This week I have had the opportunity to spend some time teaching classes with Online Trading Academy between the Houston, TX and Philadelphia, PA campus locations. As you may already know, I like nothing more than meeting new students in our world-respected trading and investing education programs, especially as I was once a student of the Academy myself many years ago. Having been a student once with practically zero understanding of how the financial markets functioned, I can appreciate many of the newer questions I get from those people who are new to the markets, as it is often the case that they are still discovering things for themselves and are often unsure of the true dynamics of the markets and, in particular, how money is really made and lost in the financial arenas.
There are many aspects of trading that must be taken into account if one is hoping to achieve their short-term income and long-term wealth goals. Once these have been recognized, it then becomes a far more simple process of developing a specific trading plan and then executing it flawlessly. Knowing this, how hard can it really be? Well, speak to any trader who has been doing this a while and they will tell you the same thing: Trading is simple, but it is not easy. Sure, it can be easy but only if we remove emotion and follow the rules to the letter. SO, what makes it so challenging then, you ask? Winning and losing is typically the culprit in most cases. Let me explain this further.
If you ask most people how you make money as a trader they will tell you, “by winning trades.” However, this statement is really only a half truth. I actually met a man 2 days ago who told me that, “You never go broke taking a profit.” If only it were as simple as that. When you are so focused on making money on trades it is very easy to forget the importance of controlling how you lose as well. In my humble opinion I would offer you this consideration: making money is the easy part. It’s the losing we have to keep an eye on. You will go broke as a trader if you don’t actually understand when and how to take a profit in your FX trading.
Imagine this scenario for a moment. I have a trading strategy which is fairly aggressive and momentum based. For every dollar I risk, I look to make a dollar in return. If this was my plan, then I now need to ensure that I am right more times than I am wrong to become profitable. It also requires my success rate on the trades to be significantly higher than 50% to make decent gains. Long story short, if I don’t have the skills to time the market effectively then I probably won’t lose too often, but I won’t likely win much either. Sounds hard doesn’t it?
So let’s flip things on their head. Why don’t I risk a little more on each trade so as to give my trade more room to work? This would eliminate those annoying stop-outs that prevent me from winning more often wouldn’t it? So let’s risk 2 dollars to make 1 dollar instead. Surely this way I can get it right more often, hence more profitability. So what happens when I get a streak of losses? Seem to me like small steps forward and giant leaps back. I want to state this clearly right now; I would never recommend trading in this manner, or the risk one to make one approach either. Both are doomed to failure as they require us to be right more than wrong, which becomes incredibly difficult when nobody really knows what will happen next! Please don’t try this at home!
Here at Online Trading Academy we teach our students to trade and invest like the Institutions, not the retail market. Institutions like Goldman Sachs could typically lose 60% of their trades, resulting in wins only 40% of the time, yet still be one of the most profitable financial institutions in the world because their risk to reward will sustain that win loss ratio. What does this tell you? Goldman Sachs is a business, and we should treat our forex trading like a business as well. If those kinds of statistics are good enough for Goldman Sachs, then they are more than good enough for me. A solid risk to reward ratio should ideally be at least 3:1 and no lower. Sure we can go higher than this from time to time but this also comes with a price. Depending on your trading style, you could adjust your reward to risk ratio, but I would encourage you to know why you are doing this before actually doing it. More on this in two weeks for Part 2 of this article. In the meantime I’ll leave you with this thought: You can be right on 99 trades out of 100 and feel like a hero but it only take 1 loss to lose it all.
Safe trading until then my friends,
Sam Evans – firstname.lastname@example.org