When most people start trading, they do not put much thought into their trades. They will either buy or sell a currency pair (probably the EUR/USD) because they think they see a trend or maybe even because they put a moving average on the chart. Sometimes there is no reason at all for the trade, they just want in. Either that trade nets a small profit or the trades starts going against the new trader. The trader that gets the small profit will feel invincible and likely base trades in the near future on the same reason as the first one. Of course they expect every trade to win. The trader whose position moves against them leaves their position open, stares at the their computer without blinking, and laments that they will get out if the market only goes back to break even.
Sooner or later, the trader who won their first trade puts on a loser and acts much like the trader above who lost their first trade. After a large loss to the account, the trader then puts on a large position trying to win it back. Inevitably that trade crushes their account, or a trade soon after will. Sound familiar?
The reason that new traders blow out their account is that they assume trading is easy, they don't realize the role their emotions play in trading with real money, and they have no trading plan. Well, it doesn't take long to learn on your own that trading isn't easy, so we won't spend too much time discussing that. However, using a consistent trading plan is the only way to reign in your emotions and develop consistency in your trading. If you enter at random places and exit when your "gut" tells you to, you are in for a lot of pain.
Every remotely successful trader I have ever spoken with has a trading plan. These traders do the same thing every time, occasionally tweaking one aspect of their plan at a time. Trying to change everything at once makes it impossible to tell what is working and what is not. We will go through the important aspects of a trading plan below, and we will go over how the FX360.com technical analysis works with these principles.
First off, I believe it is imperative to identify your entry, stop, and profit target(s) before entering every trade. If you try to determine your exits once you enter the trade, your emotions will skew your view of the facts unless you are a robot. If the exits are planned before entering, it is tough for your emotions to screw you up. By placing your exits in the system when you enter the trade, it is much easier to stay disciplined to your plan. Another advantage is that you don't have to stare at your computer 24 hours a day waiting for a place to exit.
I also feel it is important to know your risk:reward ratio before entering a trade. How on earth can you determine your risk reward:ratio if you don't plan your stop and profit target(s) before entering the trade? It can't be done. To measure this ratio, simply divide the distance between the entry and the profit target by the distance between the entry and the stop. Everyone's concept of a "good" risk:reward ratio varies, but I prefer to have a risk:reward ratio around 1:1.5.
Once you have planned your entry and stop, you can also determine your position size. Your position size should generally be the same percentage of your equity each trade. Most traders risk 1-3% on each trade, using the same percentage for every trade. In other words, all trades are weighted equally. The same amount of capital should be risked on a trade with a 300 pip stop as a 30 pip stop. In order to determine your position size, simply multiply your total equity by your percentage risk per trade (typically 1-3%), which is the amount of money you should risk per trade (X). Next, multiply the number of pips between your entry and stop by the currency's pip value (Y). You can also draw a line from your entry to stop using the value calculator to get Y. Then divide X by Number Y to get the number of lots you should trade. Once you practice this, it is easy.
The methodology we use (geometric pattern recognition) makes it very easy to follow this plan. Everything is already planned out, all you need to add is your total equity and percentage you want to risk for each trade (typically 1-3%). By planning your trades out before you enter you can now trade on any time frame because you are risking the same amount for each trade. This will lead to much more consistent results that using static numbers when determining position size.
From the Desk of
Aaron Reid
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