How to Make a Profit from Forex Trading
The general idea behind Forex trading or trading the foreign exchange market is to correctly identify the direction a currency pair is going to move and buy or sell it. If the trader is right, a profit is being made, and if not, the trading account takes a loss. The more profits are being made, the better the performance of the trading account is. Conversely, losing trades will result in the trading account being depleted. Reading a trading account is not that simple, and looking at the details in a trading report is subject to a bit of knowledge about Forex. For example, one may have ten losing trades in a row and only one winner and still, make money. It is all depending on the money management system, the risk-reward ratios, and the volume being traded. Therefore, there are many things to consider when trading the Forex market, and, on top of the ones mentioned so far, the time horizon, or the trading style matters as well.
Ways for the Account to Grow
Money management is key in planning any financial goal, and it cannot be truer than in the case of Forex trading. Not only that traders need to know everything about the technical and fundamental factors that influence the market, but they need to plan their steps carefully. Perhaps the reason why most of the newcomers in the Forex market are failing is the wrong understanding of how this market is functioning and that the psychological factor is prone to make people take wrong decisions. After all, opening and closing a trade is subject to a decision-making process.
Real Profit of Loss
Before moving forward, trading should be viewed as a regular business. Taking a trading position in the Forex market has some associated costs and benefits. Costs are always deducted first, and benefits after. Moreover, costs are fixed, while benefits are potential.
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The chart below shows the earlier EURUSD trade taken as explained in the previous article here on the Trading Academy. Again, keep in mind that this is a Demo account and not a live one.
The short trade taken earlier now is showing a loss. If you look on the bottom right corner, a loss of -81.50 USD is being shown. However, that is not the total cost associated with this position. To this, we must add the commission’s fee that already was deducted from the trading account, in this case -3.50 USD. Having said that, the account is down -84 USD so far. As you can see, the opening price of the short trade was 1.07458, and, if the stop loss is hit, the position will be squared at 1.0800. To close a short position, or to square it, a long trade will be issued. The difference between the selling price (bid price) and the closing price (ask price) represents the profit or loss of a trade, expressed in pips. But, if you check the bid and ask prices of any given currency pair, you’ll notice that they are not the same. This difference is called a spread and it must be paid too. Following up to the EURUSD short trade, the total cost of the trade is 84 dollars plus the spread. In the case of the EURUSD, the spread is one of the smallest, if not the smallest, in the industry, but anyways, it represents a cost. If the trade is not reaching the stop loss nor the take profit today, it will be still open when the overnight rollover happens. This would result in a positive or negative swap to be added or deducted to the trading account, making the total cost of the trade changing again. While so far, this trade showed a loss, it is not really one until either the stop loss or take profit is hit. Until now, the move against the position is called a “drawdown”, and, as a rule of thumb, the smaller the drawdown is, the better the performance. In the meantime, as you can see below, that loss disappeared completely, as it turned down the market only made a fake move. That spike, therefore, was only a drawdown.
Money Management and Trading Style
Money management plays an important role in Forex trading, as mentioned earlier in this article. Before explaining it a bit more, keep in mind that it is not possible to trade the Forex market without having losses. The idea is for the account to grow, so more profits than losses to be realized. It is not possible to have only winning trades, as, it is not possible to have only losing ones! What it is possible is to have a good winning streak or a long losing one. But these can be handled with a proper money management system. There are many ways to handle the money management in a trading account, and we’re going to cover all of them here on the Trading Academy. As a short mention, the most popular one is risking only a small percentage of the trading account (like one or two percent) on any single trade, but there are also other risk-handling strategies that work nicely. The time horizon of a trade has a strong impact on its success. Patience is a crucial factor in any trade, and sometimes it is the only thing that makes the difference between losing and winning. If the analysis is made on bigger time frames and the trade is having its stop loss and take profit levels set accordingly, then just letting time passing should do the trick. Again, even if the stop loss is hit, with a proper money management system this will have little or no effect on the overall profitability of a trading account. When traders can put a stop loss and take profit level on a trade, it means a trading plan is in place. If this is true, then simply let the trade taking its time, otherwise, the whole trading plan was made in vain. To sum up, I’ll end with the same EURUSD position, that, in the time this article has been written turned positive and now it is showing a profit. If a trader would lose its never and close a trade every time a drawdown hits a position, then it is most likely trading is not for that person.
Planning a trade is one thing, and execution is another. If you bothered to make a plan, then simply execute it. The problem with Forex trading is that many traders are good in planning a trade and lack the proper execution. Therefore, money management and knowing yourself as a trader is as important, or even more important than mastering technical or fundamental analysis.
Recommended Further Readings
- Forex Trading – Explaining the Concept
– What is forex trading, generalities about trading the currency market.
- Why Trading Forex?
– Advantages and disadvantages of trading the currency market, what are trader’s expectations and what is a realistic approach to follow
- What is a Forex Broker and Types of Brokerage houses
– Explaining what a Forex broker is and does, how the business should be organized, and how many types of Forex brokers exist.
- Financial Products to Trade
– Different categories of financial products that a Forex Broker is offering for the retail clients, starting with the classical currency pairs, and continuing with commodities, CFD’s, indexes, etc.
- Toward a theory of marginally efficient markets. Zhang, Y.C., 1999. Physica A: Statistical Mechanics and its Applications, 269(1), pp.30-44.
- “Autonomous Forex trading agents.” Barbosa, Rui Pedro, and Orlando Belo. In Industrial Conference on Data Mining, pp. 389-403. Springer Berlin Heidelberg, 2008.