As a general rule, small retail Forex traders know what their edge in the Forex market is and why it occurs, they also know how to best exploit it as apart of their trading strategy or system, but when it comes to putting this knowledge into practice they find that they are unable to do so and they fail. In my article on why most Forex traders lose money I wrote about why that was.
In this article I am going to write about what traders can do to make implementing their edge a little easier on themselves as part of a Forex trading strategy that is suitable for beginners. After all, no trading strategy, no matter how good it is on paper, will be of any use at all if traders are unable to actually implement it in practice.
As I said in my previous articles, in Forex trading, the edge comes from the trend and traders need to make use of the trend by maximising the amount they win on their winning trades and cut off their loses before they get out of control. But of course, regardless of how logical this is and how much sense this makes, in practice, most traders find this a very difficult thing to actually do.
One of the ways that sticking to the plan and doing this can be made a little easier is to use time-based exits. A trading system where trades either expire or are stopped out will make things easier on the novice trader as once a trade is placed there is nothing more for them to do. The trader can simply leave their computer and let things play out the way they will; this is especially important as watching a trade once it has been placed is very hard emotionally. Watching every random tick very often leads traders to exit good trades in a panic and continually change their minds, which in turn leads to them entering and closing short-term trades again and again as the costs of the spread and the effects of randomness on short time frames bleeds their accounts dry.
An example of a trading strategy with an edge,
An example of a Forex trading strategy with a time based exit is given below. Please note that the following is just an idea with an edge, each trader must learn how to trade for themselves and develop a complete trading system or strategy that suits them personally –
On the EUR/USD (which is probably the best trending currency pair) whenever a four hour candle closes 50 pips above the previous candle’s high we will go long, and likewise, whenever a four hour candle closes 50 pips below the previous candle’s low we will go short. All trades will be left open for exactly 20 hours of market time (5 four hour candles). A stop loss of 150 pips will be used on each trade, there are no profit targets. Trades will either be stopped out or timed out. The results of this system on the EUR/USD currency pair from the beginning of 2010 to the present day (early August 2013) are –
Number of Winning Trades: 192
Number of Losing Trades: 145
Number of Pips Won: 11,810
Number of Pips Lost: 7,738
Percentage of Trades That Are Winners: 56.97%
Average Size of a Winning Trade: 61.51 pips
Average Size of a Losing Trade: 53.37 pips
Win to Loss Ratio: 1.526 to 1
If a trade was entered at random then winning trades would be as common as losing trades and winning trades and losing trades would (on average) be of the same size. And adding a stop loss to a randomly entered trade wouldn’t help that much either, the tighter the stop loss the smaller the loses would become, but the problem is the tighter the stop loss the more common losses would be. With a very tight stop loss losses would be smaller but winning trades would be less frequent as trades that would otherwise have been winners would be stopped out.
The win to loss ratio of 1.526 to 1 that this particular trading strategy gives us can only really be explained by the edge, the effect of trading with the trend. A four hour candle closing 50 pips above or below the high or low of the previous candle is the sort of event that only usually happens once, twice, or maybe three times a week and is therefore a signal of a fairly strong trend.
Entering in the direction of the trend and giving the trend time to work makes winning trades more likely than losing ones and it also means that winning trades are likely to be larger than losers too. The 150 pip stop loss made very little difference to this system and is very rarely triggered, but it is essential that we have a stop loss when we are trading with leverage and not constantly watching our open trades.
Using time based exits with a stop loss and leaving the trade to either expire or be stopped out by the market is a great way for novice traders to get used to sticking to their plan and conquer their emotions. Trading is much more difficult if there is still something for the trader to do after the trade has been placed.