Hello all, I hope that 2016 is treating you well so far. My wife and I were blessed with the birth of our daughter last May and she has been keeping us very busy :). So busy in fact I have not had a chance to write anything on my blog in quite a long time. It is a bit of a lazy Sunday afternoon in our home today so I have seized the moment.
I have really been giving a lot of thought lately to why so many forex traders are unsuccessful over the long term, and what is the key thing that separates a long term consistent trader from those that crash and burn and blow up their account in less than a year?
Having been involved with forex in some degree or another since about 2005, I can say from experience that for a very long time I was very focused on finding that “holy grail” strategy. “If I could only find that perfect trading system that gives me laser accurate entry signals I would be successful” I would think. And so I would go jumping from one trading system to another on the forex system treadmill. Does this sound familiar to some of you?
Perhaps there are a lucky few who skip this initial search for the “holy grail system” phase in their trading journey but I have a feeling this is a very very common phenomenon. Eventually after getting tired of being on this “forex system treadmill”, and after much self reflection I eventually came to the conclusion that a trader’s “system” which tells them when to enter and exit a particular trade is actually a very small part of what makes a trader successful over the long term. We spend so much time focusing on this, and marketers are so successful selling us “trading systems” but what most of us actually fail to realize is that having a sound trading system is only a good start.
Do You Have a Trading Plan?
In previous posts I have already spoken about trade management, which in my humble opinion is probably more important then the decision of when to enter the trade, and yet so few “trading systems” sold to us even deal with trade management. Before entering a trade you should be able to answer the following questions:
- Why am I entering this trade (why do I feel I have an edge here)?
- Where am I going to set my stop loss to get out of the trade if I am wrong?
- How much risk am I going to take on this trade and thus what lot size am I going to take on this trade?
- If the trade goes in my direction am I going to move my stop loss to break even, or move it higher than that to lock in some profit?
- At what point am I going to move to break even or lock in profit?
- Where am I going to bank my profit and get out of this trade?
If you start thinking about all of these questions after you have already entered the trade its too late. You are no longer going to be objective about your trading decisions at that point. This is not to say that you should never alter your trading plan once the trade is open if something unexpected occurs, but I believe that we so influenced by our emotions once a trade is open and we have money on the line that these decision have to be made prior to entering a trade. Plan your trade and trade your plan.
Are You Taking on Too Much Risk?
In addition our failure to truly follow a trading plan, we as forex traders tend to use way way too much leverage and take on way too much risk. It wasn’t that long ago that I personally believed I was being conservative by only risking 2% – 3% of my trading capital per trade. Not only would I risk 2% – 3% per trade but I would sometimes take multiple positions at the same time on currency pairs that were highly correlated. For example GBPUSD and GPBJPY. In effect I wasn’t actually risking 2%-3% of my trading capital but more like 6% – 9% if I had 2 or 3 positions open. This is a recipe for disaster.
Only you can really ascertain what amount or risk is right for you, taking into consideration your trading style, your risk appetite and your trading objectives. However, I believe large draw downs are probably the number one reason traders assume their trading system is no good and abandon it prematurely and move on searching for the next “holy grail”. When in fact their trading system was fine, they were just taking on way too much risk per trade. Psychologically it is so difficult to sit through a period of large draw down.
Every trading system loses; period. In fact it is possible for your trading system to suffer, 5, 10, 15 or more consecutive loses before turning around. Will you be able to stomach a draw down of 30%, 40%, or 50% or more while maintaining the confidence that your trading system is solid long term and will bounce back? Much easier said then done.
The good news there a way to drastically reduce the draw down your trading system suffers and reduce the likely hood that you will blow your account or abandon an otherwise solid trading system. Reduce your risk!! Personally I have come to the decision that I am not willing to go through any more than a draw down of 25% on my account. Any more than this is outside of my comfort zone. How am I going to prevent a draw down of any more than 25%? Well, there are never any guarantees but I believe that if I use an absolute maximum risk of 1% of my trading account per trade and do not take multiple positions simultaneously on highly correlated pairs this should give me a very good shot at preventing a large draw down.
Trading is a long game affair. Slow and sure. The best hedge funds in the world average between 10% – 20% gain per year. If you can maintain growth of 20% per year the law of compounding will take care of the rest and you will be among the ranks of some of the best traders in the world. Resist the temptation to double your trading account every month as this will only lead to a blown trading account and leave you searching for the next “holy grail.”
I hope you have found this post informative, and if so feel free to comment, share and like 🙂
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