Wednesday, September 29, 2010

Forex Trading for Beginners: A Disciplined Approach is a Key for Success

Trading currencies, or forex as it is known, has experienced dramatic growth and popularity over the past decade due to its inherent flexibility and easy access via the Internet to sophisticated trading programs that do most of the work that in bygone days was left to the trader to assimilate. The currency market is the largest and most liquid market in the world with average daily turnover exceeding $3 trillion. Over half of this volume is between banks, but retail forex trading is the subset of the market where consumers can participate with the aid of a competent brokerage service.

However, trading forex is a risky proposition and falls at the very top of the risk pyramid when its risk profile is compared to other investment vehicles. Specialized training is required, coupled with practice on virtual systems, in order to prepare oneself for the fast action and swings of the market. As with any performance-driven profession, one needs to hone their respective skills in order to compete and be successful.

As with all investments, forex trading is all about managing risk, and there are tried and true methods for achieving this objective. For a beginner, he must accept his “amateur” status and bridle his impatience. The urge to leap into the market and begin trading right and left is compelling, but the majority of those that react to this urge soon find their pockets empty and their confidence rattled. However, a beginner need not have this experience if he follows a straightforward learning regimen:

      • Knowledge: Gain awareness by reading as much as possible on the topic. Internet websites and free tutorials are great for this task. Your goal is to become familiar with terms and the lingo so that each new piece of information about the craft makes sense to you. Enroll in a structured class to receive mentoring from an expert. He will help you choose a broker and form a trading strategy;
      • Experience: Your broker will have a forex demo account to practice with real trading data and virtual capital. Successful traders swear by their practice time, claiming that months were required to develop the confidence and consistency needed for real market conditions. There are no shortcuts to gaining experience;
      • Controlling Your Emotions: You must have a disciplined approach to the market before you enter it and to guide your decision-making once you are in a position. There is a psychology to trading in a highly stressful fast-paced situation. Your plan will help you stop your losing trades and allow your winners to run.

The reference to a disciplined approach to the market cannot be overstressed. Managing risk is what forex trading is all about, and what we mean by this statement is that you never enter the market without protecting yourself from adverse swings in the market. You will have losing and winning trades, but your objective is to keep the “net” of all of your trades in positive territory. You do that by employing sound risk management techniques. Let’s look first at a definition:

      Currency Risk, sometimes referred to as exchange rate risk, is the possibility that currency depreciation will negatively affect the value of one’s investments.

Part of a forex trader’s plan involves assessing the risk/reward of a potential trade before its execution. Different currency pairs have differing volatilities in the market, such that a fixed number of “pips” or basis points in the currency quote is not recommended as a measure of risk. Traders use an “ATR” indicator, which is the average trading range for one trading period for the last twenty trading periods. If the value were 30 pips, then a calculated downside of 70%, or about 20 pips below his entry point, is where the trader would set his stop loss order. Using a 2:1 ratio, in this situation a trader would expect to gain 40 pips before considering an exit.

A Stop Loss Order is an instruction given to your broker to automatically liquidate your open position for a currency when a specific price is reached. The placement of these orders should occur right after you establish a position in the market. Lazy traders that ignore this prudent practice soon learn to regret their neglect. Currency markets are known for dramatic swings in either direction as new information is released.

The principles discussed above are the “basics”. Forex traders should also never risk money that they cannot afford to lose and should place only a manageable portion of their capital at risk in any one position. Money management, coupled with proper risk mitigation, allows a trader to survive and thrive in the world of forex. Caution and a disciplined approach to the market are the hallmarks of success.

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