I didn’t really write an e-book but most of the e-books I’ve seen out there should be combined into a big pile and burned. If I were to write a forex e-book, it would probably be less than a page long. Here is my e-book replacement.
If you’re a beginning trader, then go out an invest in a currency related book on technical and fundamental analysis. There are tons out there that cover both and they’re a lot cheaper and easier to read than an e-book. If the book doesn’t go in depth enough on a particular subject you’re interested in, do a Google search and you’ll find all the information you will ever need.
After getting some book smarts on the subject of forex trading, jump right in and start trading. Trade a demo or put a small amount of money that you can afford to lose at a broker that offers variable sized lots. Being able to trade in variable sized lots or micro-lots is critical. If you don’t have the ability to do this, most likely you’ll be overleveraging which will most likely lead to ruin. Try different strategies, either ones you’ve picked up on forex forums or ones you’ve created on your own. Experimentation is key and success will only come with experience. Consistent profitability isn’t going to happen overnight. The goal is to stay in the game for as long as you can without getting discouraged. I hate to sound like a walking cliche but there will be many bumps in the road. You’ll have to prepare yourself to take the punches and keep getting up. Take a break when you feel overwhelmed by the market with the intention of jumping back in when you feel like you’re ready.
My brother is a pilot for a major US airline so I know how many hours he had to have flying an airplane before he was considered proficient enough to fly a large passenger jet. Why would trading be any different? Get those trading hours. Even then, there is no guarantee that you will be successful but you’ll never know if you don’t get the experience.
If you trade long enough, you’ll start to see consistencies in the forex market. Your style of trading will also appear even if you weren’t trying to find it. You’ll also start creating trading systems that match your trading style.
With this experience and increased ability, I’d like to think the rest is this simple.
- Size your position. Keep your risk low on each and every trade. I like the risk per trade to be less than 2% of my total account balance. Use my position size calculator at http://www.forexcalc.com if you don’t know how to calculate it.
- Execute your trading system(s) knowing their criteria for trade entry and exit.
- Tune and tweak your trading system if needed. Continue to search for additional trading systems that you feel may give you an edge in the market.
- Repeat step #1.
Maybe I have a case of trader muscles but I don’t think it should be much more complicated than this. There may be a time when you decide to look into carry trading or more exotic trading strategies which complicate things a bit more but even then, I feel the basic principles still apply.
Do you have a problem with exiting your positions too early? I always have. It’s one aspect of my trading that concerns me because I’m never sure if closing it early was the smart thing to do. Let me give you an example which just happened to occur today. I went long on the EUR/CAD before the European session open. I went to bed and woke up to see the position up 80 pips. I had a 100 pip stop loss and a 200 pip target. I was a bit surprised to see it up this much so quickly. I thought about it for a minute and decided to close the position and take the profit. Why violate my pip target? Based on my experience with the ebb and flow of the currency market, I figured there was a good chance that the price will not continue in my direction and retrace, wiping out any profit I had. I’ve seen this happen so many times. Today, this didn’t happen. The EUR/CAD continued going up and would have easily hit my 200 pip profit target. This frustrates me more than losing. Here are a couple of ways I’ve handled a position that goes in my favor by a substantial amount:
- Close it out based on feel or maybe fear. I’ll do this even if I have a target set on the position. My rationale for closing it is that either I’m satisfied with the amount of profit or I’m fearful that if I don’t, the pair will turn against me and wipe out my profit.
- Close a portion of my position based on feel or fear and leave the other portion open to run if the pair continues in my favor. From my experience, when I do this, more times than not, the remaining portion gets stopped out and I lose the profit. Almost always, when I close a portion of my position for profit, I’ll set the stop to breakeven on the remaining portion so I won’t lose any money.
- It runs to completion and my target price is hit. This almost always occurs when I don’t have time to monitor the position. The target price usually gets hit very quickly. I typically obtain my highest reward to risk in this scenario.
In scenario #1, I feel good about the trade if I close it out and then it does exactly what I thought it would, turn against me. I don’t feel so good if the pair continues in my favor after I’ve closed it and would have hit my target.
My feelings in scenario #2 and very similar to those in scenario #1.
In scenario #3, I feel great about the results of the trade.
So which is better, any of the three scenarios or flat out losing money on a trade? I think not losing money is best but the first two scenarios can sometimes lead to losing money. If I’m not getting a decent reward/risk because I’m exiting a position too early, when I do hit that losing streak (trust me, it will happen), my losses could be much greater than my gains. How many times have you closed a position early when it at a negative and not going in your favor? I can count the times on one hand.
I’d love some feedback on what your experiences are and if you can relate to my possible problem. It hasn’t affected my profit the last month and a half though. I’m up over 13% this month alone but like I said, this could be short-lived if I don’t address this now.
I’ve been emulating my real account trades with my demo account for the January forex trading contest. I’m currently in first place with a return of 11.16%. After today though, my return will drop 2 percentage points to about 9% since I lost 2% on a trade. I don’t know if this will be enough to hold on to the lead.
This is an overview of how I’ve been trading so far in January 2008:
- I have been risking exactly 2% on every trade. No more, no less.
- I’ve been using my forex position size calculator everyday when figuring out my trade size and find it very handy. Some of you have commented the same.
- My R-multiple on every trade has been 2R. For those of you that haven’t heard of R-multiple, it’s really just an abbreviation for reward-to-risk. 2R means my reward-to-risk is 2:1.
- I’m not watching my positions so there isn’t any fancy money management going on. I haven’t once set my stops to breakeven. I’m just letting them ride. If they hit my target, they hit it. If they don’t and stop out, so be it. This is quite different from what I’ve done in the past. In the past, I’ve been quick to set my stops to breakeven when they move a little in my favor. The consequence of doing this was typically a gain/loss of zero. I can’t tell you how many times I’ve moved my stop to breakeven only to see it get stopped out. Then I have to watch as the price goes back in the direction I was trading where it hits my initial target price. This to me was more frustrating than losing. I’d rather stick to my guns on a trade instead of playing it scared.
The blog’s been silent since Sunday which usually means I’m busy doing other things or concentrating on trading. That has definitely been the case this week. I’ve been participating in the forex trading contest, getting Metatrader primed and ready for backtesting expert advisors again, finishing the development of a new AJAX forex position size calculator, trading for real, and working my real job. Being busy is probably common for a lot of you out there too who are trading forex but have real jobs and responsibilities.
I’ve searched around for a forex position size calculator but what I mostly found were pip value calculators, excel calculators, or calculators that were part of some proprietary trading platform (like Oanda’s.) I didn’t find what I was really looking for which was a simple calculator that gave me a recommended position size in units and where I just had to enter my account balance, the percentage I want to risk on a trade and my stop loss. So this is exactly what I developed. It’s completed and in beta at http://www.forexcalc.com. It currently only works with accounts in USD but I’ll expand on that later. You have a choice of determining the position size for 110 currency pairs, way more than you’ll ever need. It also works no matter what your account size is. It can be $1 or $10,000,000 though I doubt anyone with an account this big would utilize it.
UPDATE (January 2008) I’ve created an AJAX forex position size calculator that performs the calculations for you. You can find it at http://www.forexcalc.com
Here is a complete checklist to determine the most important aspect of money management, position sizing.
1. What is my account balance? $4234.58
2. What percentage of my account balance will I be risking? 1.0%
3. What is my stop loss on this particular trade? 50 pips
4. What currency pair am I trading? GBP/USD
5. How much is a pip worth on a 10K (mini) account? $1
6. CALCULATION What is my dollar risk amount? (Account Balance x Percentage Risk) $42.35
7. CALCULATION What is my position size (Dollar Risk Amount x 10000) ÷ (Stop Loss x Pip Worth)
- It’s up to you to determine what percentage of your account balance that you want to risk. I’ve heard traders risking from 1.0%-5.0% per trade. I risk no more than 1.0%.
- It’s important to determine what your stop loss will be before continuing with the checklist.
- This is the hardest to determine by hand with the exception of currency pairs with the USD in the quote currency such as the GBP/USD, EUR/USD, and AUD/USD. These currency pairs always have a pip worth of $1 on a 10K (mini) account. For other currencies, it’s easiest to use a pip value calculator. Make sure you use the pip value from the "Lot 10,000" column.
- This is easy. Take the account balance and multiply it by .01 (1.0%), .02 (2.0%), etc. to obtain your dollar risk amount.
- This is the most important calculation. Do it right.
EXAMPLE #1 (Answer questions 1 – 7)
- 50 pips
- USING A CALCULATOR-> ($4234 x .01) = $42.35
- USING A CALCULATOR-> ($42.35 x 10000) ÷ (50 x $1) = (423500) ÷ (50) = 8470 units
What you might be thinking… I can only trade a mini-lot which is 10,000 units. This is more than my calculated position size. This means that you are under-capitalized. You need more capital to trade mini-lots. Another option is to use a variable-lot size broker like Oanda where you can specify 8470 units. Another option is to risk a smaller percentage per trade (use 0.5%.)
EXAMPLE #2 (Answer questions 1 – 7)
- 75 pips
- USING A CALCULATOR-> ($10582.26 x .02) = $211.65
- USING A CALCULATOR-> ($211.65 x 10000) ÷ (75 x $0.8829) = (2116500) ÷ (66.22) = 31962 units
In this example, you could enter a trade in the USD/JPY with 3 mini-lots or 30,000 units. If you have a variable-lot size broker like Oanda, you can enter a trade with 31,962 units.
There may be a better or quicker formula for calculating position size. This method works but if you know of a more efficient way, let me know.
I took my first trade in months this past Thursday. I have been slowly trying to get back into the forex market by cautiously watching the GBP/USD. It's been a while since I followed any currency pair so I wanted to be sure that I watched the GBP/USD for a couple of days before taking any trade. I've decided to start referring to my profits/losses in terms of expectancy. Expectancy is "simply the mean or average R-multiple generated." (Source:http://www.iitm.com/sm-Expectancy.htm)
The "R" in R-multiple is short for risk. The best way to understand it is to either read the source above or continue reading. Let's take my first trade as an example. I knew my total dollar risk before entering the trade, that amount being $650.94. (yes, that exact) I exited half of my position when I had profited $329. I moved my stop to breakeven on the remaining position. Unfortunately I was stopped out on the rest giving me a total profit of $329. To figure out the R-multiple, you would take (profit / amount risked) which in this case was $329/$650.94 = .5R. Ideally, the higher the R in a profit situation, the better. For instance, a 2R multiple would be obtained in a 2:1 reward/risk trade and a 3R multiple in a 3:1 reward/risk trade. In a loss situation, a higher R is actually worse. Ideally, if you lose on a trade, the R-multiple should be 1R or less. If it's 1R, it simply means that you lost the amount you were expecting to risk. So in my above example, if I lost $650.94 on the entire trade, my R-multiple would have been 1R. Let's just say that I got stupid and decided to stay in the position and not honor my stop loss setting. Because of this stupidity, let's also say that I wound up losing $1301.88, twice as much as my initial risk. Calculating using (loss / amount risked) I would have an R-multiple of $1301.88/$650.94 = 2R.
So what does all of this mean? Well, I only have 1 trade to calculate my expectancy which would currently be .5R. I'll get more into calculating mean expectancy once I've compiled more trades. But having .5R isn't desirable because it basically means that I risked twice as much as the reward I obtained. This is exactly why I want to try to use R-multiple when I talk about my trades because even though I had a $329 profit on my first trade, it isn't as rosy as it may seem. The R-multiple was only a .5R and although it was profitable, if I trade this way in the long haul, I'll surely lose.
Another good source that also mentions the critics of R-multiple can be found at http://tradermike.net/2006/09/r_r-multiples_defined/
I've been slowing getting my Forex "legs" back by reading a book I picked up months ago. The Book is called "Trade Your Way To Financial Freedom" by Van K. Thorp. I picked it up months ago based on recommendations from Simon over on his blog. I can see why he thinks so highly of this book because it is so different from the plethora of trading books out there. Van stresses managing reward to risk in your trades and position sizing. I was certainly most interested in his position sizing chapter of which I'll be talking about more in the future.
Poor position sizing can kill your account. Risk too much on any given trade and it could be impossible to recover. I've been down this road before and the reasons for this were inexperience and greed. If you were to open a $1000 trading account and you lose $200 on your first trade, this would be a 20% drawdown. The percentage gain you need to recover from this loss is a possibly manageable 25%. But if you were to lose $400 on your first trade, or a 40% drawdown, you would need a 66.7% gain to recover from this loss. This information may be trivial and known by many, but the extent isn't quite noticeable until you see the following table. Losses beyond 50% require "huge, improbable gains in order to get back to even."
Recovery after Drawdown
|Drawdowns, %||Gain to Recovery, %|
I was turned on to an article in the New York titled "Blowing Up" by Rob Booker's blog. According to him, it's the best article he's read in a long time and I have to absolutely agree with him.
The article is about a money manager named Nassim Taleb who created an investment strategy "predicated entirely on the existence of black swans; on the possibility of some random, unexpected event sweeping the markets." Most traders dismiss this black swan as an unlikely event like Victor Niederhoffer who was one of the most successful money managers in the country at one time. Niederhoffer blew up his entire account by selling a large number of options, betting that the market would be quiet. The odds were totally in his favor he thought because the chances of the market going down so heavily were miniscule. Unfortunately for him, the market plummeted 8% in October, 1997 due to the economic crisis in Asia. Niederhoffer made the same mistake again and lost after two planes crashed into the World Trade Center. The black swan reared its head again.
Taleb takes an opposite approach and bets that the black swan will inevitable rear its head and when it does, he will have his payday. In the meantime, he compares the waiting as bleeding a slow death and most days as other money managers are making large sums of money, he's losing small amounts of money.
So as long as you have a definable risk which only threatens a small amount of your capital, you have a chance of riding a wave of profitability that outweighs these smaller losses. I don't want to oversimplify this because it's not easy but it is possible. Weigh your time and be patient. That unexpected event that could wipe out a traders account is right around the corner.
This is definitely worth the read. My summary doesn't give it justice. http://www.gladwell.com/2002/2002_04_29_a_blowingup.htm
What is maximum drawdown? Why and how do I calculate it?
First, what is maximum drawdown? It is defined as the largest drop of a given asset within a certain time period.
Why calculate it? I've never made it a point to calculate maximum drawdown but I'm going to now. This is my attempt to start looking at more "advanced" money management concepts so I've decided to start with one of the easiest. The reason for calculating maximum drawdown is to measure the riskiness of your trading strategies. It will also give you an idea of how much money you could lose at some indeterminate point in time.
How do I calculate it? During the history of your trading strategy, I'm sure you'll be keeping track of your change in equity from one day to another, one week to another, one month to another, or whatever time period you choose. In the course of your trading, you will calculate drawdown which "represents the total percentage loss experienced by
a strategy before it starts winning again … and drives the
investment balance back up." (Source: http://www.confidentstrategies.com/maximum-drawdown.htm)
In this picture (Source: http://www.autumngold.com/Performance/DescriptionDD.htm), the drawdown is calculated with the following formula:
(Valley VAMI – Peak VAMI) / Peak VAMI
The Valley VAMI is the red arrow or approximately $1,100.
The Peak VAMI is the green arrow or approximately $1,425.
Therefore the drawdown is ($1100 – $1425)/$1425 or -22.8%.
Let's do 1 more example from the picture above. First let's find the Peak prior to the green arrow.
The Peak VAMI is approximately $1,250.
The Valley before the green arrow is at approximately $1,150.
Therefore the drawdown is ($1150-$1250)/$1250 or -8%.
So to find the maximum drawdown, select the drawdown that was greatest, in our example, -22.8%.
I have definitely been sidetracked for some time now, preoccupied with only particular GBP/USD forex trading systems. Due to this fact, I feel like I've disregarded other aspects of technical analysis that may one day turn out to be useful. This started about 6 months ago after my first full year of trading, where I found myself sitting in front of my computer staring at charts for what felt like forever. I don't know if it was burn-out or if I just felt like these other forms of technical analysis required discretion, something that I wasn't successful at. it could also have been that I was looking for instant gratification after months of hard-core learning.
I'm not sure where my trading will be next year or this year for that matter but I feel the need to start concentrating on some of these neglected areas. It's strange that I spend so much time optimizing and organizing this website but I don't translate this over to my forex trading and studies. I feel very disorganized and sometimes behind in what others have learned in an equal or shorter period of time. I've said this before but I'm going to try to put together a list of things that I want to study and learn more about. I want to continue with my GBP/USD trading systems but I also want supplement other things into the fray. Just off the top of my head are:
- Ichimoku specifically on the USD/JPY. I'm still reading the new ichimoku book that was sent to me but I've always been interested in this indicator and I want to explore it further
- Chart patterns
- Money Management
- Carry Trades
These are only a few but I think the key as I said previously is to get organized and try to create a learning schedule so that I can become more adept at forex technical analysis.