Trader Psychology – Applying Your Strategy
In the past, we have published part 1 and part 2 of trader psychology. The first article was about identifying what type of trader you may be. We wrote that you might want to take a personality test to see where you stand in the continuum from impulsive to conservative. In the other article, we presented the readers with some forex trading strategies explaining which was most suitable for each type of forex trader psychology.
It´s not important how many trades you win, but how much you profit when you do
In this article, we will take a look at the next logical step in forex trader psychology – applying your trading strategy. This is a very important part of forex trading, if not the most important. One of the most famous quotes from trader George Soros is “It´s not whether you´re right or wrong that´s important, but how much money you make when you’re right and how much you lose when you`re wrong”. These are wise words from a successful forex trader/speculator. He’s a household name in forex. These words came to my mind as he decided to sell the Australian Dollar against the US Dollar about three years ago when this pair was trading around 1.05. His strategy was fundamental; he predicted a decline in commodity prices and a tightening of monetary policy by the FED. Two years later, AUD/USD found itself about 35 cents lower and rumours were that he made more than a billion USD on that one trade.
As we know, forex strategy is important and sometimes you can be wrong, but the most important thing when trading is the implementation of your strategy. If you apply correctly, your wins will be larger and your losses smaller. But, how can you implement your forex strategy in the best way possible? Here are a few tips:
First Step is the Biggest – One of the biggest reasons for losing in forex is hesitating to pull the trigger when your forex strategy indicates that you should open a forex position. If you look at the EUR/USD weekly chart below, the 100 moving average (MA) in green clearly rejects the price at the black arrow. Both the stochastic and the relative strength index (RSI) are overbought and that week´s candle closed as an upside-down hammer, meaning a possible trend reverse will follow. All of these indicators show that EUR/USD will fall back down. Additionally, the area between 1.15-1.17 had provided resistance many times in that one-year period.
As you can see, over the next three weeks, the price moved down about 500 pips. That´s a 500 pip loss, and your forex account would have been 500 pips larger if you had taken that trade. On top of that, forex traders tend to chase the price and enter in late when they have missed a good opportunity because they get frustrated. They end up selling near the bottom or buying near the top. This would obviously result in a loss. So, if you see a perfect setup according to your forex strategy, don´t hesitate for too long.
All the indicators were pointing down four weeks ago
Build a risk-free trade – Risk-free?! How can trading forex be risk-free? A forex trade can´t be risk-free when you open it but it can evolve. If we take the EUR/USD example again, imagine you opened a sell forex position at the 100 MA around 1.1610 with a stop above 1.1730 (the high in August the previous year). When the week ended, the price was 1.14, 200 pips lower and the weekly candle closed as a reverse hammer. At this time, you´re pretty sure the price will continue lower in the following weeks. You can now move the stop loss to breakeven or even at 1.1510. This means that you would win 100 pips even if the trend reversal scenario didn´t materialize.
Building a risk-free forex position is an important part of your forex strategy. But you should apply it cautiously, you can´t move your stop loss to breakeven once the position is 5-10 pips in profit. You must be patient and wait until the price moves at least 50 pips away from the entry point. Then you can move the stop loss to break even and turn your forex trades into a risk-free position.
Placing Winners – Sometimes the direction is very clear. Take, for example, the EUR/USD pair. It was clear that the price wouldn´t stretch much further above the 100 MA in green. So let´s assume you opened a sell forex trade at 1.16. Then, by the end of the day, the price ducked again back below 1.15. At this point, the odds the price will keep moving down are about 80%. What do you do? You open another sell position, the same size as the first one.
As we can see from the daily chart below, the price moved down in the following days and closed the week at 1.14. By this time, the odds the price will move further down in the coming weeks increases even more. As we mentioned above, the weekly chart closed as an upside-down hammer and the indicators were overbought. So again, you open another sell position and move the stop loss for every position to breakeven – then you can lock in some profit as the price moves down.
It was clear that the price would move south when the daily candle formed an upside-down hammer
Losing Out – We know that your forex strategy won’t always point in the right direction. Even when all the indicators are pointing in one direction, something might happen in the forex market which changes everything – and your perfect setup could turn into a failure. The problem is to recognize the failure and accept the loss.
When you first plan your trade, you pick the take profit levels according to your strategy. When I opened the sell forex trade in EUR/USD near 1.16, I placed the stop loss at 1.1650, about 30 pips above the 100 MA. I did this because the indicator I chose for my strategy was based in this MA. I saw the 100 MA as the line in the sand; once it would let go there was no other resistance nearby to stop the uptrend.
Fortunately, the price went in my direction but if it hadn´t I would accept the 50 pip loss. Some traders keep moving the stop loss further and further away and end up losing their entire account. You can´t hope for miracles to happen in forex to turn a trade in your favor. If your strategy showed a decent stop loss level then stick to it, we can´t win every single trade!
So, a forex strategy is very important. You can´t trade forex without a strategy just as you can´t go to war without a plan. But often, implementing your strategy is more important than the strategy itself. In fact, more often than not, the strategies work just fine. The fault comes from the forex traders that implement them in the wrong way, it’s all a matter of human psychology and fear. So, if you want to be successful in forex you must apply your strategy correctly, respect the stop losses, add to the winning trades, build risk-free positions when possible and, of course, step in when your strategy tells you to do so.