Choosing Your Trading Style and Strategy
A trading plan should fit the trader’s personality. If as a trader you do not feel comfortable following your own plan, you’re very likely to fail. You do not have to challenge yourself, just make yourself comfortable and you would see that you would trade with less stress and more confidence, which usually leads to profitable trading. If you are driven by emotions you would probably diverge from your plan, eventually finding yourself in a panic situation with no plan B to follow. The trading plan is raw rules you need to follow, do not listen to other traders, do not copy others that does not fit your style and most significantly stick to your trading plan.
A new science called Behavioral Finance has recently emerged. Behavioral scientists are trying to identify the behavior of investors and traders and see map it to market efficiency theory. In economics, we assume that traders are rational human beings that do not act irrationally and always control themselves. Behavioral finance studies traders’ psychology and identifies several syndromes that are far from “efficiency” and “rationality”. Turns out, as traders, we’re not as rational as we’d like to think. An example is the tendency of humans to go with the flow and the insecurity they feel of standing alone against the crowd. For example, imagine yourself going long on EUR/USD, you are really happy for your trade since it qualifies all requirements of your trading plan and is profitable at the moment. Then suddenly you see that all of your friends are short on EUR/USD and they all deride you because “you are so stupid for going long”. Would you feel a bit uncomfortable? Or maybe you would even close your trade and follow theirs. That is an everyday example of behavioral finance and the irrationality of human beings. Your psychology plays a huge role in your trades, be careful so that you can choose a trading plan on which you would feel comfortable enough to stand alone against the crowd!
Types of Traders
The shortest interval trading award is definitely going to this type of traders! Scalpers are traders that enter and exit a position in a very short period of time targeting a small amount of pips. If you are going to enter and exit the market in a rapid timeframe you have to be able to watch market moves at all times. If you are prepared to be a scalper then you need to have the ability to stare at your platform the whole day and make trades again and again. If you are not willing to spend a lot of hours of your day in front of your computer screen then this type of trading is not suitable for you. Make sure you know how many pips you are willing to lose in order to gain around 10 pips and go on. You can also take a look at automated scalping techniques.
If you prefer to hold trades for a short timeframe but think that scalping it too fast for you, then you may prefer intraday trading. Intraday traders are those who hold a position within the day and close it before day ends. Intraday traders usually use up to hourly charts to monitor their positions and their target is within 50-80 pips per trade. This type of traders is up to date with fundamentals in order to be able to take the right decision at the beginning of their trading day. They also like to use sentiment analysis and exit their positions when they feel that the time has come.
An intraday trader may be looking for breakouts of the hourly trading range in either direction by placing pending orders in both sides of the trading range waiting for one of them to be triggered. Another way to trade within the day is to look at a longer time frame chart to determine the longer trend and then place your orders based on a shorter timeframe in the direction of the longer trend.
The last method of intraday trading is again by looking at longer timeframe charts and determines your entry point on shorter charts, but entering in the opposite direction of the overall trend in order to get some pips from overall trend’s corrections.
This type of traders is looking to keep positions open for some days. The longer a trade remains open, the wider the Stop loss and Take profit should be. Thus, this type of trading requires larger SL and TP than the two types referred above. Swing traders usually use daily time-frame charts to evaluate the overall trend and 4-hours timeframe charts for entry and exit purposes (timing purposes).
If you do not feel comfortable in keeping a trade open during the night and you can’t get enough sleep because of that, then swing trading is probably not your style. Because swing traders are looking for larger moves, price would move against the trade most frequent than intraday trading. If you cannot watch your trade losing money, then you should not be a swing trader.
Last but not least, position trading which is the longest term in trading. This kind of traders holds their positions open for several months or even years. In order for a trade to remain open for so long, you have to keep very wide stop loses and take profit orders. Since you keep a position open for so long, you have to focus on fundamentals which will move your trade accordingly. If you look for such a big move, you can’t ignore the important news announced for your selected pairs of trading.
Thus, it is very important for position traders to understand how fundamentals work and how each fundamental indicator affects their pairs.
In trading, risk management is the art of minimizing your risk and maximizing your return. It is about mastering the control of the probability and the impact of unfortunate events, so that we can maximize the opportunities to make profit.
A very important lesson to learn in trading is to avoid gambling. Gambling is the worst enemy of risk management in the world of trading. Remember that our goal is to make money and not to try our luck! Risk management includes all the parameters of a trading plan referred to at the beginning of the chapter.
Risk management is the most important concept of a trading plan.
Risk vs Return
Under money and risk management purposes, a reward to risk of less than 1 is not acceptable. Reward to risk is a simple ratio, the points you aim to gain divided by the points you risk. Thus, it is TP points divided by SL points. 1 is the minimum risk to reward ratio that traders should accept. This means that you risk the same amount of pips that you are aiming to gain. If you risk more than what you would win, then it is simply not worth it. In trading, it is generally accepted that a reward to risk ratio of 3:1 is the best one can follow. Here’s a simple example:
Trader A decided that the reward to risk ratio which fits his trading plan is 3:1. He wants to firstly apply that on EUR/USD, going long on the pair. He would like to gain around 60 pips. In order to have a 3:1 ratio, you would need to divide the TP pips by 3 to get his risk points. Thus, he would place a stop loss 20 pips below the current market price of EUR/USD a take profit of 60 pips above current market price.