5. The Joy of Risk Free Trade
- Learning how to make a risk free trading environment but moving stop loss to break even.
- Although this sounds easy, it is a skill which must be carried out appropriately. In addition we look at how to let profits run.
Unfortunately for all of us there is no such thing as risk free trading. However, from my years of forex trading and research, I have applied a method which gives me the ability to occasionally create such an environment when the appropriate conditions permit. For instance, if I have successfully detected a top, gone short and have captured a 50 to 100 pip profit, I then move my stop to secure between breakeven and 10 to 20 pips of profit. After doing this, I am then in the envious position of being able to trade risk free as long as the applicable trade is active. Deciding when to move the stop and how much profit to secure is still difficult. Quite often, my trade has been stopped out after performing this maneuver but occasionally I have enjoyed quite large profits in the order of hundreds of pips - especially if I have allowed my trade to run.
How to make the most of risk free trading, minimizing risks and maximizing profits is the subject of this chapter.
The basic problem is to be able to master forex trading to the point whereby you can generate a risk free trading environment by placing your stops at breakeven or better while attaining a good trading margin. To achieve this goal, you will need to trade your forex system consistently over a long period of time. As such, you will first need a consistent set of rules that you can follow with confidence and that can be applied using good money management strategies. Trading psychology is also highly important to ensure that all trading decisions are made with discipline, confidence, and consistency.
Sticking to your system for any length of time is nearly impossible without having sufficient trust in your trading ability. For instance, after experiencing their first bouts of consecutive losses, many traders suffer serious drops in their confidence which causes them to deviate from the essential discipline required for success. With each subsequent negative result, their natural impulse to avoid any further pain increases, causing faith in their trading ability to constantly wane.
Trading psychology is affected primarily by two factors:
- Frustrations when reality does not match expectations.
- Loss of trust in their trading systems after suffering severe drops in confidence.
How can traders regain positive attitudes when their most immediate reference point is a string of very painful losses? New traders must immediately realize that forex trading is an activity where losses always occur. One of the most recommended methods used to defend against the very debilitating experience of failure is to develop a system that can be used to trade consistently and confidently. This goal can be achieved by selecting a trading strategy which comprises a set of rules that can be readily adhered to over the long haul. Once this goal is realized, some of your risk free trades may be stopped out but at least you have managed to minimize your risks successfully which is one of the most important aspects in order to improve your long-term profits. Money management and capital protection should have the highest priority in any trading strategy. Without capital you will be out of the game. However, you must also realize that moving your stop too soon e.g. after gaining 10 pip profits will reduce your chances of gaining large overall profits of 100s of pips because your trade will most likely be closed prematurely. Finding this balance is a difficult task that will take time. However, using your trade log as described in chapter 1, to record the details of each of your trades will help you find the optimal solution faster.
My own trading logbook revealed to me that when I used small stop losses of 20 to 30 pips, whilst aiming for profits of several hundreds of pips, my trades were stopped out most of the time. Basically, the reason this seems to be that there was too much randomness in the forex market for these tight margins to succeed. That is not to say that on a short time frame there will be more random moves, as this would imply the same for longer time frames. However, the market moves in waves, and using small stop losses will easily get you stopped out, in spite of a strong trend.
I have subsequently found that I could achieve much better results by using larger stops with values of 50 to 100 pips. This is a good example of the value of keeping a trading log. As these examples highlight the uncertainty of forex trading, all traders must acquire a very good understanding of money management principles. This will help them control and restrict the impact of unavoidable losses on their account balance. Basically, a money management strategy is a statistical tool that helps control the risk exposure and profit potential of every trade activated. The successful use and deployment of its concepts is a major factor that differentiates expert traders from those who lose money trading the forex market. As an example, one of the simplest money management strategies is the fixed risk ratio which states that you must never risk more than 5% of their account on any one trade. The risk for each trade is kept within these parameters by correctly determining and evaluating its position size and stop loss.
Position size is the amount of currency to be either bought or sold.
Stop loss determines the acceptable loss a trader is prepared to take.
Entering trades with just calculated profit targets can be disastrous if you have not clearly calculated a protective stop loss. Money management will advise in determining a realistic risk:reward ratio that will limit the effects of draw-downs and they will help you in selecting essential accurate stop loss and target limits for each trade entered.
New trading systems should be back tested using historical data with the objective of producing positive win:loss ratios and expectancy values. The above mentioned analysis will help you in estimating a realistic and measured performance of the capabilities and limitations of the trading system. In particular, you will know how many losing trades might be encountered during an overall profitable period of time. This knowledge will help you during periods of adversity so you can still persevere with your system by trading in a consistent manner. All types of trading are unpredictable and even sure-fire deals can turn surprisingly bad in a matter of moments.
Once you are able to create risk free trading opportunities, how do you maximize your profits? One of the most difficult things to do in trading is letting your profits run. How do you approach this in practice? Obviously, a small trailing stop is totally inadequate. A simple manual plan would be to trade in batches of three. Then you need to pick 2 target areas to lock in profits. Let lot 1 run to target area 1 and take profit; let lot 2 run to target area 2 and take profit. Finally place lot 3's stop to breakeven and let it run until your strategy's exit condition is met. If the events occur as planned, the worst thing that can happen to you is that you have 2 profitable targets and a third that could be stopped out at breakeven. This sounds easy but it is not. Why is it so hard to hold on to winning trades? The emotion of fear comes into play because the sight of large profits entices a trader to take profit early before a possible rebound occurs producing a resultant loss. Also, watching a profitable trade reverse, invokes many mind-numbing emotions that cripple the consistency of trading decisions. After consequent losses, traders suffer confidence drops that again produce a tendency to make them snatch early smaller profits before the real earning potential arises.
Sadly, many forex traders enter good opportunities but either take premature profits or are stopped out. They then watch in frustration as the trade proceeds in their chosen direction amassing sizeable profits without them participating; an aspect which can easily result in overtrading. If you are a trend follower and are taking breakouts in many different markets hoping to catch a large move, it is crucial that you let your profits run. Trying to design a trading system capable of capturing large trends generates many human emotions such as regret, revenge, and greed that have devastating effects on the standard of trading decisions. A loss always requires a bigger win to recover. This is one important rule that you need to understand in order to become a successful trader.
You should now begin to comprehend the importance of not over-trading as well as ensuring that your position sizes are only an acceptable percentage of your account balance. As losses always require bigger wins to recoup your balance, trading appears to be a losing battle especially if you have a gambling mindset and don't adopt a more professional approach such as ensuring your trading system has a positive expectancy value. If you think trading small will take you a long time to amass serious cash, just remember, you will be able to compound your profits quickly, especially if you can master the art of risk free trading.
Table of Contents
- Legal Notice
- 1. The Importance of Using a Forex Trading Log
- 2. Through the Eyes of a Beginner
- 3. Thoughts on Fundamental News
- 4. Trend Following or Bottom-Top Picking?
- 5. The Joy of Risk Free Trade
- 6. The Importance of Risk:Reward and Winning Percentage
- 7. Technical Analysis
- 8. Separating Breakouts from Fakeouts
- 9. The Correct Use of Correlation
- 10. You Must Have an Exit Strategy
- 11. Breakout Trading Strategy
- 12. Trading Trend Retracements
- 13. Trading the Fundamental Data Releases
- 14. Picking Tops and Bottoms
- 15. Trading Gaps
- 16. Trading Fakeouts
- 17. Trading With Large Stop Losses
- 18. Candlestick Confirmation