic brokers, and fully-automated trade processing and execution, it is definitely worth the effort in looking for a very low cost way to implement your trading system.
High commission, wide spreads, and large amounts of slippage can be lowered drastically and easily by carefully choosing the right broker. This can be the difference between a system being useable or not. Paying too much for trade implementation is a way to lose money that you can actually avoid.
In order for you to be able to compete at the highest level in the trading business and be a successful player, you must be well-educated about what you are doing. Being well-educated means that you have thoroughly researched and tested your trading ideas and know why your trading system worked in the past and is still working.
It means that you understand all the technology and applications that your system needs to perform with accuracy. It means understanding your goal and objectives and how trading will help you achieve them. It means understanding yourself and how your personality will affect your results.
In order to succeed as a forex trader, you really need to become an expert in your own trading business to understand how it the dots are all connected, when it is broken, and how it can be improved. This takes commitment, hard work, dedication, and more hard work.
Avoid trading scared money
No one ever made any money trading when they had to do it to pay their bills at the end of the month. Having a requirement to make a certain amount of dollars per month or you will be financially in trouble is the best way I know to completely mess up all trading discipline, rules, objectives, and leads faster than you’d expect to disaster.
Trading is about taking a reasonable amount of risk in order to achieve a good reward. The markets and how and when they give up their profits is nothing that you can control. You should never trade if you need the money to pay bills. Do not trade if your business and personal expenses are not covered by another income stream or cash reserve. This is how hasty decisions are made.
Dealing with your losses
One of the most important rules of Forex trading is to keep your losses as small as possible. With small Forex trading losses, you can outlast those times when the market moves against you, and be well positioned for when the trend turns around.
The one proven method to keeping your losses small is to set your maximum loss before you even open a Forex trading position.
The maximum loss is the greatest amount of capital that you are comfortable losing on any one trade. With your maximum loss set as a small percentage of your Forex trading effort, a string of losses won’t stop you from trading for any particular amount of time. Unlike the 95% of Forex traders out there who lose money because they haven’t implemented wise money management rules to their Forex trading system, you will be ok with this money management rule.
To use as an example... If I had a Forex trading float of $2000, and I began trading with $200 a trade, it would be reasonable for me to experience three losses in a row. This would reduce my Forex trading capital to $800. It would then be decided that they’re going to bet $400 on the next trade because they think they have a higher chance of winning after having lost three times already.
If that trader did bet $200 dollars on the next trade because they thought they were going to win, their capital could be reduced to $500 dollars. The chances of making money now are practically nil because I would need to make 150% on the next trade just to break even. If the maximum loss had been determined, and stuck to, they
would not be in this position.
In this case, the reason for failure was because the trader risked too much money, and didn’t apply good money management to the play.
Remember, the goal here is to keep our losses as small as possible while also making sure that we open a large enough position to capitalize on profits and minimize losses. With your money management rules in place, in your Forex trading system, you will always be able to do this.
Cut your losses short
Setting a maximum loss point before you enter the trade so you know ahead of time approximately how much you are risking on this position is pretty straight up.
You just have to have an exit price that tells you that your trade is a losing one you should exit before it gets any bigger. Because of gaps at the open, or limit moves in futures we can never be 100% sure that we can get out with our maximum loss, but simply having the rules, and always sticking to them will save us from the nasty trades that just keep on going against our position until we have lost more than many winning trades can make back.
If you have a losing position that is at your maximum loss point, you should just get out right away. You can’t hope that it will turn around for as it isn’t common sense.
Being that trades are either winners or losers, and this one is shouting ‘Loser’ at you, the chances that it will turn around and become a large winner is decidedly small.
Why would you want to risk any more money on a trade that has already shown itself to be a loser when you could simply close it out (accept the loss) and move on. This will leave you in a much better place financially and mentally, than holding on to your position and hoping it will go back your way.
Even if it did do this, the mental energy and negative feelings from holding the losing position are just not worth it. this is why you should always stick to your rules and exit a position if it hits your stop point.
Never add to a losing trade
One of the few trade management rules that you should never break is ‘Never add to a losing trade’. Trades are split into winners and losers, and if a trade is a loser, the chances of it turning right around and becoming a winner are too small for you to want to risk more money on. If it actually is a winner disguised as a loser, why not wait until it shows it is a winner before you add to it.
If you do this you will notice that nearly every time the trade ends up hitting your stop loss and does not change direction. Sometimes the trade turns around before it hits your stop and becomes a winner and you can count yourself very lucky if it does.
Sometimes the trade hits your stop loss and then turns around and becomes a winner and you can count yourself unlucky. Whatever happens, it is never worth adding to a loser, hoping that it will eventually be a winner. The odds of success are just too low to risk more capital in addition to the initial risk.
Don’t take too much risk
One of the most devastating mistakes that any trader can make is in risking too much of their capital on a single trade. One thing is certain in trading and that is if you lose all your capital you are out of the game indefinitely. Why should you risk so much when you could be prevented from continuing?
There is a useful saying in poker than going all-in works every time but once. It is the same thing in trading. If you risk all of your account on every trade it only takes one loser to wipe you out, so you will be out of the game at some point as it is only a question of time.
In general, you should only risk 1-3% of the available capital allocated to a system on any individual trade. This is calculated using the size and, the difference between our entry price and our maximum stop
price, and the amount of capital that is allocated to the system.
With these things combined we are almost certain never to lose all of our trading capital. In fact, the chance of us hitting our maximum drawdown for the year is extremely low.
All trades that you make should be of a size that almost seems pointless to your future fortune. If you are worried about the size of a trade then it is too big and you should use a lower amount immediately.
Remember that longevity in any trading market is the key to making money by trading. You should trade slowly over a long time with minimal risk, is always preferable to rapidly with too much risk.
The following are rules that can significantly improve your chances of success if they are understood, practiced, and implemented consistently in your trading. These rules have been learned the hard way, mostly through trial-and-error, and the inevitable mistakes that everyone makes when they start a trading business.