The market is not driven by money but by greed and fear. The two biggest emotions that move markets up and down at random; they seem to fluctuate without any logic behind them.
Why do we get these emotions when we trade? After all, it's stocks we're trading, not playing sports where our bodies are physically working to exert energy and sweat. So why then does it take to so much emotion just to click a buy button and a sell button and watch the screen with numbers moving back and forth?
When it comes to money, it's the master of us all. It doesn't matter what walk of life we hold, we are taught that money is the only way to reflect us as successful and accomplished people. But in the end, does it come down to money to become successful in trading?
The answer is no. Why? Success comes from loving what you do, not from doing what you're doing for the sake of money. There are people who work at jobs they don't like. Many do it just to get by but do not have the drive to excel. People who love their jobs have higher probability to excel in their work because they don't see it as work but something they love to do. Many of us enter the market to make money, not lured by the challenge of figuring out how the market works. It is the reason why new investors and traders start by placing a large position thinking the trade in monetary value, profit or loss. They think will be quick and easy, not really giving thought on how to figure out this complex but interesting market first before committing money in there. By committing money, its about the money, not the pleasure of learning about the markets.
This is where fear and greed comes in. This very first thought people make when entering is 'how much can I make?' and not 'I wonder how this market works?' There is a big difference in this mindset. When we don't worry about the money, we can view things in a more objective way. Believe it or not, there is a fine line from being in a trade and out of a trade, especially holding a big position. The emotions overtake judgment very quickly when a major loss is on the line with the prices fluctuating rapidly.
So how do deal with this? There are several things we can do keep greed and fear out of the trading plan:
Start trading smallest positions possible -The idea is to learn, improve and perfect trading while not thinking about the importance of gains or losses. This should subdue if not remove the fear and the greed.
Use stop loss order - Believe it or not, stop loss orders bring comfort and peace of mind that would otherwise bring many traders sleepless nights. Why? Not knowing how much the loss is, which can be unlimited, carry a major concern. This method will get rid of the fear factor.
Create a trading plan - Having a plan of attack, where to get in and where to get out in a certain market condition relieves the trader from having to think on his feet; without a plan will cause the trader to freeze and be indecisive and in turn cause more emotional stress.
Forex Trading Plan Elements
First write down your goals and objectives that you want to see happen in your trading business. Keep your trading plan as simple as possible. It should have enough details and a set of strict rules like for example include the golden rule “never invest more than 5% of your capital on any one particular trade”. Always question your trading activity, and look to your forex plan for guidance. If you are off track use your forex plan to get back on track. A forex trading plan should guide you at all times in your trading activity. If you ever want to achieve consistency in your trading pattern, having a forex trading plan is a must. In fact your own individual personalized forex trading plan would be the cornerstone of your entire trading activity.
When you have a forex trading plan, you have automatically programmed yourself to embark on a path of continuous growth and expansion in your trading business. By sticking to your plan, you would hopefully trade larger lots and make better profits over a period of time.
Perhaps at some point in your trading life you are likely to run into the adage “Plan your trade and trade your plan”. However this is easier said than done. But if you follow this advice, you would in effect be following very safe trading guidelines. The guidelines in your forex trading plan could very well be set up to watch out for both exit and entry rules in entering and exiting a trade, and the common pitfalls you got to avoid at every step.
A good currency trading plan will remove all the emotions from your trades. Some points that you should consider including in your currency trading plan are as follows:
Analysis Criteria: Specific conditions must be met to consider a currency pair to trade with and requires the use of technical indicators such as trend indicators, momentum indicators or hybrid indicators, how you read them, chart patterns that you trade and don't trade.
Entry Strategy: determines the price at which you will enter your trade. For example, an entry order can be an order to buy if the market trades above a certain level. Learn how to read technical indicators and learn what an entry signal looks like to you, know what you will use as entry signals.
Open Position Strategy: Is the most important and focuses on managing your emotions after you have entered the market. Too many open trades are harder to track and they put too much of your money at risk. When real money is involved your emotions change greatly which can effect your profitability as a trader. If your emotions are not in check they may cause you to stop following your currency trading plan because fear or greed got the better of you.
Stop Loss Strategy: A disciplined stop loss strategy is critical to the preservation of profits and trading capital. Your currency trading plan must include a stop loss strategy for use on all trades. The stop loss price that you set is up to you. It depends on your risk profile, trading capital and financial goals as of how much you should set for a stop loss. A stop loss between 1-2% of your trading capital is suggested. If your starting balance is small and you trade mini lots you may need to set your stop loss order far enough to make the trade workable. For this reason a higher percentage of risk may sometimes be acceptable.
Profit Taking Strategy: Before entering a trade you need to determine your profit taking level. Good traders remain flexible with the profits they take. When a trade moves in your favour you may have a strategy to lock in a profit that matches the amount of your trade at risk. You can then move the stop loss to the entry point while you continue to watch the profit run. A limit order can be placed at a price at which you will automatically sell if the trade goes your way. You will automatically collect your profits even if you are away from your account Discipline: Without it a currency trading plan is useless. If you stick to your currency trading plan and you are not successful then your plan needs adjustment. If you don't there is no way to tell if your currency trading plan is at fault, or if it was the decisions that you made outside of your plan.
Exposure: You should always know what level of exposure you are comfortable with in the market. A general rule of thumb is to risk no more than 2-3% of your available trading capital for any one trade. This will ensure that regardless of what happens to you, you will still have money left to trade with even if you have made a number of consecutive losses. After making the necessary changes to your currency trading plan you can still go back to the market.
Money Management: Forex money management is very important as it focuses on how you protect and allocate your trading capital. You need a strategy of limiting risk while making the most out of favorable market moves. When you allow your profits to run it is necessary to trade with a risk/reward ratio of about 1:2 or greater. Risk is the amount of pips you are willing to lose in any one trade and reward is the amount of pips you intend to gain in any one trade. To maintain the risk/reward ratio it is wise to cut your losses short and let your winning trades run.