In chapter 8 I want to talk about developing your own method. You see it’s something that I believe is critical to ensuring your longer term success as a Forex Trader because there are so many different ways of potentially making money and trading the Forex market. Some of them are good and some are not so good. However there are probably very few ways that actually suit you as an individual. I know with myself that was certainly the case.
You see there are two different personality types here and it’s your own personal personality, what you’re like as a person - whether you’re a calm person or an aggressive person, a proactive person or someone who prefers to wait for things to happen.
As a trader it depends whether you like to really fast pace action of the five minute charts or whether you like something slower like the four hourly charts, the daily charts or the weekly charts. As I’ve mentioned there is no right and wrong way but there’s probably a right and wrong way that suits you as a person and also as your own trading personality. It’s something that you need to develop and recognise over time and that will come overtime because you would try certain strategies that just don’t suit you. Other people say “Look you know I’m making a lot of money with the strategy” but you try it yourself it doesn’t work.
So just because one person is successful with a particular strategy does not mean to say everybody trading that particular method or way of trading will become successful so it’s something that you need to develop for yourself and I know that for myself I developed that over a number of years.
It seemed like every article that I was reading at that time was saying it was all about the shorter timeframe charts and I got to realise that what most people were doing was hunting pips. If you look at most signal services or most systems out there, people would tell you how many pips they’ve made in a day or in a week or in a month or in a year. That’s how they measure their success and that’s how most people would tell you to measure the success of any system, by looking at how many pips they’ve made or lost.
I realised that overtime this was probably not something that was going to work for me because when you’re trading pips, it probably means that on the longer timeframe charts which I was developing into, it meant that the stop loses need to be huge and I’m talking somewhere maybe 50 to 200 or 300 pips as a stop loss and when you’re someone who is used to measuring pips (because that’s all I really knew at that time) those were massive stop losses which meant that I couldn’t really trade those longer timeframe charts and what it meant was I ended up coming back again to the shorter timeframe charts but they just didn’t suit me.
I wasn’t someone who was prepared or wanted to or enjoyed sitting watching charts for 2-3 hours on end and it just didn’t suit me. Now jumping forward a number of years to today, I have a lot of clients who love trading one minute, five minute, fifteen minute charts and do extremely well from it.
When I trade on my live webinars today in front of my clients I trade those shorter timeframe charts because I’m live on a webinar but they don’t really suit me for the majority of the time. So it’s important to develop what suits you. Now there is really nothing wrong with scalping the market and trading those shorter timeframe charts if that’s something that you really enjoy doing and you have the time to do it. However, a number of years ago I realised that most people traded those shorter timeframe charts because they wanted to have small stop losses in terms of the number of pips they were placing on the trade.
After a while I’ve got thinking about this whole money management system and I realised that pips were probably not the answer even though the vast majority of people out there was saying pips is the way to measure success.
So I did some more research into money management and I started to understand that most of the big institutions measure success on a percentage gain. Of course it’s not all about percentage gain because it’s the percentage gain as opposed to the percentage draw down or percentage risk but the percentages to me made more sense. You see if I could say I’ve just made 5% in a week or 5% in a month, to me that was 5% and it didn’t matter whether my account was $1,000 or $10,000 or million dollars it was still a 5% gain which is something that I could measure.
If I had for instance a $10,000 account and I’ve made 50 pips it didn’t mean anything because it depended on the position size that I placed at that time. What I was finding was I was making some successful trades on the shorter timeframe charts and maybe making let’s say a total of 200 pips but if I had one trade on the daily chart that lost and it lost 150 pips, all of a sudden I’ve already made 50 pips total. I’ve made 200 pips on the short time frame charts and that was over the multiple trades but I lost one trade on the daily charts of 150 pips and now all of a sudden I’ve only made 50 pips. To me that just didn’t make sense because all the great trades I was taking on the shorter timeframe charts got almost wiped out by one loosing trade on the daily charts.
So I needed to develop an understanding of money management and the percentage idea really did make a lot of sense. You see the way I trade now, the way that I teach and the way that I started to develop back then was to understand that every single trade that I take has an equal risk percentage so it didn’t matter whether I was risking 20 pips on the trade or 200 pips on the trade. If that trade went wrong and lost, I lost a pre-known amount of my account as a percentage on that trade.
So most people tell you out there to risk somewhere between about 3 and 5 percent of your account per trade. I got to realise that this was crazy because if I had let’s say 3 or 4 trades go wrong and I was risking 5% per trade I was suddenly down by 20% which was a massive amount of draw down and it put emotional pressures on me and then started of making me doubt by next trade because I couldn’t afford to be 20% down on just 4 or 5 trades, it was a crazy amount.
So I’ve got to develop a very low risk way of trading and it’s what suited me and I still use that method today. I risk no more than 0.5% or half of 1% of my account on any one trade. If I was trading a $10,000 account, I risk no more than $50 maximum per trade and I know my risk. Now if I’m trading on a one hour chart it may have a 20 pip stop loss and I lose 0.5% of my account if that trade gets stopped out.
If at the other extreme I’m trading on the daily chart and it has a 200 pip stop loss I still lose half of 1% of my account (0.5%) if that trade goes wrong. I got to understand that I really don’t like risk as a person, well not ridiculous amounts of risk. I like controlled risk and so by knowing that 0.5% of my account was the maximum I was risking on any one trade, it didn’t matter what type of trade was, what the timeframe was, what time of day it was, what currency pair it was, it didn’t matter. I knew the total amount that I could lose has a maximum on each trade.
Now when you develop that further and you add the power of compounding to this you suddenly realise that the idea of risking a certain amount of your account as a percentage risk trade is an extremely powerful money management tool. You see overtime let’s say you grow your $10,000 account into an $11,000 account, all it means that each time as your account grows you are risking a large amount of money on the next trade but it’s still an equal percentage risk. So as your account grows to $11,000 I’m now risking $55 per trade as it grows up to $12,000 I’m now risking $60 per trade. So as you have profitable trades and knew a winning sequence you are actually compounding on your gains because you are risking still the same percentage but a bigger amount of money.
The other benefit of that way of trading is if you have losing trades, which everybody does you are still only risking the same amount as a percentage of your account on each trade. So for example if your account went down from $10,000 down to $9,000 you’re now risking $45 per trade so if you are in a losing run and again everybody has a losing runs and drawdown, as you have losing trades you are actually risking a smaller amount of money per trade and in theory that way you should never ever lose your account because you’re always trading smaller amounts or smaller position sizes per trade if your account is going down.
The benefit is if you develop yourself a winning strategy and a profitable strategy you can still increase your account gain by using the power of compounding to your advantage.
What this now meant was I could then start trading the longer timeframe charts which really suited me better as a person and as a trading personality with confidence knowing I had controlled risk on each trade and so that really did make a huge difference to the profitability of my trading system.
The other thing that also happened is that I suddenly realised that as I’ve mentioned previously is that not all candle patterns are equal and I needed to understand what part of the chart the candle patterns occurred. I also needed to look at the candle pattern where it occurs in relationship to support and resistance levels and pivot points.
The other thing that I developed was the use of round numbers and thay are price levels that end in 50 or 00. You can go and have a look at any chart, on any timeframe on any currency pair and have a look at it and you will see and be amazed about the number of times that the price will bounce at a 00 or 50. When you think about it’s the psychology behind taking the trades, human emotion people like to use those round numbers because there are numbers that are easy to place.
Have a look at let’s say the EUR/USD and it will bounce at 1.3200 or 1.3250 or 1.3300 and it happens all the time on any currency pair. So when I developed the understanding of round numbers it was yet another horizontal form and support resistance to aid my trading. What I didn’t want to do was buy the EUR/USD at 1.3295. It just doesn’t make sense because you’re buying into that huge psychological number which is the 1.3300 level. It makes no sense at all to do that.
However if the currency of the EUR/USD had progressed and pushed through and closed to let’s say 1.3310 what it now meant was I was in a better position to take the trade knowing that the pair had already pushed through and closed above that psychological strong barrier of 1.3300. It also came into my advantage of using those levels when looking for profit targets and stop losses. You wouldn’t want to place a profit target at 1.3405. It just wouldn’t make sense because the price make up to 1.3395 and bounce there and then retrace. So by placing my profit target before the round number if I’m buying, such as at 1.3395, I have a higher probability of exiting my trade for profit without worrying about the price having to breakthrough at 1.3400 and bounce there and potentially retrace and stop me out.
Likewise if I’m placing a stop loss on a buy trade I want to put my stop loss below a round number. So for instance if I was buying at 1.3310, I might to place my stop loss at 1.3290 or 1.3245 so that it’s placed down below the round numbers because the price could come back down to 1.3250 and bounce there. So by having my stop loss below that 50 at 1.3245 it actually means I have another barrier, a support barrier in the way of my stop loss.
So you can see how those levels, those round numbers can be really beneficial to your trading. So by putting all of this information together I also realised that there are two different ways of trading that suited me. I was trading what I called the reversal pattern or I was trading what I called a continuation pattern.
Both of them used price action, support and resistance levels, round numbers and everything else that I was looking for within my trading but it was just an understanding of what part of the chart the trade is in the or the pair is in right now.
A reversal trade looks more dramatic on your charts and for instance if you have a very large uptrend and then a reversal pattern you would then be looking for a sell position at the top of an uptrend. It looked really very good on a chart and it does make some fantastic trades but it can be a little bit more unreliable because you’re trading against the previous trend.
When you use candle patterns you also look for things like exhaustions so that could be pin bars, or dojis or hanging man patterns which give you a clue that the uptrend coming to an end first and then we’re looking for the reversal pattern. When you see these on your charts you’re also ideally looking for that exhaustion and reversal to happen at a strong barrier level, a psychological resistance level so it’s not just the candle pattern just showing on the charts. It’s now candle patterns showing on the charts for a reason. There may be a previous bounce at that level sometime in the past, it may be a very strong 00 number, it may be the pivot point. Whatever it is by having some form of reason for the reversal it adds to the probability of your trade working.
The other form of price action that I really enjoyed trading is trading more with the longer term trend but let’s say we still had the same uptrend, we then have a pull back and after that pull back we’re looking for that pull back to end and stall and then for overall uptrend to continue. I call that a continuation pattern. So there are various things that I’m looking for my charts to backup the two patterns but what we’re doing by adding these psychological bounce levels is adding probability to the pattern. Now when I was trading with the money management system that I described and I was getting away from pips it meant that I was happier with my trading, I was calmer with my trading, I was spending a lot less time trading on the charts but I was making a lot more money.
Ultimately that’s what you want for your trading. You probably don’t want trading be tying up your life in terms of being forced to watch charts all day and night and of course you want to make money from it. So by having controlled risk, by working to the longer term timeframe charts such as the daily charts I was developing a method that work for me.
The other timeframes that I really did enjoy trading apart from the daily charts was down to probably the one hour charts which to this day I still enjoyed trading. It means that I know I can go to my charts once every hour and for me generally is in the European session. I don’t trade the US session because for me it’s in the middle of the night but depending on where you live in the world you can trade the Asian session, the Euro session or the US session or whichever combinations suit you if you want to trade the shorter timeframe charts.
As I’m looking at candle patterns I know that I can only take a new trade on the completion of each new candle. So if I’m trading on the one hour charts I know that once the clock has ticked over at the top pf the hour I can go to my charts and look at candle patterns and potentially take a new trade.
Once I’ve taken that trade or pass on any trades I know I have a full one hour until there are any new potential trades and again when it comes to developing a system that suits you, knowing when to trade and having that control around when you’re trading to me is very important. You see there are so many systems out there that will trade when A crosses B, when B crosses C and of course that could happen anytime of the day or night and to me that was a big disadvantage. Trading candle patterns is a big positive and a big advantage because I could only trade once the candle pattern or the candle itself had completed. So it meant that I could set my trading around everything else that I was doing.
When it came to four hour charts trading today that was also one of my very favorite timeframes to trade because it means that I have four hours after taking or looking at the charts or taking a trade before any potential new trade.
However back a number of years ago when I started looking at four hour charts I realised that four hour charts look different on different brokers and initially to me it was something to stay away from because if I was looking let’s say for instance on Go Markets platform, their four hour chart might be showing what looked like a bullish pattern. If I went let’s say to my FXCM charts they would completely different. If I went to another broker such as the Dukascopy, Alpari, Pepperstone or Axitrader they might look completely different again.
The reason for this is that there are certain brokers start and end their day at different times and I got to realise that it’s very important when you’re trading the four hour charts and also the daily charts to choose a broker who starts their day both the new week and the new day at 5pm Eastern Standard Time/New York Time each day.
When you trade that day you’ll realise that the daily chart is from 5 o’clock pm New York Time to 4:59pm which is coinciding with the New York Time close of day time with the other markets in New York such as the Stock Exchange which also closes at 5pm. So when it comes to four hour charts you really notice that if you have different brokers with different start of day times.
My advice is to choose a broker who starts their day at 5pm Eastern Standard Time throughout the entire year. If you do that you’ll find that your pivot points, your support and resistance levels, the look of your candle patterns will be uniform with what I called the correct charts. It’s something that a lot of brokers still don’t understand and still don’t offer their clients so just a really important tip there for you if you want to trade the four hour charts and the daily charts. In fact probably any timeframe charts at all so choose your broker that has a 5pm Eastern Standard Time start of day and start of week. So that’s a really understanding of why you need to develop your own method that suits you.