Date: July 21, 2005 14:00GMT
Expert: Edward Ponsi, FXstreet.com FX Educator
Topics:
- Recognize and develop winning strategies
- Risk management techniques
- Trade With A Plan.
Who is Edward Ponsi?
Edward Ponsi has been recently appointed new FXstreet.com FX Educator and is the president of FXEducator LLC.
Session Transcript:
How to Plan Your Trades
To have a successful career as a trader is the goal that everyone wishes to achieve. The rewards are great, both in terms of money and freedom. Winning traders can do what they please, when they please. Financial success certainly cannot cure all of life’s problems, because money is just one aspect of life. But on the whole, I think most of us would agree that given a choice, it’s better to be wealthy than to be poor.
We know that for most of us, trading is difficult. The sad fact is, most traders fail; in fact, the vast majority of traders fail. It is impossible to know the exact figure of successful vs. unsuccessful traders, and estimates vary. I think we can conservatively estimate that only about twenty percent of all traders succeed on a long-term basis, and the other eighty percent fail. I’m sure that just like most of us, many of these failed traders were convinced that they would succeed in this business. As a trading instructor, it is my job to get you to stop thinking like the eighty percent who are destined to lose, and get you to think like the twenty percent who will win.
Trading is difficult because we are hard-wired to fail as traders. The same personality traits that may make you a good doctor, or a good salesperson, or a good athlete can cause you to fail at trading. Remember when you tried to accomplish something difficult, and you kept trying and trying, harder and harder until you succeeded? In fact, perhaps you believe that anything you can accomplish that is worthwhile will require tremendous effort and struggle. This is considered to be one of the “lessons of life”, that if we work hard we can achieve anything.
In fact, you may be correct…anything that is worth having is worth working for. But when we apply this same ethic to trading, it can work against us. If you are using strategies incorrectly, or using the wrong strategies, or no strategy at all, you are digging yourself into a hole. And the harder you dig, the deeper the hole you will find yourself in. The market doesn’t care how hard you try, or how badly you want to win. In fact, if you don’t know how to trade, the harder you try, the faster you will lose. This is what is meant when someone says trading is “counter-intuitive”.
Maybe you have been successful at most of the things you have attempted, and you are confident that trading will also fall under the spell of your prowess in all things. Once again, this self-confidence, which can be such an asset in so many facets of your life, tends to work against traders. When we are overly self-confident, we believe that nothing can stand in our way, and we feel that the rules do not apply to us. We feel that we can do whatever we please and that no matter what path we choose to follow, everything will work out in the end.
Once again, the things that work for us in everyday life can cause us to fail at trading. Traders who are overconfident have a tendency to break their own rules when it suits them. Without adherence to risk management rules, we are always one trade away from potential disaster.
Remember the movie “Top Gun” starring Tom Cruise? Cruise played a character called “Maverick”, a fighter jet pilot who did exactly as he pleased and played the game by his own rules. We are all familiar with the iconic, my-way-or-the-highway characters on television and in the movies that live their lives by their own rules, and society idolizes these characters. Many of us believe that trading is the same way, that if we trade successfully we can call our own shots and do exactly as we please. In fact, the public’s perception of traders is that they are wild, devil-may-care gamblers who will bet everything on a hunch or a gut feeling.
Well, I suggest to you that Mr. Cruise’s Maverick character would have failed as a trader. His overconfidence, lack of discipline and inability to follow the rules would have eventually caught up with him, making him just another failed trader. The same personality traits that made him a successful fighter pilot would cause him to break risk management rules, place trades that are too large and risky, and place trades that are based on hunches instead of on a solid plan. He would be unlikely to have the discipline to plan his trades and then follow the plan on a consistent basis.
With all of these problems facing us, and with our own human nature being our worst enemy, it’s no wonder that so many traders fail. We have been literally training all of our lives to fail as traders. We have developed common personality traits that make success in many aspects of live more likely, but also make success in trading difficult at best.
The good news is that trading can actually be quite easy. There are strategies that are effective and easy to use, if we are willing to use them with care and accuracy. These strategies should be based on common sense, and designed to capitalize on some tendency of the market. All markets have tendencies, for example the Forex market has a tendency to form strong trends. This is just one example of a tendency, there are many other tendencies of the Forex market that a good trader can take advantage of. Good strategies anticipate and exploit the tendencies of the market; they have built-in risk management that reduces or eliminates the risk of self-defeat at the hands of our own human nature.
In fact, trading itself isn’t hard if you know what you are doing. The hard part is figuring out what to do. Without guidance and left to our own devices, most traders make the same fatal mistakes, over and over again. It never ceases to amaze me that so many traders are unwilling to take the time to learn how to trade properly. It does cost money to learn how to trade, but usually much less money than the uneducated trader is likely to lose in the market. Failure to obtain a trading education is one of the biggest mistakes that a new trader can make.
When I was the Chief Trading Instructor for Forex Capital Markets, I had the ability and the privilege to view thousands of accounts, and to see which traders were successful and which traders were not. Even further, I was able to see what the successful traders were doing that made them successful, and I could also see the type of trades that the losing traders were placing. This allowed me to recognize and develop winning strategies based on my own experiences as well as the experiences of other traders. What I learned opened my eyes to the differences between the winning traders and the losing traders, not just relating to their respective strategies but also to the psychology of the winning trader and the losing trader.
The winning traders used every different type of strategy you can imagine. They used trend-following techniques, range bound techniques, volatility based trades, and more. More importantly they used solid risk management techniques, to keep their accounts safe from large losses.
The losing traders’ accounts had an eerie similarity to them. It was almost as if all of the losing traders had independently arrived at the same ineffectual strategy. In fact, when I view the accounts of traders, I can almost predict the type of problems that they will encounter. This is because they often are not following good strategies, or perhaps they have a good strategy but they are not executing it properly. Instead they are falling prey to human nature, our number one enemy as traders, or trading based on hunches or emotion.
What happens? The trader starts out with a strategy, possibly a good strategy. But when the strategy is not immediately successful, the trader abandons it and just begins to place random trades. He holds on to his losing trades, and gets out of his winning trades too soon. This happens because the trader feels anxiety when he or she is holding a winning trade, and relieves this anxiety by exiting the winning trade prematurely. The small gains in the account cannot make up for the losses, because the losses are much larger than the gains. If the trader continues to behave in this manner, he or she is almost certainly doomed to failure.
Trade With A Plan.
One of the most important things that we can do as traders is to have a clearly defined plan. This means that I must determine my entry point, stop placement, exit, and position size, how I will manage the trade (at what point will I take a partial profit, at what point will I raise my stop?) before entering the trade. Should my plan of action change if the exchange rate quickly reaches point X? You must ask yourself these questions before you enter the trade; this gives the trader the ability to deal with the trade in an objective matter. What the trader is doing is determining the course of action under any circumstance that may arrive before he or she enters the trade. This removes all of the stress from the trade, because the decision making process has been completed before we ever take a position.
All of my students are given strategies for every conceivable market environment. They know how to create a trading plan, how to enter, how to place the stop, and how to choose exits. They know the proper time to use the proper strategy, and how to choose the right tool at the right time. They have risk management rules that are designed to keep them out of trouble and to hold on to their gains. They are aware of economic events and their effect on the currency markets. And, they have an experienced mentor looking over their shoulder, making sure that they are integrating all of these different aspects of trading completely and correctly.
Here’s an example of a plan for a trade. On the daily chart of USD/CAD (See Chart 1),
Click to enlarge:
we can clearly see that the pair is in a downtrend, as represented by the green trendline. Whenever we are in a downtrend, we want to look for opportunities to sell short. The price is beginning to retrace, so we add Fibonacci levels (See Chart 2),
Click to enlarge:
to look for potential resistance.
At this point, you may be wondering, why did I choose that particular Fibonacci retracement, and how do I know which Fibonacci is the right one to use? Actually, there are several potential Fibonacci Retracements that we can draw (See Chart 3),
Click to enlarge:
and all of them are acceptable. I especially like to look for areas where different Fibs meet, like the area near 1.2300 where three different Fibonacci levels coincide. I’ll certainly try to use that as resistance if the price reaches that point, but for now we will deal with the Fibonacci resistance level that is closest to the current price. If the nearby Fibonacci level doesn’t act as resistance and the price continues to rise, that 1.2300 level may come into play later.
So how will I enter my short trade? Should I try to guess whether the price is going to turn around at this level and head lower? Of course not; many traders are under the false impression that a good trader “knows” what will happen next. This is simply not true. Trading is not prediction; it is creating a plan to deal with the current situation. If someone tells you that they can predict the future, run quickly in the opposite direction.
Let’s move down to the 15-minute chart. The price is currently just above the Fibonacci level of 1.2193 (See Chart 4).
Click to enlarge:
Is it possible that the price can move slightly above the Fib level before reversing? That’s one possibility; remember we want to sell short if the downtrend resumes, but we want proof that the downtrend has resumed before we enter. Let’s enter an order to sell short at 1.2175 (See Chart 5),
Click to enlarge:
so that if the price falls we can catch it on the way down. If the price continues to rise, we will simply look to sell short at a higher level.
Now that we have our entry point, we have to decide where to place the stop. The stop must be above the Fibonacci level of 1.2193, and ideally it should be above the price peak of 1.2217, as long as this does not cause excessive risk. If any trading idea creates too much risk, we cannot place that trade and must look for a better opportunity. Let’s place the stop at 1.2225, above the Fibonacci level of 1.2193 and also above the price peak of 1.2217 (See Chart 6).
Click to enlarge:
That way, if the price breaks above 1.2217 to a new short-term high, we are out of the trade. We don’t want to short a currency pair that is making a new high.
How many lots should we sell? The answer depends on the amount of risk you are willing to take. Let’s assume that our trader wants to limit his or her risk to $1500:
Risk Per Lot = 50 Pips (1.2225 minus 1.2175)
USD/CAD Pip Cost = $8.19 (See Chart 7)
Click to enlarge:
$Risk Per Lot = $409.50 ($8.19 X 50 Pips)
$1500 divided by $409.50 = 3.66
We can enter 3 lots. Our total risk is $1228.50
Of course we are not finished yet. We still have to plan the exit (or exits if we want to get out of the trade in portions), and we have to determine at what point we will move the stop lower. Determine your exits via support levels, and use a sensible risk/reward ratio. Try to plan for every possible situation that you can think of, so that you are never in the position of trying to figure out what to do while you are in the trade.
Will this trade succeed? The answer is, it doesn’t really matter. If you consistently plan your trades well and execute them properly, your good trades should outweigh your bad trades. Remember, we can’t control what occurs in any one trade, but we can control our long-term success or failure.
Expectations
In life, it’s important to set goals that we can achieve and be proud of, that will cause us to stretch ourselves to achieve our full potential and to ordain our ultimate destiny. I frequently speak with students or traders who have tremendously high expectations, and this can be another negative factor that can work against us. Once again, what works in trading is different from what works in the real world. Having high expectations is a great thing in many parts of life, but many traders have expectations that are so high that they can only be reached by taking huge risks. For example, a trader who has set lofty goals may be having a difficult month; it could be that the conditions for trading are not conducive for creating large gains at this time, or perhaps the trader is distracted and not executing properly. For whatever reason, the trader is having difficulty and now it appears that the goal will not be met.
The problem is, this trader is not achieving his or her lofty goal and is now going to feel pressure to do the wrong thing; he or she will be tempted to overtrade, take positions that are too large for the size of the account, abandon solid risk management rules, or otherwise put the account in jeopardy. Eventually the pressure to overachieve can ruin the account completely, all because the trader was unwilling to deal with the fact that sometimes you simply cannot reach your goal.
Instead of putting all of this pressure on yourself, keep your goals modest at first. Becoming a consistent winner should be your top priority. It’s not necessary to become a huge winner to be successful. You can always increase your goals later, and once you are consistently profitable you can gradually raise your expectations. Once you have achieved consistent profitability, modestly increase your goals and continue to do so as long as you can meet your goals. When you finally reach the inevitable point when you are having difficulty reaching your goal, don’t struggle with it. If by this time you can look back and see that you have become a consistent trader, you have already won the most difficult part of the battle. If you fail to reach your goal, don’t be overly concerned. Too much concern can cause you to abandon your risk management in an effort to reach the goal, and cause a trader to make a real mess of the account. When we care too much about the goal itself, we are losing sight of the big picture, which is consistent profitability.
Part of becoming a winning trader is learning not to worry about the results of any particular trade. Any trade can become a winning or a losing trade, and just because you win or lose one trade shouldn’t change our attitude or our strategy. Unfortunately, many traders will abandon a strategy if it does not show immediate results. Remember, there is no such thing as a strategy that works all the time in every market condition. That is why every trader should have an arsenal of strategies, along with the knowledge of the proper times to use them. We also need to understand that a strategy should be judged not only one or two trades, because any given trade can be a winner or a loser. What matters most is using strategies that will work over time, and create success in the long run.
$1500 divided by $409.50 = 3.66
We can enter 3 lots. Our total risk is $1228.50
Of course we are not finished yet. We still have to plan the exit (or exits if we want to get out of the trade in portions), and we have to determine at what point we will move the stop lower. Determine your exits via support levels, and use a sensible risk/reward ratio. Try to plan for every possible situation that you can think of, so that you are never in the position of trying to figure out what to do while you are in the trade.
Will this trade succeed? The answer is, it doesn’t really matter. If you consistently plan your trades well and execute them properly, your good trades should outweigh your bad trades. Remember, we can’t control what occurs in any one trade, but we can control our long-term success or failure.
Recent Comments