Part 3: Retail Forex Trading is All About Controlling Risks and Emotions

Provided by guest contributor Jennifer Gorton from Forex Traders

Up to this point, we have continually stressed the high risks involved with trading currencies in the forex market.  Even wise traders get overly confident at times, ignore their preconceived trading plans, and trade based on their gut instincts, forgetting to deploy basic risk measures designed to protect their interests.  Unfortunately, these very risk measures are what allow a trader to lose one day and return the next, once again on the lookout for the “trend” that will become his “friend”.  Trading without risk measures is a catastrophe waiting to happen.

Controlling one’s emotions is one more form of risk that must be mitigated.  The psychology of trading has received much attention in the past decade, and the results of many studies confirm that our minds can be our worst enemies when making decisions in high stress environments where real money is on the line.  Like it or not, our psyches can make us hold on to losers too long and sell winners too early, two actions that will undermine even the best intellectual framework.

Do you need a therapist to trade in forex?  No, but self-awareness helps, as does listening to a professional trader explain how he copes.  Experienced traders have learned that the best way to control risks and emotions is to have a detailed trading plan that you follow to the letter.  Many write down their steps and tape the list to their monitors to emphasize the point.  Most will practice their disciplined approach to the market on a forex demo account for hours until the steps become almost habitual.  In this way, they treat forex trading like a business where each decision is based on a set of rules with no emotional input.

A simple trading plan may be like the following:

•    Assess your currency volatility by using an ATR (Average True Range) indicator for the last twenty trading periods;
•    Your risk tolerance will be an appropriate percentage of the ATR times the value of your intended position.  The value will be your downside risk amount, and your profit target will be “2X” this amount;
•    Use technical indicators and pattern recognition to optimize your entry point in the market;
•    After entry, place a “Stop-Loss Order” at the ATR value below entry;
•    After hitting a profit target, always enter a “Trailing Stop-Loss Order” to lock in profit and let your winner run;
•    Use technical indicators and pattern recognition to optimize your exit point in the market;

Are you now ready to trade the Malaysian Ringgit in the forex market?  No, of course not.  Based on your class instructions, you need to develop your personal trading plan and practice it on a forex demo account.  When you have achieved a level of success and consistency in that medium, then you may have the confidence to put real money at risk.  However, capital invested in forex trading should always be risk-based, meaning that if you lose it, you can do without it.

If you do enter the real market, start with small lots until you are comfortable with the trading environment.  The experience will differ from your demo account since the trade orders are now real and must be executed.  There may be delays and quote changes. Your mind will also try to distract you since real money is on the line.  Stick to your plan and use stop-loss orders frequently. But keep in mind that in volatile market conditions you might not be able to get filled at your stop-loss limit which mean losses can be larger than you expected.

Knowledge, experience and emotional control are the hallmarks of success for any investment strategy.  Practice, and earn the “Forex Trader” title.

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