FOREX MASTERY ACADEMY @Zw
Risk Management
Risk management is one of the most important topics you will ever read about trading.
Why is it important? Well, we are in the business of making money, and in order to make money we have to learn how to manage risk (potential losses).
Ironically, this is one of the most overlooked areas in trading.
Many forex traders are just anxious to get right into trading with no regard for their total account size.
They simply determine how much they can stomach to lose in a single trade and hit the “trade” button.
There’s a term for this type of investing….it’s called…
GAMBLING!
✅When you trade without risk management rules, you are in fact gambling.
You are not looking at the long-term return on your investment. Instead, you are only looking for that “jackpot.”
Risk management rules will not only protect you, but they can make you very profitable in the long run. If you don’t believe us, and you think that “gambling” is the way to get rich, then consider this example:
People go to Las Vegas all the time to gamble their money in hopes of winning a big jackpot, and in fact, many people do win.
☝️In the end, forex trading is a numbers game, meaning you have to tilt every little factor in your favor as much as you can.
In casinos, the house edge is sometimes only 5% above that of the player. But that 5% is the difference between being a winner and being a loser.
You want to be the rich statistician and NOT the gambler because, in the long run, you want to “always be the winner.”
How Much Trading Capital Do You Need For Forex Trading?
It takes money to make money. You need trading capital.
The answer largely depends on how you are going to approach your new start-up business.
First, consider how you are going to be educated.
There are many different approaches to learning how to trade: classes, mentors, on your own, or any combination of the three.
While there are many classes and mentors out there willing to teach forex trading, most will charge a fee.
👉The benefit of this route is that a well-taught class or great mentor can significantly shorten your learning curve and get you on your way to profitability in a much shorter amount of time compared to doing everything yourself.
👉The downside is the upfront cost for these programs, which can range from a few hundred to a few thousand dollars, depending on which program you go with.
👉For many of those new to trading, the resources (money) required to purchase these programs are not available.
✅As long as you are disciplined and laser-focused on learning the markets, your chances of success increase exponentially. You have to be a gung-ho student. If not, you’ll end up in the poor house.
👉Second, is your approach to the markets going to require special tools such as news feeds or charting software?
As a technical forex trader, most of the charting packages that come with your broker’s trading platform are sufficient (and some are actually quite good).
👉For those who need special indicators or better functionality, higher-end charting software can start at around $100 per month.
👉Maybe you’re a fundamental trader and you need the news the millisecond it is released, or even before it happens (wouldn’t that be nice!).
👉Well, instantaneous and accurate news feeds run from a few hundred to a few thousand dollars per month.
👉Again, you can get a complimentary news feed from your forex broker, but for some, that extra second or two can be the difference between a profitable or unprofitable trade.
👉Finally, you need money/capital/funds to trade. Retail
👉Retail forex brokers offer minimum account deposits as low as $25, but that doesn’t mean you should enter immediately!
This is a capitalization mistake, which often leads to failure. Losses are part of the game, and you need to have enough capital to weather these losses.
👉So how much trading capital do you need?
Let’s be honest here, if you’re consistent and you practice proper risk management techniques, and stick to trading micro lots, then you can probably start off with $5k to $10k in trading capital.
It’s common knowledge that most businesses fail due to undercapitalization, which is especially true in the forex trading business.
👉So if you are unable to start with a large amount of trading capital that you can afford to lose, be patient, save up and learn to trade the right way until you are financially ready.
Drawdown and Maximum Drawdown Explained
A drawdown is the reduction of one’s capital after a series of losing trades.
This is normally calculated by getting the difference between a relative peak in capital minus a relative trough.
Traders normally note this down as a percentage of their trading account.
A trading system that is 70% profitable sounds like a very good edge to have. But just because your trading system is 70% profitable, does that mean for every 100 trades you make, you will win 7 out of every 10?
Not necessarily! How do you know which 70 out of those 100 trades will be winners?
The answer is that you don’t. You could lose the first 30 trades in a row and win the remaining 70.
That would still give you a 70% profitable system, but you have to ask yourself, “Would you still be in the game if you lost 30 trades in a row?”
This is why risk management is so important. No matter what system you use, you will eventually have a losing streak.
Even professional poker players who make their living thro
✅The reason is that the good poker players practice risk management because they know that they will not win every tournament they play.
Instead, they only risk a small percentage of their total bankroll so that they can survive those losing streaks.
This is what you must do as a trader.Drawdowns are part of trading.
The key to being a successful forex trader is coming up with trading plan that enables you to withstand these periods of large losses. And part of your trading plan is having risk management rules in place.
Only risk a small percentage of your “trading bankroll” so that you can survive your losing streaks.
Remember that if you practice strict money management rules, you will become the casino and in the long run, “you will always win.”
Never Risk More Than
How much should you risk per trade?Try to limit your risk to 2% per trade.
But that might even be a little high. Especially if you’re newbie forex trader.
You can see that there is a big difference between risking 2% of your account compared to risking 10% of your account on a single trade!
If you happened to go through a losing streak and lost only 19 trades in a row, you would’ve gone from starting with $20,000 to having only $3,002 left if you risked 10% on each trade.
You would’ve lost over 85% of your account!
If you risked only 2% you would’ve still had $13,903 which is only a 30% loss of your total account.
☝️Of course, the last thing we want to do is to lose 19 trades in a row, but even if you only lost 5 trades in a row, look at the difference between risking 2% and 10%.
👉If you risked 2% you would still have $18,447.
👉If you risked 10% you would only have $13,122.
That’s less than what you would’ve had even if you lost all 19 trades and risked only 2% of your account!
The point of this illustration is that you want to setup your risk management rules so that when you do have a drawdown period, you will still have enough capital to stay in the game.
Here is a table that will illustrate what percentage you would have to make to break even if you were to lose a certain percentage of your account.☝️
☝️You can see that the more you lose, the harder it is to make it back to your original account size.
This is all the more reason that you should do everything you can to PROTECT your account.
By now, we hope you have gotten it drilled into your head that you should only risk a small percentage of your account per trade so that you can survive your losing streaks and also to avoid a large drawdown in your account.
Remember, you want to be the casino… NOT the gambler!
☝️You can see that the more you lose, the harder it is to make it back to your original account size.
This is all the more reason that you should do everything you can to PROTECT your account.
By now, we hope you have gotten it drilled into your head that you should only risk a small percentage of your account per trade so that you can survive your losing streaks and also to avoid a large drawdown in your account.
Remember, you want to be the casino… NOT the gambler!
Reward-to-Risk Ratio
To increase your chances of profitability, you want to trade when you have the potential to make 3 times more than you are risking.
If you give yourself a 3:1 reward-to-risk ratio, you have a significantly greater chance of ending up profitable in the long run.
Example 3 to 1 Reward to Risk Ratio
☝️In this example, you can see that even if you only won 50% of your trades, you would still make a profit of $10,000.
Just remember that whenever you trade with a good risk to reward ratio, your chances of being profitable are much greater even if you have a lower win percentage.
On the very surface, the concept of putting a high reward-to-risk ratio sounds good, but think about how it applies in actual trade scenarios.
Let’s say you are a scalper and you only wish to risk 3 pips.
Using a 3:1 reward to risk ratio, this means you need to get 9 pips. Right off the bat, the odds are against you because you have to pay the spread.
If your broker offered a 2 pip spread on EUR/USD, you’ll have to gain 11 pips instead, forcing you to take a difficult 4:1 reward to risk ratio.
If you were to reduce your position size, then you could widen your stop to maintain your desired reward/risk ratio.
Now, if you increased the pips you wanted to risk to 50, you would need to gain 153 pips.
By doing this, you are able to bring your reward-to-risk ratio somewhere nearer to your desired 3:1. Not so bad anymore, right?
In the real world, reward-to-risk ratios aren’t set in stone. They must be adjusted depending on the time frame, trading environment, and your entry/exit points.
☝️In this example, you can see that even if you only won 50% of your trades, you would still make a profit of $10,000.
Just remember that whenever you trade with a good risk to reward ratio, your chances of being profitable are much greater even if you have a lower win percentage.
On the very surface, the concept of putting a high reward-to-risk ratio sounds good, but think about how it applies in actual trade scenarios.
Let’s say you are a scalper and you only wish to risk 3 pips.
Using a 3:1 reward to risk ratio, this means you need to get 9 pips. Right off the bat, the odds are against you because you have to pay the spread.
If your broker offered a 2 pip spread on EUR/USD, you’ll have to gain 11 pips instead, forcing you to take a difficult 4:1 reward to risk ratio.
If you were to reduce your position size, then you could widen your stop to maintain your desired reward/risk ratio.
Now, if you increased the pips you wanted to risk to 50, you would need to gain 153 pips.
By doing this, you are able to bring your reward-to-risk ratio somewhere nearer to your desired 3:1. Not so bad anymore, right?
In the real world, reward-to-risk ratios aren’t set in stone. They must be adjusted depending on the time frame, trading environment, and your entry/exit points.
Leverage: Why Most New Forex Traders Fail
Most professional forex traders and money managers trade one standard lot for every $50,000 in their account.
If they traded a mini account, this means they trade one mini lot for every $5,000 in their account.
Let that sink into your head for a couple seconds.
If pros trade like this, why do less experienced forex traders think they can succeed by trading 100K standard lots with a $2,000 account or 10K mini lots with $250?
No matter what the forex brokers tell you, don’t ever open a “standard account” with just $2,000 or a “mini account” with $250.
Heck, some even allow you to open accounts with just $25!
❗️The number one reason new traders fail is not because they suck, but because they are undercapitalized from the start and don’t understand how leverage really works.
☝️Don’t set yourself up to fail.
We recommend that you have at least have $100,000 of trading capital before opening a standard account, $10,000 for a mini account, or $1,000 for a micro account.
Of course, open an account only when you are consistently good.
So if you only have $60,000, open a mini account. If you only have $8,000, open a micro account.
☝️We believe most new traders who open a forex trading account with the bare minimum deposit do so because they don’t completely understand what the terms “leverage” and “margin” really are and how it affects their trading.
It’s crucial that you’re fully aware and free of ignorance of the significance of trading with leverage.
If you don’t have rock solid understanding of leverage and margin, we guarantee that you will BLOW YOUR TRADING ACCOUNT!
Leverage and Margin Explained
What is leverage?
We know we’ve tackled this before, but this topic is so important, we felt the need to discuss it again.
The textbook definition of “leverage” is having the ability to control a large amount of money using none or very little of your own money and borrowing the rest.
Forex Leverage example, to control a $100,000 position, your broker will set aside $1,000 from your account. Your leverage, which is expressed in ratios, is now 100:1.
You’re now controlling $100,000 with $1,000.
Let’s say the $100,000 investment rises in value to $101,000 or $1,000.
If you had to come up with the entire $100,000 capital yourself, your return would be a puny 1% ($1,000 gain / $100,000 initial investment).Fortunately, you’re not leveraged 1:1, you’re leveraged 100:1.
The broker only had to put aside $1,000 of your money, so your return is a groovy 100% ($1,000 gain / $1,000 initial investment).
Now we want you to do a quick exercise. Calculate what your return would be if you lost $
What is margin?
So what about the term “margin”? Excellent question.Let’s go back to the earlier example:
In forex, to control a $100,000 position, your broker will set aside $1,000 from your account. Your leverage, which is expressed in ratios, is now 100:1. You’re now controlling $100,000 with $1,000.
The $1,000 deposit is “margin” you had to give in order to use leverage.
Margin is the amount of money needed as a “good faith deposit” to open a position with your broker.
It is used by your broker to maintain your position. Your broker basically takes your margin deposit and pools them with everyone else’s margin deposits, and uses this one “super margin deposit” to be able to place trades within the interbank network.
Margin is usually expressed as a percentage of the full amount of the position. For example, most forex brokers say they require 2%, 1%, .5% or .25% margin.
Based on the margin required by your broker, you can calculate the maximum leverage you can wield with your trading account.
☝️There is much confusion about what these different “margins” mean so we will try our best to define each term:
👉Margin requirement: This is an easy one because we just talked about it. It is the amount of money your broker requires you to open a position. It is expressed in percentages.
👉Account balance: This is just another phrase for your trading bankroll. It’s the total amount of money you have in your trading account.
👉Used margin: The amount of money that your broker has “locked up” to keep your current positions open.
While this money is still yours, you can’t touch it until your broker gives it back to you either when you close your current positions or when you receive a margin call.
👉Usable margin: This is the money in your account that is available to open new positions.
👉Margin call: You get this when the amount of money in your account cannot cover your possible loss. It happens when your equity falls below your used margin.
If a margin call occurs, some or all open positions will be closed by the broker at the market price.
☝️Margin can be thought of as a good faith deposit or collateral that’s needed to open a position and keep it open.
Margin trading gives you the ability to enter into positions larger than your account balance.
Although buying and selling on margin does not provide leverage in and of itself, it can be used as a form of leverage.
This is because the amount of margin you are allowed to take out typically depends on how much money you have in your account.
Trading currencies on margin let you increase your buying (and selling) power.
Margin Call
All traders fear the dreaded margin call.
It’s not a great feeling.
This occurs when your broker notifies you that your margin deposits have fallen below the required minimum level because an open position has moved against you too much.
While trading on margin can be profitable, it is important that you take the time to understand the risks.
Make sure you fully understand how your margin account works, and be sure to read the margin agreement between you and your broker.
Always ask any questions if there is anything unclear to you in the agreement.
Your positions could be partially or totally liquidated should the available margin in your account fall below a predetermined threshold.
You may not receive a margin call before your positions are liquidated (the ultimate unexpected birthday gift).
✅In the event that money in your account falls below margin requirements (usable margin), your broker will close some or all open positions.
👉This can help prevent your account from falling into a negative balance, even in a highly volatile, fast-moving market.
👉Margin calls can be effectively avoided by monitoring your account balance on a very regular basis and by utilizing stop loss orders on every open position to limit risk.
👉Keep in mind though that your stop loss may experience massive slippage when the market is moving fast!
☝️If you are going to trade on a margin account, it’s vital that you know what your broker’s policies are on margin accounts and that you understand and are comfortable with the risks involved.
You should also know that most brokers require a higher margin during the weekends. This may take the form of 1% margin during the week and if you intend to hold the position over the weekend it may rise to 2% or higher.
Brokers also may have different margin requirements for different currency pairs so pay attention to that as well!
All traders fear the dreaded margin call.
It’s not a great feeling.
This occurs when your broker notifies you that your margin deposits have fallen below the required minimum level because an open position has moved against you too much.
While trading on margin can be profitable, it is important that you take the time to understand the risks.
Make sure you fully understand how your margin account works, and be sure to read the margin agreement between you and your broker.
Always ask any questions if there is anything unclear to you in the agreement.
Your positions could be partially or totally liquidated should the available margin in your account fall below a predetermined threshold.
You may not receive a margin call before your positions are liquidated (the ultimate unexpected birthday gift).
✅In the event that money in your account falls below margin requirements (usable margin), your broker will close some or all open positions.
👉This can help prevent your account from falling into a negative balance, even in a highly volatile, fast-moving market.
👉Margin calls can be effectively avoided by monitoring your account balance on a very regular basis and by utilizing stop loss orders on every open position to limit risk.
👉Keep in mind though that your stop loss may experience massive slippage when the market is moving fast!
☝️If you are going to trade on a margin account, it’s vital that you know what your broker’s policies are on margin accounts and that you understand and are comfortable with the risks involved.
You should also know that most brokers require a higher margin during the weekends. This may take the form of 1% margin during the week and if you intend to hold the position over the weekend it may rise to 2% or higher.
Brokers also may have different margin requirements for different currency pairs so pay attention to that as well!
Never Underestimate Leverage
Most beginners underestimate the potentially devastating damage leverage can wreak on their accounts.
Understanding leverage enough to know when to use it and when NOT to use it is critical to your success!
Never Underestimate Forex Leverage
Leverage is a very powerful tool but both old and new traders use it to destroy their trading capital simply because they take its destructive force too lightly or ignore it altogether.
It’s a pity, but the more of them there are, the easier it is for us smart traders to make money. Sad but true.
Always keep in mind these words from a famous superhero:
“With great power comes great responsibility.”
👉Most brokers want you to trade with a short-term mindset.
They want you to trade as much as possible as often as possible.
It’s the only way they make money. One or two pips are important to them.
The more you trade the more they make on the spread.
It’s not in their best interest to tell you to let your trades run longer than the same day.
If you want to give yourself the best chance to succeed, first learn to trade profitably without leverage.
Play it safe. Protect your capital.
When you can consistently make more pips more than you lose then, and only then, should you use unleash this weapon of mass destruction called leverage.
☝️Forex trading should be treated as a job or business.
Don’t think that just because brokers allow you to use high leverage with a low minimum deposit that you can “make a quick ” or “get rich quick”. Approach the currency markets with respect.
Be realistic in your expectations and be willing to properly educate yourself.
❗️If you don’t, you will die.❗️
Okay, not really, but your account will die.
Position Sizing
Position sizing is setting the correct amount of units to buy or sell a currency pair.
It is one of the most crucial skills in a forex trader’s skill set.
👉Forex Position Sizing
Actually, we’ll go ahead and say it is THE most important skill.
Traders are “risk managers“, first and foremost, so before you start trading real money, you should be able to do position size calculations in your sleep!
Finding the position size that will keep you within your risk comfort level is relatively easy…and we use the phrase “relatively easy” loosely here.
Depending on the currency pair you are trading and your account denomination (is your account in dollars, euros, pounds, etc.), a step or two needs to be added to the calculation.
☝️Now, before we can get our math on, we need five pieces of information:
👉Account equity or balance
👉Currency pair you are trading
👉The percent of your account you wish to risk
👉Stop loss in pips
👉Conversion currency pair exchange rates
Stop Loss
Managing and preserving your trading capital should is your most important job as a trader.
If you lose all of your trading capital, there is no way you can make back the lost amount, you’re out of the trading game.
If you make pips, you got to be able to keep those pips and not give them back to the market.
But let’s face it. The market will always do what it wants to do, and move the way it wants to move.
Every day is a new challenge, and almost anything from global politics, major economic events, to central bank rumors can turn currency prices one way or another faster than you can snap your fingers.
☝️Being in a losing position is inevitable, but we can control what we do when we’re caught in that situation.
You can either cut your loss quickly or you can ride it in hopes of the market moving back in your favor.
Of course, that one time it doesn’t turn your way could blow out your account and end your budding trading career in a flash.
The saying, “Live to trade another day!” should be the motto of every trader on Newbie Island because the longer you can survive, the more you can learn, gain experience, and increase your chances of success.
✅Having a predetermined point of exiting a losing trade not only provides the benefit of cutting losses so that you may move on to new opportunities, but it also eliminates the anxiety caused by being in a losing trade without a plan.
Less stress is good, right?
Of course, it is, so let’s move on to different ways to cut ’em losses quick!
Now before we get into stop loss techniques, we have to go through the first rule of setting stops.
Your stop loss point should be the “invalidation point” of your trading idea.
❗️Why Use a Stop Loss?
The main purpose of a stop loss is to ensure that losses won’t grow too BIG.
While this might sound obvious, there is a little more to this than you might assume.
For each trade, the trading strategy only has two possible outcomes:
👉A profit.
👉A loss.
This means that the strategy exits a trade when the stop loss (SL) is hit OR when the Take Profit (PT) is hit.
❗️How To Set A Stop Loss Based On A Percentage Of Your Account
The percentage-based stop uses a predetermined portion of the trader’s account.
For example, “2% of the account” is what a trader is willing to risk on a trade.
The percentage risk can vary from trader to trader. More aggressive ones risk up to 10% of their account while less aggressive ones usually have less than 1% risk per trade.
Once the percentage risk is determined, the forex trader uses his position size to compute how far he should set his stop away from his entry.
☝️You should always set your stop according to the market environment or your system rules, NOT how much you want to lose.
We bet you’re thinking right now, “Huh? That doesn’t make any sense. I thought you said that we need to manage risk.”
We agree that this sounds confusing, but let us explain with an example.
You have a mini account with $500 and the minimum size you can trade is 10k units. You decide to trade GBP/USD, as he sees that resistance at 1.5620 has been holding.
As per his risk management rules, you will risk no more than 2% of your account per trade.
At 10k units of GBP/USD, each pip is worth $1 and 2% of your account is $10.
☝️But GBP/USD moves over 100 pips a day! You could easily get stopped out at the smallest move of GBP/USD.
Because of the position limits your account is set to, you are basing your stop solely on how much you want to lose instead of the given market conditions of GBP/USD.
☝️How To Set A Stop Loss Based On Support And Resistance From Charts
A more sensible way to determine stops would be to base it on what the charts are saying.
Since we’re trading the markets, we might as well base our stops on what the markets are showing us… Makes sense, right?
One of the things that we can observe in price action is that there are times when prices can’t seem to push or break beyond certain levels.
Often times, when these areas of support or resistance are retested, they could potentially hold the market from pushing through once again.
Setting stops beyond these levels of support and resistance makes sense, because if the market does trade beyond these areas, then it is reasonable to think that a break of that area will bring in more traders to play the break and further push your position against you.
Or, if these levels DO break, then there may be forces that you are unaware of suddenly pushing the market one way or another.
Let’s take a quick look at a way to set your stops based on support and resistance☝️
On the chart above, we can see that the pair is now trading above the falling trend line.
You decide that this is a great breakout trade setup and you decide to go long.
But before you enter your trade, ask yourself the following questions:
👉Where could you possibly set your stop?
👉What conditions would tell you when your original trade idea is invalidated?
In this case, it makes the most sense to set your stops below the trend lines and support areas.
If the market moves into these areas, that means the trend lines drew no support from buyers and now sellers are in control.
Your trade idea was invalidated and it’s time you to suck it up, exit the trade, and accept the loss.
✅How To Set A Stop Loss Based On Price Volatility
Knowing how much a currency pair tends to move can help you set the correct stop loss levels and avoid being prematurely taken out of a trade on random fluctuations of price.
For instance, if you are in a swing trade and you know that EUR/USD has moved around 100 pips a day over the past month, setting your stop to 20 pips will probably get you stopped out too early on a small intraday move against you.
Knowing the average volatility helps you set your stops to give your trade a little breathing room and a chance to be right.
If the market moves into these areas, that means the trend lines drew no support from buyers and now sellers are in control.
Your trade idea was invalidated and it’s time you to suck it up, exit the trade, and accept the loss.
✅How To Set A Stop Loss Based On Price Volatility
Knowing how much a currency pair tends to move can help you set the correct stop loss levels and avoid being prematurely taken out of a trade on random fluctuations of price.
For instance, if you are in a swing trade and you know that EUR/USD has moved around 100 pips a day over the past month, setting your stop to 20 pips will probably get you stopped out too early on a small intraday move against you.
Knowing the average volatility helps you set your stops to give your trade a little breathing room and a chance to be right.
You can use Bollinger Bands to give you an idea of how volatile the market is right now.
This can be particularly useful if you are doing some range trading. Simply set your stop beyond the bands.
If price hits this point, it means volatility is picking up and a breakout could be in play.
Another way to find the average volatility is by using the Average True Range (ATR) indicator.
This is a common indicator that can be found on most charting platforms, and it’s really easy to use.
All the ATR requires is that you input the “period” or amount of bars, candlesticks, or time it looks back to calculate the average range.
For example, if you are looking at a daily chart, and you input “20” into the settings, then the ATR indicator will magically calculate the average range for the pair over the past 20 days.
Or if you are looking at an hourly chart and you input 50 into the settings, then the ATR indicator will show you the average movement of the last 50 hours. Pretty sweet, huh?
☝️This process can be applied by itself as a stop or in conjunction with other stop loss techniques.
The point is to give your trade enough breathing room for fluctuations here and there before it heads your way… and hopefully, it does.
This is a common indicator that can be found on most charting platforms, and it’s really easy to use.
All the ATR requires is that you input the “period” or amount of bars, candlesticks, or time it looks back to calculate the average range.
For example, if you are looking at a daily chart, and you input “20” into the settings, then the ATR indicator will magically calculate the average range for the pair over the past 20 days.
Or if you are looking at an hourly chart and you input 50 into the settings, then the ATR indicator will show you the average movement of the last 50 hours. Pretty sweet, huh?
☝️This process can be applied by itself as a stop or in conjunction with other stop loss techniques.
The point is to give your trade enough breathing room for fluctuations here and there before it heads your way… and hopefully, it does.
3 Rules of Setting Stop Losses
👉Rule #1: Don’t let emotions be the reason you move your stop.
Like your initial stop loss, your stop adjustments should be predetermined before you put your trade on. Don’t let panic get in the way!
👉Rule #2: Do trail your stop.
Trailing you stop means moving it in the direction of a winning trade. This locks in profits and manages your risk if you add more units to your open position.
👉Rule #3: Don’t widen your stop.
Increasing your stop only increases your risk and the amount you will lose. If the market hits your planned stop then your trade is done. Take the hit and move on to the next opportunity.
Widening your stop is basically like not having a stop at all and it doesn’t make any sense so to do it! Never widen your stop!
These rules are pretty easy to understand and should be followed religiously especially rule number 3!
👉Rule #1: Don’t let emotions be the reason you move your stop.
Like your initial stop loss, your stop adjustments should be predetermined before you put your trade on. Don’t let panic get in the way!
👉Rule #2: Do trail your stop.
Trailing you stop means moving it in the direction of a winning trade. This locks in profits and manages your risk if you add more units to your open position.
👉Rule #3: Don’t widen your stop.
Increasing your stop only increases your risk and the amount you will lose. If the market hits your planned stop then your trade is done. Take the hit and move on to the next opportunity.
Widening your stop is basically like not having a stop at all and it doesn’t make any sense so to do it! Never widen your stop!
These rules are pretty easy to understand and should be followed religiously especially rule number 3!
Scaling In And Out Of Positions
What is “scaling” and why would you use it?👉Scaling in doesn’t mean weighing yourself before, during and after a trade (although it doesn’t hurt to monitor that too!).
👉Scaling basically means adding or removing units from your original open position.
👉Scaling can help you to adjust your overall risk, lock in profits, or maximize your profit potential.
Of course, when you add or remove from your position, there are potential downsides to be aware of as well.
✅Benefits of Scaling
The biggest benefit is a psychological one.
Scaling in and out of your position takes away the need to be absolutely perfect in your entry or exit.
Scaling In And Out Of Positions In Forex
No one can consistently predict price action or the exact turning point of a market.
It’s way too difficult to keep expecting to get the best entry possible all the time. You are setting yourself up for a lot of heartache.
The best we can do is identify an “area” of potential support/resistance, reversal, momentum change, breakout, etc.
You can enter your position in bits and pieces around those areas and/or take your trade off at different levels to lock in profits.
☝️Properly executed with a trailing stop, scaling out of winning positions can help you protect your profits just in case price suddenly reverses.
Finally, if you add more to your open position, and the market continues to go your way, your bigger position size will increase the amount you will make for every pip.
✅Drawbacks of Scaling
The major drawback of scaling is when you add more to your position. Can anyone guess what that drawback is?
You got it….YOU INCREASE YOUR OVERALL RISK!!
Remember, traders are “risk managers” first, and if done incorrectly, “scaling in” can wipe out your account!!
Lucky for you, we’ll explain how to SAFELY add to an open position.
The second drawback is when you remove portions of your open position, you reduce your max potential profit. Who wants to do that?
Well, in markets as fast and dynamic as the foreign exchange market, it may benefit you to reduce your risk and “take some off the table.”
👉Scale Out Of Positions
scaling out has the obvious benefit of reducing your risk as you are taking away exposure to the market…whether you are in a winning or losing position.
When used with trailing stops, there is also the benefit of locking in profits and creating a “nearly” risk-free trade.
☝️Remember, there is the possibility of the market moving beyond your profit target and adding more bling-bling to your account.
There’s always much to consider when adjusting trades, and with practice over many trades, you’ll find a process of taking off trades most comfortable to you.Next up, we’ll teach you how to scale into positions.
You may be asking, “Why? Why would I wanna scale into a trade?”
Scaling into positions, if done correctly, will give you the benefit of increasing your max profit.
But as they say, “Higher reward means higher risk.”
If done incorrectly, the value of your account could drop faster than you can even think about clicking the close button on your trade.
Before you know it, you’ll be staring at your computer screen, eyes wide open watching your account get margin called.
✅Scale In Positions
Adding more units to a” losing” position is tricky business and in our view, it pretty much should never, ever be done by a new trader.
If your trade is clearly a loser, then why add more and lose more??? Doesn’t make any sense right?
Now we say “pretty much” because if you can add to a losing position, and if the combination of risk of your original position and the risk of your new position stays within your risk comfort level, then it is ok to do so.
To make this happen, a certain set of rules has to be followed to make this trade adjustment safe. Here are the rules:
A stop loss is necessary and MUST be followed.
The levels of position entry must be pre-planned before the trade was put on.
Position sizes must be pre-calculated and the total risk of the combined positions is still within your risk comfort level.
👉Determine Trade Invalidation Point (Stop Loss)
Let’s determine our stop level. For simplicity, let’s say you pick 1.3100 as the level that signals you were wrong and that the market will continue higher.
That is where you exit your trade.
👉Determine Entry Level(s)
Second, let’s determine our entry levels. There was support/resistance at both 1.2900 and 1.3000, so you’ll add positions there.
There was support/resistance at both 1.2900 and 1.3000, so you’ll add positions there.
👉Determine Position Size(s)
Third, we will calculate the correct position sizes to stay within the comfortable risk level.
Let’s say you have a $5,000 account and you only want to risk 2%. That means you are comfortable risking $100 ($5,000 account balance x 0.02 risk) on this trade.
Let’s determine our stop level. For simplicity, let’s say you pick 1.3100 as the level that signals you were wrong and that the market will continue higher.
That is where you exit your trade.
👉Determine Entry Level(s)
Second, let’s determine our entry levels. There was support/resistance at both 1.2900 and 1.3000, so you’ll add positions there.
There was support/resistance at both 1.2900 and 1.3000, so you’ll add positions there.
👉Determine Position Size(s)
Third, we will calculate the correct position sizes to stay within the comfortable risk level.
Let’s say you have a $5,000 account and you only want to risk 2%. That means you are comfortable risking $100 ($5,000 account balance x 0.02 risk) on this trade.
How To Add To Winning Positions
✅Rules to safely add to winning positions:
👉Pre-determine levels entry for additional units.
👉Calculate your risk with the additional units added.
👉Trail stop loss to keep growing position within comfortable risk parameters
☝️In general, scaling into winning positions is best suited for trending markets or strong intraday moves.
Because you are adding to a position as it goes your way, your average opening price moves in the direction of the move as well.
What this means is that if the market pulls back against you after you have added, it doesn’t have to move as far to get your trade into negative territory.
Also, you should know that scaling into winning positions in range bound markets or periods of low liquidity leaves you open to being stopped out often.
Lastly, by adding to your position, you are also using up any available margin.
This eats up into margin that can be used for other trades! You have been warned!!
Currency. Correlation.
The first half… easy. Currency. No explanation needed.The second half. Still easy. Correlation: a relationship between two things.
What is Currency Correlation?
In the financial world, correlation is a statistical measure of how two securities move in relation to each other.
Currency correlation, then, tells us whether two currency pairs move in the same, opposite, or totally
random direction, over some period of time.
When trading currencies, it’s important to remember that since currencies are traded in pairs, that no single currency pair is ever totally isolated. (Did we just confuse you with our “currencies” tongue-twister sentence there?)
Unless you plan on trading just one pair at a time, it’s crucial that you understand how different currency pairs move in relation to each other.
Correlation is computed into what is known as the correlation coefficient, which ranges between -1 and +1.
Perfect positive correlation (a correlation coefficient of +1) implies that the two currency pairs will move in the same direction 100% of the time.
Perfect negative correlation (a correlation coefficient of -1) means that the two currency pairs will move in the opposite direction 100% of the time.
If the correlation is 0, the movements between two currency pairs are said to have uh ZERO or NO correlation, they are completely independent and random from each other. We have no idea how one pair will move in relation to the other.
Perfect negative correlation (a correlation coefficient of -1) means that the two currency pairs will move in the opposite direction 100% of the time.
If the correlation is 0, the movements between two currency pairs are said to have uh ZERO or NO correlation, they are completely independent and random from each other. We have no idea how one pair will move in relation to the other.
Doubling Your Risk Without Knowing It
When you are simultaneously trading multiple currency pairs in your trading account, always make sure you’re aware of your RISK EXPOSURE.
For example, on most occasions, trading AUD/USD and NZD/USD are essentially like having two identical trades open because they usually have a positive correlation.
You might believe that you’re spreading or diversifying your risk by trading in different pairs, but many pairs tend to move in the same direction.
So instead of reducing risk, you are magnifying your risk! Unknowingly, you are actually exposing yourself to MORE risk.
This is known as overexposure.
✅Going long one currency pair and going short another currency pair that are highly correlated is extremely counterproductive.
More than paying for the spread twice, you minimize your gain because one pair eats into the other pair’s profits.
And even worse, you could end up losing due to the different pip values and ever-changing volatility of currency pairs.
Because the two pairs move in opposite directions like they hate each other’s guts, one side will make money, but the other will lose money.
So you either end up with little gain because one pair eats into the other pair’s profits.
Or you could simply end up with a loss due to each pair’s different pip values and volatility ranges.
5 Reasons Why Factoring In Currency Correlations Help You Trade Better
Currency correlation tells us whether two currency pairs move in the same, opposite, or totally random direction, over some period of time.
When trading currencies, it’s important to remember that since currencies are traded in pairs, that no single currency pair is ever totally isolated.
Correlation is computed into what is known as the correlation coefficient, which ranges between -1 and +1.
Here is a guide for interpreting the different currency correlation coefficient values.
✅1. Eliminate counterproductive trading
Utilizing correlations can help you stay out of positions that will cancel each other out. As the previous lesson shown, we know that EUR/USD and USD/CHF move in the opposite direction almost 100%.
Opening a position long EUR/USD AND long USD/CHF is, then, pointless and sometimes expensive. In addition to paying for the spread twice, any movement in the price would take one pair up and the other down.
We want our hard work to pay off with something!
✅2. Leverage profits
Leverage profits….or losses! You have the opportunity to double-up on positions to maximize profits. Again, let’s take at look at the 1-week EUR/USD and GBP/USD relationship from the example in the previous lesson.
These two pairs have a strong positive correlation with GBP/USD following behind EUR/USD virtually step for step.
Opening a long position for each pair would, in effect, be like taking EUR/USD and doubling your position.
You’d basically be making use of leverage! Mucho profit if all goes right and mucho losses if things go wrong!
✅3. Diversify risk
Understanding that correlations exist also allows you to use different currency pairs, but still leverage your point of view.
Rather than trading a single currency pair all the time, you can spread your risk across two pairs that move the same way.
Pick pairs that have a strong to very strong correlation (around 0.7). For example, EUR/USD and GBP/USD tend to move together.
The imperfect correlation between these two currency pairs gives you the opportunity to diversify which helps reduce your risk. Let’s say you’re bullish on USD.
Instead of opening two short positions of EUR/USD, you could short one EUR/USD and short one GBP/USD which would shield you from some risk and diversify your overall position.
In the event that the U.S. dollar sells off, the euro might be affected to a lesser extent than the pound.
✅4. Hedge risk
Currency correlation allows you to hedge your position - Although hedging can result in realizing smaller profits, it can also help to minimize losses.
If you open a long EUR/USD position and it starts to go against you, open a small long position in a pair that moves opposite EUR/USD, such as USD/CHF.
Major losses averted!
You can take advantage of the different pip values for each currency pair.
For example, while EUR/USD and USD/CHF have an almost perfect -1.0 inverse correlation, their pip values are different.
Assuming you trade a 10,000 mini lot, one pip for EUR/USD equals $1 and one pip for USD/CHF equals $0.93.
If you buy one mini lot EUR/USD, you can HEDGE your trade by buying one mini lot of USD/CHF. If EUR/USD falls 10 pips, you would be down $10. But your USD/CHF trade would be up $9.30.
Instead of being down $10, now you’re only down $0.70!
Even though hedging sounds like the greatest thing since sliced bread, it does have some disadvantages.
If EUR/USD rallies, your profit is limited because of the losses from your USD/CHF position.
Also, the correlation can weaken at any time. Imagine if EUR/USD falls 10 pips, and USD/CHF only goes up 5 pips, stays flat, or falls also!
✅5. Confirm breakouts and avoid fakeouts
You can use currency correlations to confirm your trade entry or exit signals.
For example, the EUR/USD appears to be testing a significant support level. You observe the price action and are looking to sell on a breakout to the downside.
Since you know EUR/USD is positively correlated with GBP/USD and negatively correlated with USD/CHF and USD/JPY, you check to see if the other three pairs are moving in the same magnitude as EUR/USD.
You notice that GBP/USD is also trading near a significant support level and both the USD/CHF and USD/JPY are trading near key resistance levels.
This tells you that the recent move is U.S. dollar-related and confirms a possible breakout for EUR/USD since the other three pairs are moving similarly. So you decide you will trade the breakout when it occurs.
Now let’s assume the other three pairs are NOT moving in the magnitude as EUR/USD.
The GBP/USD is holding not falling, USD/JPY is not rising, and USD/CHF is sideways.
This is usually a strong sign that the EUR/USD decline is not U.S. dollar-related and most likely driven by some kind of negative EU news.
Price may actually trade below the key support level you’ve been monitoring but because the other three correlated pairs aren’t moving in proportion with EUR/USD, there will be lack of any price follow-through and price will return back above the support level resulting in a fakeout.
If you still wanted to trade this setup, since you didn’t get any “correlation confirmation” from the other pairs, you could play it smart by reducing your risk and trading with a smaller position size.
Currency Correlations Change!
The forex market is like a schizophrenic patient suffering from bipolar disorder who constantly eats chocolates, experiences extreme sugar highs, and has volatile mood swings all day long.
We’re not even exaggerating.
Although currency correlations between currency pairs can be strong or weak for days, weeks, months, or even years, they do eventually change and can change when you least expect it.
The strong currency correlations you see this month may be totally different next month
Compare the coefficients for a given pair across the different time frames.
The forex market is like a schizophrenic patient suffering from bipolar disorder who constantly eats chocolates, experiences extreme sugar highs, and has volatile mood swings all day long.
We’re not even exaggerating.
Although currency correlations between currency pairs can be strong or weak for days, weeks, months, or even years, they do eventually change and can change when you least expect it.
The strong currency correlations you see this month may be totally different next month
Compare the coefficients for a given pair across the different time frames.
☝️For the most part (thanks, USD/JPY!), they’re different across the board, changing from one time frame to another. And they change in all directions.
❗️The lesson here is that currency correlations do change, and they change frequently.
And they can change by a drastic measure in a short time frame, as is apparent by looking at EUR/USD at the 1 Month and 3 Month interval.
That’s a big swing!
Because of the constant sentiment shifts of the currency market, make sure you’re aware of the current currency correlations.
For example, over a one week period, the correlation between USD/JPY and USD/CHF was 0.22. This is a very low correlation coefficient and would indicate that the pairs have an insignificant correlation.
However, if we look at the three-month data for the same time period, the number increases to 0.52 and then to 0.78 for six months and finally to 0.74 for a year.
In this example, you can see that these two pairs had a “break-up” in their long-term correlation relationship. What was once a strongly positive association in the past has extremely weakened in the short-term.
☝️If they were a real couple and had only dated a month or less, they would’ve thought they were incompatible.
Little do they know, the passion will start heating up later!
If you look at EUR/USD and GBP/USD, here’s an example of the extent to which currency correlations can change and jump around.
The one-week period shows a very strong correlation with a 0.94 coefficient!
…But this relationship severely deteriorates in the one-month period, dropping to 0.13, before improving again for its three-month period to a solid 0.83, then deteriorating again to a weak correlation in its six-month trailing period.
☝️When you are simultaneously trading multiple currency pairs in your trading account, the most important thing is to make sure you’re aware of your RISK EXPOSURE
You might believe that you’re spreading or diversifying your risk by trading in different pairs, but you should know that many of them tend to move in the same direction.
By trading pairs that are highly correlated, you are just magnifying your risk!
Correlations between pairs can be strong or weak and last for weeks, months, or even years. But always know that they can change on a dime.
Staying up-to-date with currency correlations can help you make better decisions if you want to leverage, hedge, or diversify your trades.
✅A few things to remember…
Tips On Using Currency Correlation In Forex Trading Coefficients are calculated using daily closing prices.
👉Positive coefficients indicate that the two currency pairs are positively correlated, meaning they generally move in the same direction.
👉Negative coefficients indicate that the two currency pairs are negatively correlated, meaning they generally move in opposite directions.
👉Correlation coefficient values near or at +1 or -1 mean the two currency pairs are highly related.
When you find yourself wanting to trade two pairs that are highly correlated, it’s okay if you take both setups.
Just make sure you have rules in place when you traded correlated pairs and always stick to your risk management rules!
Tips On Using Currency Correlation In Forex Trading Coefficients are calculated using daily closing prices.
👉Positive coefficients indicate that the two currency pairs are positively correlated, meaning they generally move in the same direction.
👉Negative coefficients indicate that the two currency pairs are negatively correlated, meaning they generally move in opposite directions.
👉Correlation coefficient values near or at +1 or -1 mean the two currency pairs are highly related.
When you find yourself wanting to trade two pairs that are highly correlated, it’s okay if you take both setups.
Just make sure you have rules in place when you traded correlated pairs and always stick to your risk management rules!
Watch out for the last part of how to become an expert trader coming next
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