Lessons from the Pros

Forex

The Three Parts to Every Trade

Here, I’ll cover the three parts to every trade, and which one you actually have control of…

OK, so at Online Trading Academy, we look for the supply and demand zones formed by institutions to enter and exit our trades. The main reason for this is to be able ride the waves on the charts from one area of buying pressure to another area of selling pressure. The demand zones (when going long) allow us to use the massive buy orders from these institutions to help push prices higher; and the supply zones (when going short) allow us to use these massive sell orders to help push prices lower.

On the attached USDCAD chart, I’ve marked out a couple of obvious demand zones at 1.3370 – 1.3385, and supply zones at 1.3493 – 1.3505. When price returned to the demand zone on May 10, a buy order could have been placed to go long near 1.3385, and the subsequent target at 1.3492.

Stock chart showing a supply and demand zone on a forex trade

Three Parts to Every Trade

STOP LOSS – an order that is used to take exit a position either for a small loss if the trade went opposite expectations, a breakeven if price has moved as expected allowing the stop to be moved to the entry price, or for a profit when price has moved further as expected allowing the stop to be moved as price goes up to lock in profits.

ENTRY – the act of getting into a position; buy in demand to go long, sell in supply to go short

TARGET – an order to exit the position with a predefined profit

Now, as far as I’m concerned the only one of these orders I actually have control over is the entry. My stop loss always goes on the OTHER SIDE of the zone I use for entry (below the demand zone for a long, above the supply zone when going short.) My target always goes JUST BEFORE price could get to the opposing zone (just below the supply zone on a long profit target, and just above demand for a short profit target.)

If I only have true control over my entry, then I want to enter my trades as CLOSE TO the stop loss as possible. This way I can maximize the pips on this trade. If a trader were to enter this trade at the top of the zone at a price of 1.3385, with a stop just below the zone at 1.3368, it would have given us risk of 17 pips, with a potential profit target of 1.3490. The reward, then, would have been 105 pips. The reward to risk ratio would have been about 6:1 which is not bad at all! Now consider this, if the trader would have missed the good entry and not entered until about 1.3440, their reward to risk ratio would have been WORSE than a 1:1!

The point is this: institutions and their orders rule the markets. Traders need to be able to recognize where they have their orders positioned, so they can ride the moves between these massive buy and sell orders, (demand and supply zones). If the stop loss is placed randomly, they aren’t using the institutions to their advantage!

Another great thing about getting a very good entry is this: it could be possible to make A LOT more pips with potentially NO MORE RISK. The first time this was explained to me I was flabbergasted! Here is how it works:stock chart showing a forex trade entry, stop loss and target.

Let’s say we have a $100,000 trading account, and we have a rule in our trading plan that says we will risk no more than 2% ($2,000) on a position. Using the following EURUSD as an easy example, with an entry at 1.1313 and a stop above the zone at 1.1326, our risk is 13 pips and, with a target of 1.1260, our reward is 53 pips. With the 13 pips of risk and $2,000 of risk on any one position, our position size would be about 15.38 standard lots. With that position size, our gain in pips would be about 815 pips! (15.38 lots x 53 pips of reward.)

Now, with a much better entry, say, 1.1320, our risk would be 6 pips (remember, the chart tells you where the stop is!) and target would then be 60 pips. With the same $2,000 of risk, our position size is now 33.3 lots, approximately twice as large but with virtually no more risk! What do you think happens to the reward in pips when the position size doubles?

Be aware, it is NOT advisable to put this huge position size on in a $100,000 account! While the risk is theoretically limited to only 2%, if something unusual happens over a weekend, for example, a giant gap in the wrong direction could crush the account. This would be another example of a risk management rule, which we’ll have to save for another time. To learn more about additional risk management rules, check out our Professional Forex Course or contact your local center for more information.

To summarize, there are three parts to every trade: stop, entry, and target. When using the charts properly with supply and demand zones, traders only need to concentrate on the entry. With a very good entry, trade position size could increase dramatically with risk remaining virtually the same!

Until next time,

Rick Wright


DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.

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