Any financial instrument traded in any market will present two requirements that investors must follow if they hope to take profits: proper money management and a reasonable trading strategy. In the case of forex trading, finding a comfortable trading strategy is a matter of researching, testing and adjusting what really works.
First things first: money management will always be the most important aspect of trading. Those who venture into forex trading without adhering to the basic principles of money management will likely suffer losses that they will not be able to recover from. The first rule of money management is quite simple: investors should only risk funds that they can actually afford to lose.
An individual trader who dips into their reserve savings account to take EUR/USD short positions is not practicing money management. But who has puts away three months worth of living expenses and also has residual income can certainly take a long USD/JPY position because they know loss can be overcome.
The most egregious example of disregard for money management was observed in the cryptocurrency markets during the 2017 holiday season, when the Alabama Securities Commission reported that people were taking out second mortgages on their homes to purchase Bitcoin.
Money Management Principles for Forex Traders
Even though the forex market is 100 percent liquid, its massive volume and sheer liquidity requires most individual traders to leverage their positions, which means that they will always initiate a trade with a bit of a loss; for this reason, money management is crucial. In essence, forex traders must always keep in mind the following:
* A 50 percent loss will require a 100 percent gain to break even.
* A 75 percent loss will require traders to gain 400 percent to break even, which would be quite a lot of pips.
Forex traders have two main money management strategies to consider:
* Frequently setting small stops to prevent major losses.
* Frequently taking profits on gains and taking infrequent chances on large stops.
The two aforementioned strategies will likely yield similar results for seasoned traders who take opposite positions; what this means is that the choice of strategy is a matter of personal preference. Most beginners start out taking small stops so that they can avoid losses, and quite a few of will stick with this strategy even after they have realized consistent profits.
Fundamental Versus Technical Analysis
In the world of stock trading, the merits of fundamental analysis versus its technical counterpart are endlessly debated. This is not the case with forex trading, where individuals who operate at the retail brokerage level should acknowledge that their standing in the market pushes them to keep an eye on fundamentals while applying technical analysis strategies such as the pivots indicator prior to taking buy or sell positions.
The forex market is known for its diversity of participants; sovereign central banks are at the very top of the markets, followed by interbank players and investment banking firms, and these are the participants that will mostly stick to fundamental analysis as they observe how economic and geopolitical events as well as monetary policy influence currency exchange rates. Individual forex traders cannot thrive on fundamentals alone because they operate at a level that requires technical analysis, meaning that they need to identify certain patterns that correspond to behavioral situations observed in the past.
For the most part, both technical and fundamental analysis are highly subjective in terms of interpretation; for example, on a day that the Bank of Japan announces that it will issue billions of yen worth of bonds to cover a budget deficit, fundamental traders may think about taking a buy position on USD/JPY, but not before checking on what is happening at the U.S. Federal Reserve.
While major forex players could then decide to go long on USD/JPY and check back on their profits in the next quarter, individual traders do not have this luxury; they must wait for the market to react and watch for technical analysis before taking positions.
Technical Indicators
Some of the most successful forex traders in history have made their fortunes with trading strategies derived from technical analysis. Before getting into politics, George Soros studied trading bands and took a famous short position on the pound sterling. Philosopher Nassim Nicholas Taleb applied technical analysis as a currency options traders in the mid-1980s; he was also a keen observer of randomness, which prompted him to take chances on exuberantly long positions that had many trailing stops to avert severe losses.
As you search for a perfect trading strategy to adopt, you should keep in mind that acting on indicators is only one part of the process. Every trade must have an exit strategy that takes into account various scenarios and conforms to your established money management principles. In the end, the trading strategy you choose should conform to your money management style, your fundamental observations, and how you choose to structure a market position when you spot a technical indicator.
