This article will delve into the key component of profitable Foreign Currency trading which is trade small based on your account, do not risk more than 2-3% per trade and focus on catching big winners while keeping the losses meticulously small.
The trick to making money in trading Forex, or any market, is having small losses and LARGE wins. You don't have to be winning on a majority of your trades to make a net profit; you simply have to focus on having small losses while maximizing your wins.
How Do You Prevent Yourself From Suffering Big Losses?
First, determine where the market has to go to indicate that your trade is likely to be wrong. I typically use the previous swing low for buys and swing high for sells plus a couple of pips so that noise doesn't knock you out and cause you to miss a profitable move. With the TopGun Software , my partner I have created our systems to win 60-80 percent of the time, however, as I said above, you don't have to win that often to succeed. A high win rate system will let you use smaller stops (10-12 pip stops are our maximum for most USD pairs). The next step is to determine how much in % terms you are willing to risk per trade.
Risking 2% Per Trade Is A Good Base Line
This way you can have five consecutive losses, which rarely, if ever, happens if you know how to trade Forex.
Advanced Traders Only
If you are a profitable and experienced trader, you will likely have varied trading styles, methods, and strategies. Some may succeed 50% of the time, while others don't occur too often, but are extremely successful when they do. For advanced traders only, I recommend they risk more on the trades that are likely to succeed that also often have much bigger pip gains than other systems.
So, for instance, if you’re normal systems win 40 to 60 percent of the time, but one only finds a few trades per week but is usually 80% winning and gives you giant wins, say 30 to 50+ pips on average, I recommend you INCREASE the size of your trade. I will increase the size on my trades 30 to 100%. This can have dramatic impact on your AVG WIN size, which I'll explain later, along with how it impacts your NET PROFITABILITY!
Once you've made the above two DECISIONS, you can then determine how many Forex lots to trade. A mini lot is $10k, and a full lot is $100k of currency. Additionally, a mini lot is worth $1 per pip, while a full lot is worth $10 per pip of price movement.
Number of lots to trade = (Account Size X Risk % per trade ) / ( Stop in pips * Value per pip )
So, for example, you have a $5,000 account and are risking two percent on this trade where you are having a ten pip stop and are trading mini lots ($1 per pip).
$5,000 x .02 = 100. You can only lose $100 on this trade, which would be two percent of your account.
Then, simply take the 100 and divide by your 10 pip stop * $1 per pip = 10, which results in ten. You can trade ten mini lots in this trade, which is the equivalent to 1 full lot.
If you were a full lot trader, you take ($5,000 x .02) / (10 * 10), and the result would be one lot!
It’s simple!
Now, this is only the beginning. In order to be profitable, your wins should be 50% larger than your losses. This means that if on average you lose $100 on your losses, you should be making $150 on average for your winning trades.
By examining my personal experiences and watching the accounts of my close to 2,000 traders, I've found that big wins (30-50+ pips) happen 10 to 20% of the time for most traders. This means that often times our wins are 5, 10, 15, or 20 pips. The huge 30-50+ pip wins just additionally increase our average.
The profitability formula is: Number of trades X winning % X average win amount in dollars minus Number of trades X losing % X average loss amount in dollars.
So, there are a few things you can do to MAXIMIZE your Forex profits. First, increase your winning percentage while doing everything you can to reduce your losses. We teach our traders to move their stops to BREAK EVEN once the market moves 10-12 pips their way. This lowers winning percentages, but also DRAMATICALLY reduces the average loss in dollars! It's one of the secrets to trading that you will rarely read in books, and I have many 40% winning traders that make a steady income trading Forex because they have few losses, just break evens on most trades that don't work!
You should also AVOID trades that are unlikely to earn 50 percent more than you risk. For example, if you see two or three major resistance points five pips above current prices, and you are using a ten pip stop, DO NOT TAKE THE TRADE! If you are "likely" to make only five pips while risking 10, this is a recipe for disaster. AVOID IT AT ALL COSTS!
If, on the other hand, the next resistance area is 30 pips away and you have a ten pip stop and the trade is 50 to 60%+ likely to work, you MUST take the trade. Those 20-30 pip wins will increase your average winnings. This is another reason why I told you to increase your trade size on trades you think have a 80-100% chance of working or are more likely to give you huge gains.
by Chris Donnell
