Archive for the ‘Trading Advice’ Category

Guide to stop losses

Wednesday, February 23rd, 2011

Every forex trader likes to think he is able to think swiftly on his feet and respond to any which way the market turns. However the truth is that when caught with an unexpected market movement, the initial gut instinct is not always the right one. In a world where one bad decision can mean the end of a trader, it is essential to have a strategy for when the deals don’t go as planned. And have no doubts, this will happen. Frequently.

Stop losses are one way of protecting the capital in the account to ensure there is always enough left to continue trading. It is essentially just another name for a risk management system where the trader pre-determines exit levels which when hit mean the deal is closed, regardless of the dealer`s position.

trading stop losses

Some dealer’s dislike the concept of stop losses as they feel they are a reflection on a dealer’s ability to judge when to exit the market and restrict trading. However, when the market is moving against a deal, it can be very tempting to pursue a position, in the vain hope that the odds will eventually turn. However, by the time they do, all of the capital funds may have been obliterated meaning the trader is unable to continue.

Stop loss level

Every trader will decide at what point they will set up their stop losses but the recommended value is around 1-2% below the support level. There is little point setting stop losses just below the support level as it is expected that this level would be tested with minor break throughs, before rising back above the level again. Setting the stop loss level too low could result in deals being closed too early, when support levels are merely being tested by the market and not actually broken.

Trailing stops

Trailing stop losses are possibly one of the loosest types of orders to place, with no set numerical value specified. Trailing losses follow the market with the stop loss stepping in when the market dips below a certain percentage, but allows for fluctuations.

Slippage

However, when stop loss orders are executed, the price is not usually exact. A broker may not be able to exit the market until the next available price, meaning there may be a slight difference in the actual close and the stop loss order. This difference is called slippage. There is a way to prevent this and this is by using a guaranteed stop loss order. This means any deal will be closed at the exact price the stop loss order specifies but usually command an additional fee from the broker.

Time based stop loss

An alternative approach is time-based stop losses. This type of trading very much relies on the good judgement of the trader and perhaps is not the easiest approach for beginners. A trader decides beforehand on the exact amount of time he will stay in the deal for and exits at exactly that time, regardless of how the deal is going. The skill lies in finding the right trade to enter sat the right time so that the market goes in the right direction to make the gains.

Regardless of how many traders feel about using stop losses, they are an essential part of forex and will help protect capital from being wiped out.

Five tips for winning at forex trading

Thursday, December 17th, 2009

1. Exits are more important than entries

Forex traders often over think about when they should enter a trade. Huge amounts of time can be spent looking at indicators, reading news, and drawing lines on charts to try and figure out if now is the perfect time to open a trade.

Unfortunately for them they should be focusing some of that energy elsewhere.

It is true that a good entry into a trade is important. For example opening a new ‘long’ trade when the price has massively spiked is probably a bad thing, as the price will probably reverse just as quickly.

What is more important is when you exit the trade. It is at the time of exit that your trade becomes either profitable, non-profitable, or breaks even. It doesn’t matter if you were up 10% one hour ago. If you close the trade when you are down 2% then that is the final result. Being right about the price direction for the much of the trade duration gets you no profit if you closed the trade after a large reversal.

japanese currency yen

By all means spend time working out when to enter a trade – this is an important thing to do. But do also spend time thinking about when to exit. Don’t just exit in a panic. You should have a plan and then stick to it.

Which brings us onto…

2. Have your trade lifecycle planned out before you enter

Some people treat trading like a computer game, just clicking on the buy and sell buttons in the hope that they will make money. These people will probably find that their account balance goes down very quickly.

Blindly entering and exiting trades without having any real plan in place is only going to lead to one thing – a smaller bank account balance!

Before entering a trade you should know:

  1. Why you are opening this trade?
  2. How long you expect the trade to go on for?
  3. At what level would you either take profit or tighten your stops?
  4. At what price would you accept that your initial analysis was wrong and exit the trade?

Many traders find that small losses become large losses because they haven’t planned their trade in advance. They just entered the trade without thinking it through. The trade goes against them, and rather than exiting they stay in the trade hoping that it will turn around. Does this sound familiar?

If you are unable to trade in a disciplined way then you will consistently lose money to those traders who are able to trade with a disciplined methodology.

Trading with a disciplined methodology means trading with a plan. A plan means having answers to the four questions above – and then sticking to the plan!

The 4th question is about knowing when the trade has gone wrong so you can exit. The next tip covers an important aspect of planning your exit.

3. Have a stop loss in place in case it all goes wrong

As covered in my previous blog post about stop losses, a well thought out stop loss can be worth its weight in gold. It can stop you from losing large amounts of money, and enable you to ‘lock in’ your profit.

A stop loss should initially be the record of your trading plan’s worst-case exit price. Placing a physical stop loss is much better than using a ‘mental stop loss’ as the physical stop loss isn’t affected by your emotions.

As the trade progresses then you should tighten the stop loss according to your trading plan. What you should not do is decide to loosen your stop loss because you want to stay in the trade for longer.

Loosening a stop loss, or removing it altogether after it has been placed is a sign of not having control over your trading.

4. Monitor your trade appropriate to the timeframe

Unless your trade’s exit points are always determined by a stop loss and limit order that you placed your trade will require monitoring whilst it is in progress.

You should monitor your trade in a way that is appropriate to the timeframe in which you are trading.

If you are trading a small timeframe such as 1m, 2m, etc, then you obviously can’t afford to leave the screen or room for a few minutes as you might miss an important exit signal and end the trade in a loss. At very small timeframes even going to the toilet can cost you real money!

If trading longer timeframes such as 1h, 4h, 1 day, 1 week, etc, then you really shouldn’t be spending large amounts of time staring at the screen watching your trade. Doing this will turn you into a nervous wreck as the price continually moves up and down. Trading at a longer time frame should mean you don’t need to know about such micro-movements of the price.

5. Understand how much money is ‘on the table’

No matter what you are trading you should always have a thorough understanding of just how much money you have at risk.

Don’t just think about the potential profit. Think about the potential loss. Think about the worst case scenario. How much money could you lose? If you are not comfortable with the figure then you are trading with positions that are too large for you.

You should always be able to withstand all your positions going against you at the same time, no matter how unlikely it may seem. If you can handle it (note – just handle it – you don’t have to be happy about it!) then you are trading at an acceptable level.

Can trading forex make me rich?

Wednesday, December 2nd, 2009

Many people are attracted to the idea of trading in forex (or other financial instruments such as CFDs, shares, or spread betting) because they think it is an easy way to make money.

In theory it is very easy. All you have to do is to predict whether a price is going to go up or down. If you are right then you get make money. The degree to which you are right or wrong will determine how much money you make or lose.

pound sterling bank notes

It can seem all too easy when the papers or the TV news are running stories day after day about how a currency or a stock is going up or a currency or stock is going down. You may look at these stories and think that if only you had placed a bet a few days ago you’d be ‘in the money’.

Forex in particular seems to have a certain mystique about it. The major currencies are highly liquid, there is often a good amount of volatility, and the retail brokers will let you trade with large amounts of leverage.

It can also be enticing because rather than having to look at boring company reports and exotic financial ratios, you can read about how the economy is doing and make guesses on where economic policy is going to go.

So do people get rich from forex?

Of course they do. People can get rich from anything. People can get rich from winning the lottery or from betting on horse racing. That doesn’t however mean that *you* can get rich from doing these though.

Some people make a very good living from forex and win consistently week in, week out.

Some people trade forex for a few months and double or triple their money. Does this mean that they will become rich? Not necessarily. In fact if they are making money very quickly then it is extremely likely that they will lose it all even quicker.

Trying to become rich from doing a few trades in forex over a short period of time will not make you successful as pretty much the only way you can achieve very high percentage wins is by taking unmanageable risks. If you are taking unmanageable risks then the one thing which is almost certain is that you will get burnt – and probably badly. There is even a big chance that you will lose a lot more than you put in.

If you look at the forex bulletin boards then you can find many sorry accounts from people who make a large amount of money very quickly but then lost it all in a fraction of the time. Did they become rich? Even thought their account may for a few days have had $20,000 of winnings in it, they never got to enjoy the money as it was all lost too soon.

The odds are stacked against you from the start

Remember that as forex is a game of currency pairs, for one currency to go up, the opposing currency must go down. This means that where people are making money, others are losing money.

This is very different to trading in stocks and shares where it is possible for all the shares to go up in value at the same time if the economy is doing great, and for them all to go down at the same time if some major economic upset occurs.

Unfortunately the split of winners to losers is not an even 50:50. For starters for every trade that is made the broker is taking a small commission. This means that there is less money to win, than has been put into the ‘forex pot’.

On top of that professional forex traders, banks and other financial institutions will be taking an uneven percentage of the winnings.

This means that you as a beginner forex trader have the odds very much stacked against you.

As some people get rich from forex, can’t I?

I hope you can see that most people won’t be getting rich from forex. But some do – so could you be one of them?

Let’s think about this another way.

Private dentists can make lots of money. However it isn’t easy. You need to study for many years, practice all the various techniques, pass exams, and have the time and money to be able to go through all of this.

You can’t just become rich overnight by starting a dentist practice.

So why do you think it is any different for trading?

I think the reason for this perception is due to how easy it is to trade. No one (who is sane anyway) would think about having a go at doing a root canal procedure. Where would you even start! However anyone can make a trade on forex. You just have to open an account, press a few buttons, and you are making a trade!

The fact that it is easy to make a trade does not mean it is easy to consistently make winning trades every day, year after year.

To be a winning trader you will need to do large amounts of study, practice regularly, and have the right attributes to place and manage your forex trades.

In conclusion

Forex can indeed make you rich. It just probably won’t.

Always have a stop, and ideally a limit

Thursday, November 26th, 2009

When trading financial derivatives such as forex, CFDs should you always use a stop?

Short answer: Yes!

Long answer: Yes you should always have a stop in place – even if you think you really don’t need one.

Note that I’m only referring to financial derivatives such as forex and CFDs where you trade on margin. If you are trading or investing in instruments where you pay the full price up front (as you will usually do with shares) then this doesn’t apply to the same extent.

Leveraged price moves

A stop is very important with derivatives because when you are trading on margin any moves in the market price is magnified (often by huge multiples –1:400 leveraged forex – are you insane!). A move in the wrong direction can easily wipe you out – along with any other unrelated positions that you currently have open. In the worst case you could even end up owing your broker money – and that is not a good place to be.

forex trading screen 4

Stops are for wimps!

If you talk to people or read the trading bulletin boards there is often a certain amount of bravado about trading without a stop. Some people seem to think that stops are for wimps or are irrelevant for the strategy they are using (“I don’t need a stop because if the market moves against me I manually close out the position in time”).

Emotional decision making

Some people may be disciplined enough to close out at a sensible price but most aren’t. When the numbers on your screen start moving against you it is all to tempting to think – “I’ll stay in a bit longer – the price might go in my favour again”. The chances are that it will just keep going against you making your loss bigger. If you have a stop then you remove your emotions from exiting at the right time.

You should decide your worst exit price when you place the trade when you are thinking more rationally. You of course always have the option to exit earlier if you realise you are wrong before you stop gets hit. Just whatever you do don’t start loosening your stop. Remember the reason you set it at that value in the first place.

My strategy doesn’t require stops

Some people (for our example we’ll call our trader ‘MrNoStop’) will argue that the strategy they are trading does not require stops. They talk about never leaving the screen when a trade is open. If something happens there are always at hand – and cool headed enough – to close that trade.

So what happens then if some huge incident occurs which has a massive impact on prices. For example an unprecedented terrorist attack. Imagine that due to the incident the internet grinds to a halt – as it did on 9/11.

Suddenly MrNoStop’s trading platform stops responding, his previously fast internet connection grinds to a slow trickle. Now MrNoStop can’t exit his trade using his computer. Never mind thinks MrNoStop – I’ll telephone my broker. I always have their number to hand.

MrNoStop calls the number. It is engaged. He keeps trying. Eventually the number rings but no one answers. What is going on? Well of course MrNoStop isn’t the only one affected by the internet outage – all the broker’s customers are affected and they are now phoning the company on mass to either find out what is going on or close their positions. If only MrNoStop had used a stop.

Even if his normal strategy didn’t need a stop he still should have used an ‘emergency contingency’ stop to prevent this kind of thing from happening. It could have saved him a lot of money.

It can be good to have a limit order in place

In the title for this post I mentioned that you should always have a limit as well. Why is this?

Well let’s go back to MrNoStop’s bad situation. It is entirely possible that the terrorist attack could have had a massive positive effect on MrNoStop’s position. The price could have spiked up and then headed back down whilst MrNoStop was unable to use the internet or get though on the phone. If he’d used a limit order as well for this trade then it is possible that he may have made it out with a profit.

Some caution suggested

Maybe I’ve convinced you that always having a stop and a limit order is a good idea.

Well I’ll give you some warnings as well. If your trading platform implements stops and limits as separate tickets from the main trade then you need to be very careful to make sure you know exactly what tickets you have open! Make sure that you don’t accidentally get into trades that you didn’t mean to. If you close your trade ticket then close any associated stops and limit orders as well. Ideally you should have a blotter listing all your open tickets permanently on screen. If you have enough monitors then using one of them for account information can be worthwhile.

If your trading platform implements the stops and limits as part of the same order (and automatically cancels the stop and limit when the trade is closed) then things are much easier. This is because you can’t end up with forgotten stops and limits that are waiting to trigger when you least expect them!

Trading from the news

Wednesday, July 22nd, 2009

Making trading decisions based on live news is a popular way of trading. It is also one of the most difficult trading methods.

As a beginner trying to trade on live news will in most cases lose you money. There several factors why it is hard to win from breaking news:

1. Professional traders will have already placed their trades and moved the market as much as can be expected before you even finish reading or hearing the story.

2. It is hard to predict which way the market will move from news. Good news does not necessarily equal up and bad news does not necessarily equal down. A lot of price reaction to news is based on how the news compares to the expectation. In other words traders will have already ‘priced in’ the expected news before it is even released.

3. Around times of expected news (results updates, financial reports, etc) the market can become so volatile that you are very likely to lose by getting stopped out rather than winning anything.

If you want to be able to trade from the news you will need plenty of practice and a very good knowledge of how news affects prices.

Live news feeds can easily be obtained for free by opening a live or even a demo account from most brokers. Watch the news and how prices are affected. If you think you can correctly predict the price movements then you may be able to give news trading a go. If not then you should perhaps look to trade using a different method such as company fundamentals or technical analysis.

How much money could I lose trading CFDs?

Friday, July 17th, 2009

Before placing any contracts for difference (CFD) trades you should ask yourself the question of “How much money could I lose?”. If you are to trade responsibly you should always be focusing on what you could lose, not what you could win. If you are focusing on how much you could win then you are either at high risk of losing a lot of money, or you could even be a gambler rather than a trader.

There are several different ways of looking at how much money you could lose.

Lose as much as you put in

A small number of CFD providers will cap your losses at the amount of money you have in your account (or offer a lower risk account which guarantees this). If you have an account with a company who does this then your worst case loss is obviously whatever money you put into your account.

Even if your CFD provider doesn’t cap your losses then you may be able to fix your maximum risk by using a guaranteed stop. Unfortunately there is usually an extra charge for these, often in the form of a larger spread.

Lose your entire position size – going long

Most CFD account providers have agreements that say you must cover all your loses – which can be larger than your account balance. They will usually close out your trade before your account balance hits ‘0’ but in a very fast moving market you might be closed out with a negative balance.

If you are betting long then your theoretical maximum loss will be your total position size. If you bought £10,000 of Vodaphone shares using CFDs then you may have only needed to put down a £100 deposit (if we assume a 1% deposit requirement) but your loses could far exceed that £100. Your maximum loss would occur in a situation where the share price went down to 0. If you’d used CFDs to buy £10,000 of shares and the price suddenly plummeted to 0 then you could owe £10,000 if your trade wasn’t automatically closed out.

Could this happen in real life? Certainly share prices can go down to 0 – recent cases of large companies collapsing include Enron and Lehman Brothers.

If you were going long on indicies, such as the FTSE 100 then your theoretical loss would be the loss that would be incurred if the index went down to 0. As I write this the FTSE100 is at 4365. If I bought at £1 a point then my theoretical risk is £4365.

Unlike shares which can go down to 0 a share index is very unlikely to. It the FTSE 100 ever dropped to 0 then that would probably mean that the UK had been nuked to oblivion. In which case you may well be dead and your CFD broker wouldn’t exist either! Very unlikely but it is always worth bearing in mind just how much money you are playing with.

Could the value collapse so fast that you would end up owing far more than your account balance? You can end up owing your CFD provider more than you balance if you have a very large and highly leveraged position, and things move fast. In this case it may simply not be possible to liquidate your position fast enough to prevent your loses.

Losing a fortune – going short

The amount you can lose is often defined in terms of prices going down. Of course with CFDs we can bet on prices going up and down. How much could you lose by going short?

In theory you could lose an infinite amount of money!

I’m not saying it is likely – just theoretically possible. Lets imagine that you think UselessPowerPLC is going down. It is at 5p per share and you think it will fall further. You sell £10,000 worth – this is 200,000 shares. It is a small share and you need a 10% deposit. In other words you have to put down a £1000 deposit. They make an unexpected announcement – they have perfected fusion power, using patented technology, and can now produce almost unlimited amounts of power extremely cheaply. The company will make billions! The share price rockets to £20 and moves so fast that your CFD provider can’t close your position out in time. Suddenly you owe your CFD provider £3,990,000 (200,000 * (£20 – £0.05)). Yes – nearly £4 million. Crikey. Stretching the bounds of believability perhaps, but it makes a point about how risky the CFD game could be. Especially if you make stupid bets!

Is any of this really likely to affect me?

How fast could prices move? Very fast. Look at the stock market crash page on Wikipedia. How would your account have coped during one of those days?

My doom-munging scenarios wouldn’t normally happen of course. You CFD provider knows that trying to claw back debts from customers is much harder, and more expensive than simply deducting the money from their account. This is why they have automated systems in place to try to automatically close your positions before you get into this predicament. If you do find yourself in this predicament then you should look at the way you are trading – it probably means you did something very stupid, i.e. holding positions that were far too large and highly leveraged.

Although the unlikely is by definition ‘unlikely’, is always worth thinking beyond your usual risk scenarios. Don’t forget that a factor of the current credit crunch was that banks rejected the sudden default of hundreds of thousands of mortgages as being such an unlikely thing to happen that it wasn’t worth taking seriously. Ooops! Fortunately the banks had the government to bail them out. If you mess up then the banks certainly won’t be bailing you out.

The simple moral – consider the usual risks, and then consider beyond the usual risks. If you are still happy then you can play the CFD game. If you aren’t happy then maybe you should put you money in the bank.

Avoid getting screwed by your CFD / Forex trading broker

Thursday, June 18th, 2009

If you read trading forums such as trade2win and babybips then every so often you’ll come across someone who is asking for advice as it appears that they have been well and truly ripped off by their broker. I’m sure most brokers are honest but here are a few things you can to avoid the risk of bad things happening to you.

When you start generating a profit make sure they’ll let you withdraw the money

There are stories of people who have spent a lot of time building up their trading account, only to find that they have a lot of trouble getting the money back out. In the worst cases there are reports of people who can’t get their broker to give them any of their own money.

You could get into problems if:

  1. You have closed the bank account which was originally registered with them. For fraud prevention purposes they may make you jump through hoops to get a new account registered. Of course you’ll never have any problems paying money to your broker from whatever means you want. Similarly you could run into problems if they pay the money to your credit / debit card and it has expired.
  2. They tell you they have problems verifying your identity and require more details. This could severely delay your cash withdrawal as you’ll have to post/fax off whatever documents they request.
  3. They simply ignore your request. Sometimes it seems that requests to withdrawer your own money isn’t a very high priority for them.
  4. Your broker tells you that you have broken a rule in their terms and conditions. Have you read yours? They could easily say that because you haven’t obeyed whatever obscure rule they are suspending / terminating your account and won’t give you any of your money back.

The lesson to learn here is that as soon as you have made some money test their account withdrawal procedure. Take some of the money out and have it paid back to you. And then regularly transfer money out – if you are good at trading you should in effect be ‘paying yourself a salary from your trading account’.

Not only does making regular money withdrawals prevent you from running into this particular problem it also prevents you from accidentally losing your account with a highly risky trade gone bad or from some other trading mistake.

Don’t let your account get too big

This is related to the above advice. If your account gets too big then you will start getting noticed by your broker. This can cause all kinds of problems for you as they may start referring your trades to the dealer or be less willing to pay your money back to you. Best to stay ‘under the radar’ and withdraw money regularly. Of course this is only a problem with you are able to win regularly enough to get a big account balance 🙂

Keeping your account small also has a few more advantages.

  1. If a trade goes badly wrong (e.g. you bet the wrong way, the price massively moved and you didn’t have a stop!) your broker is likely to automatically close the trade for you when the balance gets within their minimum liquidity limit. If you had a huge pile of cash in there then your cash would just get eaten up until it is all gone.
  2. Keeping a small account means you are less likely to be tempted to get into overly risky trades.

Don’t build up huge positions

If you keep on putting more and more money into a winning position then you may run into problems when you try to close it. I’ve heard of people being ‘referred to dealer’ at the critical moment, which of course could lose them a whole load of profit as you either have to wait for the dealer to accept the trade or call them up. In the wrong conditions this could even turn a winning trade into a losing one.

In one horror story that I read the guy claimed to have built up a position of £1000 per point! That’s an insane thing to do with a retail broker and is bound to get you noticed when most other people are betting in the single or double digit range per point. If you are able to play around with that kind of money then you should probably be getting a professional trading account.

As with the previous tip you are best off staying away from their watch lists by keeping your positions small.

Conclusions

Regularly take profits out of your account. It is much safer in your personal bank account than in your trading broker’s account. It is much harder for your high street bank to refuse to give you back your own money than it is for a broker. You certainly don’t want to be with any broker who makes a fuss / takes too long / or just generally makes it difficult for you to withdraw your trading profits.

Don’t make yourself stand out from the crowd! It is best to be one of the masses rather than getting ‘special attention’ from your broker. Withdraw your money regularly to keep your account at a reasonable level and keep the size of your trades within the standard range that the broker would expect.

My first trading mistakes

Monday, June 15th, 2009

I first opened a CFD trading account about three months ago. In that time I’ve already made quite a few mistakes but hopefully I’ve learnt from them. Here are some of them.

Not checking the spread before entering a trade

If for example the index is moving in a range of say 10-20 points and you want to do a short term bet then opening a trade with a spread of 10 is going to make it almost impossible for you to come out with a profit.

Similarly if the index is trending then a large spread will still make it much harder for you to make a profit – any profit will be smaller because of the spread and any loss will be magnified.

Lesson: Make sure the spread is appropriate for the type of trade you are going into before you enter.

Forgetting about pending orders

Having pending orders which you have forgotten about can be very expensive as trades can then be opened without you even being aware of it. You could get lucky and it could go your way but more likely you’ll lose.

Lesson: If your platform supports it have the pending order blotter on screen at all times. Check for any pending orders before you leave your screen and before you close the trading platform down.

Not fully understanding your trading platform

I’ve had one situation that worried me. I somehow got into a trade that I wasn’t expecting (see forgetting about pending orders above), and I couldn’t work out how to close it down. It was a Forex trade and as the trading ticket wasn’t on screen I couldn’t work out whether I needed to buy or sell! It took me a few minutes to figure it out. No major loss was made and it could have been a lot worse.

Lesson: Read the manual before you start!

Not setting the default trading sizes correctly

For a particular stock the default trade size was 10,000. I wanted to trade much smaller so I set the market buy/sell size to 100. However I forgot to change the default trade size for the stop order as well. I entered the trade by selling 100 shares. I set a stop – which I didn’t properly check! The stop was hit and it bought 10,000 shares! Ooops!

Closed it quickly and of course it turned a small profit into a much larger loss.

Lesson: Make sure that you exit a trade and set your stops correctly! Especially if you will be away from your trading screen for any length of time. And check your stops when you have created them to make sure they are correct.