Leverage, the Double-Edged Sword

Most brokers provide leverage to investors and traders alike. So what is leverage?

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.

For example, you deposit $10,000 in your trading account. You buy 2 standard 100K lots of EUR/USD at a rate of $1.0000. The full value of your position is $200,000 and your account balance is $10,000. Your true leverage is 20:1 ($200,000 / $10,000)

Let's say you buy another 2 standard lots of EUR/USD at the same price. The full amount of your position is now $400,000, but your account balance is still $10,000. Your true leverage is now 40:1 ($400,000 / $10,000)

Let’s say the price of EUR/USD increased by 2% to $1.0200. Your 4 standard lots of EUR/USD will now be worth $408,000. If you closed the position, you would have made $8,000 in profits which equates to a 80% profit.

However, suppose the price of EUR/USD fell by 2% to $0.9800. Your 4 standard lots of EUR/USD will now be worth $392,000. If you closed the position, you would have made a loss of $8,000, depleting your account by a whopping 80%!

Your profit/losses are calculated using the following:

(true leverage used)  x (% change in market price)

A Consistent Approach Yields Consistent Results

We shouldn’t expect to win every trade.  Some of the best traders in the world win on less than half of their trades.  But they also know that after a series of trades, because of sound money management, they can expect to be profitable. This is because they are consistent in their approach, so they expect some consistency in their results. 

When developing a new strategy, you have to judge it’s effectiveness through different market conditions. This means that you have to see how it works when the market is trending up, trending down, in a range bound situation and also when the market seems confused and directionless. This may mean running through 100 practice trades to get a good feel for the strengths and weaknesses of the approach. Just because that approach loses three trades in a row does not mean it doesn’t work.  If you and I were flipping a coin where I won on heads and you won on tails, we know that we would each win on about half of the flips. But if tails came up three times in a row, that does not mean that there is something wrong with the coin, it is just chance. We would still know that after a series of 100 flips, we would each still have won and lost about half of the flips. Think of this as you are working on ways to trade the market. Don’t be too quick to judge that approach on a small number of trades. Think long-term when judging and then if the results are acceptable, be consistent in taking the trades and your trading results will also start to show some consistency. 

Taken from:

http://www.dailyfx.com/how_to_trade_forex/course_trading_tips/

Learn to Crawl, Then to Walk, Before Running to Wealth

In order to be a professional, one must go through vigorous training and learning. It is difficult to become a consistently profitable trader and most new traders will quit before attaining that status. Becoming profitable is achievable, but it takes time and practice.

Get a feel for trading by first practicing in a demo account or do paper trading. Start out small, trading one trade at a time. After months of trading and creating a plan to take on the market profitably, do live trading.

Start out small with your live account. The difference between trading with and without real money is like a wide chasm separating the two. People often think it’s the same and start squirming after the market goes against them. A 20 pip move against you and fear starts to overwhelm you in live trading. With time, you will find that trading with real money becomes easier, but you should learn to walk before you start trying to run with the professionals.

Look at the Big Picture, then Take Out the Microscope

I recommend identifying the weekly or daily trend, before zooming in on the 4-hourly or hourly chart to look for your entry and exit. Only enter in the direction of the daily trend. Too often though, new traders lose their way and start with the short-term charts to find a trade and then move up to the daily chart to justify their choice. 

Know Your Exit

Many traders exit a trade without a strategy in place. More often than not, the decision to exit is determined by emotions of the trader. Emotions of fear and greed. Decisions made by fear and greed are not only inconsistent, but many times seem to lead to an exit at the worst possible moment. The best way to keep our emotions out is to have a sound strategy.

Many experienced traders follow a simple risk-to-reward ratio as an exit strategy. A risk-to-reward ratio of 1:2 allows the trader to place a target that is twice the risk. For example, Trader A place a EUR/USD long @1.4500 with a S/L @1.4400 or 100 pips, He would place his T/P @1.4700 or 200 pips.

Trading Rules!

1. Never risk more than 5% of your investment capital. If you have $10,000 in your account, you can risk up to $500.

2. Always use stop orders. Forex markets can move quickly, so a stop order can save you from potential losses as well as profit protection. Identifying your risk is the key to successful trading.

3. Never trade against the daily trend. Never buy or sell if you are not sure of the trend.

4. Never enter a trade without a good reason. A consistent approach increases your chance of success.

5. Trade only in active currency pairs. Keep out of slow, inactive ones.

6. Avoid co-related risk. Avoid tying up all your capital in any one currency.

7. Don’t close your trades without a reason.

8. Never average a loss

9. Never get out of the market just because you have lost patience or get into the market just because you are anxious from waiting.

10. Never cancel/move a stop loss order to allow for more losses, hoping that the market will reverse.

11. Be just as willing to short as you are to long. Your objective is to keep with the trend and make money.

12. Never buy just because the price of a currency pair is low or sell just because the price is high.

3 Choices to Investing

When it comes to money and investing, people have three fundamental reasons or choices for investing. They are:

1. To be secure,
2. To be comfortable, or
3. To be rich.

All 3 choices are important. The difference in one's life occurs when the choices are prioritized.

Most people place the choices in the following order:

1. To be secure
2. To be comfortable
3. To be rich

For most people, if becoming rich disturbs their comfort or makes them feel insecure, they will forsake becoming rich. That is why so many people want that one hot investment tip. People who make security and comfort their first and second choices look for ways to get rich quick that are easy, risk free, and comfortable. A few people do get rich on one lucky investment, but all too often they lose it all again.

I put my priorities in this order:

1. To be rich

2. To be comfortable

3. To be secure

As stated earlier, when it comes to money and investing, all three priorities are important. Which order you put them in is a very personal decision that should be made before beginning to invest. To be rich, comfortable, and secure are really personal core values. One is not better than the other. I do know, however, that making the choice of which core values are most important to you often has a significant long-term impact upon the kind of life you choose. That is why it is important to know which core values are most important to you, especially when it comes to the subject of money and financial planning.