Foreign Exchange & Trading: Looking in the Mirror

By Andrey Dirgin, Head of Research at Forex Club

Trading any financial market is challenging and requires a particular set of skills to achieve success – Foreign Exchange (FX) is no exception. As with many other pastimes, FX trading takes a minute to learn and a lifetime to master. This probably helps to explain why every month thousands of people jump into the world of trading currencies as soon as they’ve picked up the basics of how to buy and sell.

It is vital for aspiring and novice traders to be aware of various key principles underlying FX and so have the best possible chance of success in the long-term. It is very common for people to trade without looking back at their previous trades, trading style, profits and losses and how they are evolving as traders over time. Such an approach is what all successful traders tend to do, and for good reason –self-analysis and reviewing your performance are key elements of becoming a successful trader.

Inevitably, the success of a trader boils down to how profitable he/she is over time. However, the shape of a traders’ profit curve can reveal a lot about the psychology and methodology behind trading. Looking closely at the shape of your profit curve and asking yourself the right questions can be very informative and helpful towards becoming more successful.

Novice trader
Most trades lose whilst winning trades are rare. The largest losing trade is five or six times bigger than the largest winning trade. Traders exhibiting such a curve tend to have a poor understanding of risk management and its importance and tend to manifest weak discipline in their trading routine. This trading pattern indicates a trader who avoids setting stop-loss orders and allows trades to run heavily [offside] into loss whilst hoping for the market to turn around in their favour. The amount of capital staked on each trade tends to rise as losses mount leading to heavier losses.

Improvement and Learning
Winning trades are more frequent and losing trades are not as devastating because of the use of strategies to manage risk. The trader is almost breaking even but finds it difficult to attain consistency within his/her trading strategy. Trades are still rooted in emotion which undermine profitability even though the amount of winning trades is high.

Consistency and over-confidence
After an initial period of success, the trader makes two or three large losing trades that wipe out most of the previous gains. Emotions run high and the trader cannot resist the temptation to stake increasing amounts of capital to win back what he/she lost.  Take-profit orders are set very close to market entry while stop-loss orders are placed far away. This strategy tends to work for a limited period of time because FX volatility usually ensures take-profit orders are hit first. But every once in a while the market trades in one direction against the trader leading to heavy losses.

Consistently successful trader
The trader plans his/her trades and trades the plan with no deviation. Losses are cut quickly while winning trades are run for longer as well as being supported with additional capital when the trading idea has been confirmed via preset indicators. The temptation to close the trade early for a quick profit is resisted. A successful trader understands that losses are part of trading and cannot be completely avoided. Instead losses can be mitigated and managed with appropriate risk management Overall, the proportion of winning trades against losing trades isn’t necessarily important although it can indicate the accuracy of the trader’s market analysis and often indicates room for improvement in terms of entry/exit points.

An ideal trader
Ideally, a novice trader should go through a gradual process of understanding and learning the market they are trading. Initial losses are analysed in detail, mitigated and reduced over time as a well-thought out trading strategy is formulated and refined.  Profitability is a by-product of strong discipline and determined hard work rather than a goal in itself. An ideal trader is someone who can consistently stick to a preset dynamic trading strategy without neglecting core rules set in order to discover and act upon good opportunities in the marketplace.