discipline to:• Refrain from overtrading• Adhere to a sensible money management regimen• Act according to a structured trading plan• Cut losses and let profits run• Follow religiously a trading system with a proven positiveexpectancy• Trade without succumbing to the destructive emotions ofgreed and fear• Avoid chasing a runaway market• Use stop losses and/or trailing stops• Stay out of a trade if there is no valid reason to be in that tradeTrading emotionally is one of the easiest ways to be unprofitable in forex. Of course, as humans we could never be devoid ofemotion, nor would we ever want to be. But as traders, it is mostcertainly in our best interests to use discipline to overpower manyof the negative effects of emotional trading.There are many examples of emotional trading that both novicetraders and experienced traders alike succumb to on frequent occasions. For one, many traders fall into the trap of trading aggressively,
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or even angrily, after either a string of losses or one particularly devastating loss. This is often caused by a desire to get back at the marketwith a vengeance. The trader’s underlying sentiment is that the marketis the adversary, and that aggressive trading can somehow make backthe lost equity, teaching the market a lesson in the process. Clearly, thisis irrational behavior that invariably leads to even further devastationof the trading account. Discipline to accept losses gracefully and tocontinue adhering to the trading plan is the primary weapon againstfalling into this kind of a psychological trap.A related trap that is found often in foreign exchange tradingoccurs when traders experience a winning streak and begin believing that they have mastered the market. Oftentimes, these traderswill start thinking that they are unstoppable and that the principlesof prudent trading somehow do not apply to them. Greed and recklessness then enter the picture. When this occurs, prior winningsgenerally turn into subsequent losses, and these traders then becomecompelled to play catch-up by attempting to make back the winnings.This results in a vicious cycle that eats away quickly at any account, iftrading discipline is not reintroduced before it becomes too late.Another example of emotional trading occurs when traders arealerted to a runaway price move after a large portion of the movehas already occurred. The emotion that surfaces is one of fear—fearof missing out on the trade of the decade. Traders in this positionthat have not mastered the discipline to refrain from acting uponreckless emotions, will often jump into the trade blindly in anattempt to chase the market. They do this even if the entry turns outto be at the worst possible time, like buying at a top, where pricehas already exhausted itself after a significant upmove. Trading in this
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manner, without discipline, is a sure method of racking up frequentand substantial losses.Yet other traders who need to work on developing disciplineenter into positions for no other reason than the excitement of trading. To these individuals, trading represents a recreational activitymuch like gambling or sports, where constant action is the nameof the game. When these types of traders treat forex trading as gambling, it can actually become very similar to gambling. If positionsare opened purely for the purpose of creating excitement and avoiding boredom, forex can have even worse odds than many casinogames. Of course, this is the extreme. The vast majority of forextraders do not constantly act on an insatiable itch for action. Forsome traders, however, there is usually an occasional need to tradefor no other reason than the thrill of it. This type of trading shouldbe avoided at all costs, as it is thoroughly detrimental to a healthyaccount balance.It is also detrimental to trading accounts when traders fail to follow their own tested trading methods because of a combination ofimpatience, greed, fear, and/or other psychological factors. For example, a trader may have backtested a technical trading system that wasshown to have a high positive expectancy under diverse market conditions. But suppose this system dictates that three different prerequisites should occur on the chart all at the same time before a trademay be initiated. What will often happen, for a variety of reasons, isthat the trader will become anxious to trade, and will therefore startbecoming both lazy and lenient on the prerequisites. If the conditions are close enough, the trader may just take the trade. This typeof undisciplined trading completely invalidates any backtesting work
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performed prior to live trading. Therefore, failing to follow a testedstrategy faithfully is virtually the same as gambling on an untestedstrategy.Finally, to close out this section on discipline and trading psychology, here are just a few words on hoping and wishing. To put itsuccinctly, there is no room in profitable trading for these two sentiments. The markets will move where they need to move, and noamount of hoping or wishing can change that. No individual forextrader could ever actually will the market to move a certain way. Butall day and every day, traders are still trying. Doing so, however, canseriously hurt these traders. When they hope and pray for the bestunder deteriorating circumstances, they often fail to prepare for theworst. Among other negative consequences, this can mean a failureto cut losses when those losses most need to be cut. The best way toprevent the potentially destructive sentiments of hoping and wishing is to have a strict trading plan and to develop the discipline tofollow it consistently, no matter what may happen. This brings usto the next and final section of this chapter and this book.
P lan the Trade and Trade the PlanThe master trading plan should encompass elements of everythingthat has been discussed throughout this book. This includes a basicfoundation in the mechanics of foreign exchange trading, an analytical base including both technical and fundamental analysis, arepertoire of solid trading strategies and methods, a comprehensiverisk/money management plan, and a disciplined approach to trading.Every detail of the trading plan should be recorded in a dedicated
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journal, addressing all aspects of day-to-day trading in order to coveras many contingencies as possible.At the very least, a solid trading plan should include the following specific elements:• Amount of starting capital to be used for trading• Primary lot size and leverage used• Maximum percentage of trading capital risked on each trade• Reward-to-risk ratio target• Realistic daily, weekly, and monthly profit goals• Specific daily, weekly, and monthly loss limits (the point ofmonetary loss at which a trader stops trading for the givenperiod)• An entire description of the trading strategy(s) used• Specific trade entry criteria according to the tested tradingstrategy• Specific trade exit criteria (stop losses, profit limits, and/ormanual exits) according to the tested trading strategyIt cannot be emphasized enough how important a good tradingplan is to a successful trader. Running a successful business, whichis how forex trading should be approached, usually demands somekind of a written business plan at some point. Of course, a businesscan certainly run without a written business plan, but its potentialfor success is increased a great deal if there is a plan in place thatstresses the vision, direction, and step-by-step process for reachingconsistent profitability. Trading is no different.
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Besides maintaining this written trading plan, successful tradersalso take notes every day, recording the trading activities of the day.In this way, these traders can find out if their actions conformed tothe plan, and how they can constantly improve their trading habits.With these good trading habits, along with knowledge, practice,and a well-thought-out trading plan, any individual can hold theblueprint for success in foreign exchange trading. Possessing all ofthe characteristics of a successful forex trader is not an easy goal. Butin the end, it is well worth the effort to get there.
C hapter Summar yInitially, most traders tend to gravitate toward the most tangibleaspects of foreign exchange trading that are the easiest to grasp.This includes technical and fundamental analysis, as well as concretetrading methods and strategies. What many of these traders tend tooverlook are some of the most important attributes necessary forsuccessful foreign exchange trading.To begin with, successful traders have learned how to managerisk. This is especially crucial in the highly leveraged world of foreign exchange trading. In order to manage this risk, experiencedtraders make their highest priority the preservation of capital. Inmany respects, this can be considered even more important than afocus on just making profits.A concentration on risk control and the preservation of capital starts with good money management. The most basic requirement for good money management is sufficient capitalization. Theamount of capital required depends first on the amount of risk
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Chapter Summary
capital one can afford without substantially impacting one’s lifestyle.Then, it depends on the planned magnitude of trading and level ofrisk appetite.After the capital requirement basics are satisfied, a trader canthen turn attention toward reward-to-risk ratios, fixed fractionalmoney management, and potential trailing stop-loss strategies. Theseall have to do with the proper placement of stop losses in relationto the larger goals of preserving capital, reducing risk, and achievingconsistent net profitability.Beyond these key components of intelligent trading, the tradermust additionally address the prudent sizing of trades, which, in turn,also means an avoidance of overloading on positions. Overtrading inthis respect carries the danger not only of margin overextension, butalso potentially precarious exposure to a nondiversified, highly correlated portfolio of currency holdings.With regard to the analytical side of trading, technical analysisexcels as a method for quantifying and controlling risk through stoploss placement. In addition, any trading strategy employed must ultimately have a significant positive expectancy in order to contributeto a viable money management system and potential net profitability. The expectancy of a strategy can be determined through backtesting, whether manual or automated, where the strategy is appliedto past price data in order to evaluate its hypothetical historicalperformance.Risk and money cannot be managed effectively without onekey component of healthy trading psychology. That component isdiscipline. Even if all other factors are in place to foster success inforeign exchange trading, a trader will fail without discipline. There
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are many types of discipline that are essential to achieving consistentprofitability in trading, all of which need time and effort to develop.Perhaps the most important discipline is that of adhering to awell-prepared trading plan.The trading plan brings all the necessary elements of tradinginto one cohesive whole. It acts as the blueprint and the businessplan for traders that are serious about seeking sustainable successin the foreign exchange markets. Perhaps no other tool, whether achart or a news feed or a crystal ball, carries as significant an impacton a trader’s potential success as a good, specific trading plan. It istruly one of the essentials of foreign exchange trading.
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Index24-hour market, 7–9Ask price, 40.AUD/NZD currency pair, 23AUD/USD currency pair, 11, 23, 39Australian dollar (AUD), 11Autotrading, 190–192Average Directional Index (ADX)indicator, 89, 141Average True Range (ATR) indicator, 89Backtesting, 187–190, 210Bank for International Settlements (BIS),6, 11Bank of Canada (BOC), 106Bank of England (BOE), 106Bank of Japan (BOJ), 6, 106Bar charts, structure of, 52–56Base currency, 22Bid price, 39–40Bollinger Bands indicator, 89–91, 149Bollinger, John, 91Breakout trading, 138, 139–140, 150–157,158–160, 178, 186–187Bretton Woods Agreements, 3–4British pound (GBP), 10, 22CAD/JPY currency pair, 23Canadian dollar (CAD), 11Candlestick charts, structure of, 52–56. Seealso Patterns, candlestick chartCarry trading, 42, 108–110, 179–182
CCI (Commodity Channel Index)oscillator, 94–95Central banks, 6, 13–14. See also Interestrates, central bankChart patterns. See Patterns, chartCommissions, broker 39–41Commitments of Traders (COT) Report,185–186Consensus data, 123, 183Consumer Price Index (CPI), 113Contrarian trading, 184–187Correlation, currency pair, 205–207Cost of carry, 41–44. See also Carry tradingCounter currency, 22. See also QuotecurrencyCurrency conversion, 2, 14, 38Currency pairs, structure of, 22–23Day trading, 137–140Discipline, trading, 28, 211–214Divergence, price-oscillator, 92, 170–172Diversification, 205–207Downtrend, definition of, 66–67Durable Goods Report, 114Economic indicators/data, 110–118,121–124Economic growth, 107Economics, basic, 15–16, 104–105Elliott Wave Theory, 98–99, 166–169Employment Cost Index (ECI), 115–116Employment situation, 15, 112–113
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Entry orders:limit, 27–28stop, 27–28Euro (EUR), 10EUR/GBP currency pair, 23EUR/JPY currency pair, 23EUR/USD currency pair, 10–11,23, 39European Central Bank (ECB), 6, 106Existing Home Sales Report, 116
Long, going, 24, 44Lot sizes, 32–33, 39
Federal Open Market Committee (FOMC)Rate Decisions, 118Fed Funds rate, 118Fibonacci:golden ratio basis for, 96–97, 162theory of, 96–98, 162trading, 161–163Fixed fractional money management,200–201Floating currencies, 4Fundamental analysis, 15, 103–126,130–133, 183–184GBP/CHF currency pair, 23GBP/USD currency pair, 10–11, 23, 39GDP (Gross Domestic Product), 15,111–112Golden ratio. See Fibonacci, golden ratiobasis forGold Standard, 3Hedge funds, 13Hedging, 44–45, 206–207“Holy grail,” 128–129Housing Starts report, 116Indicators, technical chart, 88–95, 139Industrial Production report, 115Inflation, 15, 107, 118Interest rates, central bank 15, 42–43,105–107, 108–109, 118, 119–120Japanese yen ( JPY), 10, 22, 37Leverage, 12, 33–34, 39, 43Liquidity, 5–6
MACD (Moving Average ConvergenceDivergence) indicator, 92–93Major currency pairs, 9–12Manual exits, 31–32Margin, 33–36, 45Margin call, 34–36Market manipulation, 6Market orders, 27Mental stops, 31–32Micro-lots. See Lot sizesMini-lots. See Lot sizesMoving averages:crossovers of, 74–77definition of, 72–74trend trading use of, 141Multiple fractionalpositions, 204–205Multiple timeframe trading, 172–175News trading, 121–124, 183–184New Zealand dollar (NZD), 11Nison, Steve, 54–56Non-Farm Payrolls (NFP) data, 112OHLC (Open, High, Low and Close), barand candlestick, 53–56Oscillators, technical chart, 92–95, 149,170–172Overbought and oversold, 92Over-the-counter (OTC), trading, 7Overtrading, 205–207Parabolic Stop–And–Reverse (SAR)indicator, 90–92Paralysis by analysis, 51Patterns:candlestick chart, 78–82, 161continuation bar chart, 84–88,159–160general chart, 56multiple candle, 80–82reversal bar chart, 83–84, 159–160single candle, 79–80trading, 158–161
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Western bar chart, 82–88, 158–160Personal Income and Outlays Report,117–118Pips, definition and calculation of, 36,37–39Pivot points, 95–96, 164–166Point & figure charts, 57, 99–100, 175–178Ponsi, Ed, 157–158Position trading, 130–134Positive expectancy, 209–210Prechter, Robert R., 25–26Producer Price Index (PPI), 114Profit:limits, 31targets, 160Psychology, trading, 210–214Pullbacks and throwbacks, 156–157Purchasing Managers Index (PMI), 115Quote currency, 22. See also CountercurrencyRange trading, 147–150Real body, candlestick, 55–56Reserve Bank of Australia (RBA), 106Retail sales report, 113Retail trading, 4, 14Revisions, economic, 123–124Risk/reward ratio, 32, 146, 198–200ROC (Rate Of Change) oscillator, 94Rollover, 5, 43, 109, 180RSI (Relative Strength Index) oscillator,93–94Shadows, candlestick, 55Short, selling, 24, 44Spot forex, 5–7Spreads, 39–41
Standard lots. See Lot sizesStochastics oscillator, 94Stop losses, 28–30, 36, 155–156, 200–201,208–209Super-mini lots. See Lot sizesSupply and demand, 15–16, 105, 117Support and resistance, 16–17, 59–64, 149,153–155, 178Swap. See Cost of carrySwing trading, 134–137Technical analysis, 16–17, 50–102, 183–184,208–209Terminology, currency, 11Timeframes, charting, 57–59, 65–66,172–175Trade balance, 15, 116–117Trade size, 32–33, 202–205Trading plan, 214–216Trailing stops, 30, 145, 201–202Trend:channels, 68–72concept of, 64–72lines, 67–72, 178trading (following), 140–146Trevisani, Joseph, 119–121Turnover, trade, 6Uptrend, definition of, 66–67USD/CAD currency pair, 11, 23, 39USD/CHF currency pair, 11, 23, 39USD/JPY currency pair, 10–11,22–23, 39U.S. dollar (USD), 10, 22, 38U.S. Federal Reserve (the Fed), 6, 106, 118Whipsaws, 76–77Wicks, candlestick. See Shadows, candlestick
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