Risk and Reward

Imagine a coin-toss game where the odds are even, that is where there is an equal chance of the coin landing on a head or tail. If the coin lands on a head (H) you win $2, if it lands on a tail (T) you lose $1. If we flip the coin 10 times, you only need to win the game 4 times out of 10 to make money i.e. your 4 wins produce $8 and your six losses leak $6, resulting in a net gain of $2. You lost more games than you won but you still made money. This should be the focus of every trader: on making money not winning or losing. The idea is to risk less than what you potentially stand to gain not the other way round. This is called the risk-reward ratio, the higher it is the better. This might seem obvious to say but let me ask you this: how many people do you know of who out of 7 days a week spend 5 looking forward to only 2? By simply observing the hanging faces on a Monday which evolve to euphoric on a Friday, I don’t need statistics to prove there are multitudes. But, wouldn’t it be better to spend 2 looking forward to 5 or best to look forward to all 7? Well, we say time is money don’t we? If you are asked to choose a person to invest in based on how they spend their week, what type of person would you invest in?

The character of risk and reward manifests itself daily in the markets. Novice traders let their losses run hoping to be eventually proved correct. They also become excited by and are quick to take small profits. It takes just one loss to wipe out all their accumulated profits. Professionals do the opposite – they cut their losses and let their profits run. It’s not how many times you win or lose, rather it’s how much money you lose when you are wrong and how much you make when you are right. Trading is not about trying to be right, it’s about making money! Strip off the ego and emotion of trying to prove yourself because the market will humble you.

Richard Dennis is one extraordinarily successful trader. To illustrate his brilliance, he borrowed US$1,600 and turned it into US$200 million in about 10 years. That should startle you! In an interview with Futures Magazine he said “If you look at all my trades for a year, I suppose that all the profits are in five percent of the trades.”

May all you wish for be the least you receive!

The Art of Trading 2

Trading is about survival. In fact for any organization the first goal is to survive. The four largest money movers which together can create the most formidable economy in the world are war, medicine, insurance and religion. Why? Because they have to do with the survival of our most personal organization – ourselves. They buy and sell fear and survival. War breaks things and kills people, medicine repairs people, insurance is in case things happen to people and religion…well, we all know the story!

Trading is simple but it’s not easy. The trick is to want what the market wants. The word speculation is derived from the Latin word “speculari” which means to observe. That is what trading is all about – observing what the market is doing and acting on your observation. There are only three actions to take which are to buy, sell or stay out – depending on whether the market is moving up, down or sideways.   The market is like the weather – it is always right despite what we might all think and feel about it. Ask yourself this question – do I care which way the market moves? If you do care, then you will most likely impair your ability to observe. You need to put yourself in what Mark Douglas calls “the now opportunity flow”, which simply means that in order to make money you don’t need to know what is going to happen (predict), nor do you need to know what happened (history); you only need to know what is going on now (the present). It’s like driving at night to an unfamiliar location, you focus and concentrate on the distance ahead of you that your headlights allow you see. No matter how far you are going, focusing on that short distance ahead of you can take you a very long way.

Ralph Waldo Emerson said “He who observes, and observes again is always formidable.” I couldn’t agree more.

May all that you wish for be the least that you receive. Be abundantly blessed!

Leverage

The most fascinating thing about forex is the enormous amount of leverage available to all traders. Most new traders are lured to the market by leverage. The seduction of leverage can be as fatal as it can be thrilling.. Leverage is virtual credit received from your broker on your margin. Margin is the actual amount of money you deposit into your forex trading account. Leverage multiplies your margin by up to 500 times. So, for example if the margin (actual deposit) on your account is US$1,000, it means you can make trades of up to US$500,000 i.e. the broker “loans” you US$499,000. However, you cannot withdraw the leveraged amount, it is virtual credit, you can only use it to trade.  You earn or incur the gains or losses that result from using leverage and these affect your margin. Simply put, where your minimum gain or loss is US$1 without leverage, this becomes US$500 with leverage and these gains or losses are added to or subtracted from your margin. Such an effect is obvious. Whether this scares or excites you gives an indication of your attitude towards risk. The basic principle is the higher the leverage used, the higher the potential risk but also the higher the potential gain – your risk and profit are multiplied by the same leverage factor.

The improper use of leverage is the main reason why traders lose money in the markets. It’s a lot like driving; the speed at which one drives is dictated by the conditions on the road and the driver’s attitude. It’s obvious to say a good driver adapts his/her attitude to suit road conditions. Always driving too slow or too fast is a model for disaster, so is being a “raging bull” in traffic and a “snail” on the highway. Manage your use of leverage properly through money management so that as your account balance increases so does your use of leverage and vice-versa. I will explain this further in money management.

Remember, a good trader makes use of all the tools available to him/her; the trick is to know when and how.

Be abundantly blessed!

Risk !

Put bluntly speculation is a very dangerous business. Your focus as a trader should be survival. If you don’t survive you can’t win. The safety of your capital is number one priority.

In order to survive the first requirement is that you have a credible premise to speculate upon. Rumours, tips, feelings and full moons are not a premise. A premise suggests that there is an underlying truth to what you are taking action upon. Different traders may have different premises and whatever they are they need to be backed by proven logic. Secondly, in order to survive you need to think and act defensively. Instead of thinking of, anticipating and imaging how much money you can make on a trade your focus should rather be on how much money you can lose from that trade. Risk (potential loss) is the only variable you can define and control, play to your strengths and exercise that control religiously because the safety of your money depends on it.

Losses are inevitable in trading, the idea is to accept small losses (cut them short) and let profits run. Few people have the character, mental stability or the courage to take small losses.  This is swimming upstream against human nature. When a trader makes a trade decision he naturally expects to be right. When the market shows him otherwise, his ego steps in to help him defend his decision and it brings with it all sorts of reasons and emotions. The fact that his money is on the line and he is losing it makes the situation worse because he has an emotional attachment to that money and we all know letting go is not easy. He stubbornly holds on to the trade decision until he realizes he is at the mercy of market and the worst (blowing up his account) is about to happen. This is about the time he turns to hoping and praying and repenting not having cut his losses. Unfortunately, for most traders it takes the pain of an emotionally wrecking loss for them to realize the importance of cutting their losses – yes, I have been there and I paid a very expensive tuition.

Warren Buffet put it right when he said “The market like the Lord helps those who help themselves, but unlike the Lord it does not forgive those who know not what they are doing.”

Be abundantly blessed!

The Art of Trading

Trading is like a war. You can win one battle in a war, but that does not mean it’s over. The war continues. Too often traders are so focused on the next trade, or on making money immediately, they lose sight of the fact that this is a long-term business. If more traders would think of this as being a business they would understand that point more clearly. Do you know of any business that tries to make all the money they can in the first week or two? Or even a business that’s going to make enough money in one year to quit and retire? I don’t, and the ones that I’m aware of that operate on that principle are rip-offs and scams. They make a quick buck and leave town. The success of business comes from endurance and staying power. The difference between great forex traders and the many that have come and gone is that great ones are still here because they have a long-range view of their business of trading.

Many people that come into the trading game are lured by the prospect of instant wealth, which is like winning a ticket to travel first class on the Titanic. They start out too fast by over trading, betting too much on the trades, trading too often, trading too many markets. They want to make a killing. And that killing is now!

You have to get rid of that mentality, shake it off and realize that the massive wealth that has been taken out of the market was never taken out in a short time. The fortunes were generated by consistent application of effective trading strategies.

Many want to earn a daily income from trading. This is an extremely difficult enterprise to pursue – some days are good, some days are bad and remember trading is a marathon not a sprint. Good marathon runners understand the importance of their pace, this is the key to winning a race. Likewise wealth is generated by combining consistency and time. The traders subscribed to trying to put money in their pockets on a basis daily hit and miss – make it and lose it and in fact most just lose it without first making it.

Break out of the short term gratification mentality; trade as though you are in a marathon. Have perspective of the correct goal.

Be abundantly blessed!

Trading forex – The basics

Forex Trading is speculating on the value of one currency against another. I appreciate from my experience that people would normally picture the transaction process of a bureau de change when forex trading is mentioned. Similarities may be drawn just to get a general idea of the concept; however forex is traded online (over the internet). There is no physical exchange of money, it’s a numbers game.

You buy a currency (the value) in anticipation that it will increase against another. You start to profit if there is an increase in the current price from the initial price you bought at. You also start to lose if there a decrease in the current price after you have bought. Likewise, you sell a currency (the value) in anticipation that it will fall against another, you start to profit if the price falls from the initial price you sold at. You also start to lose if there is an increase in the current price. You can initiate trades from both sides (buy and sell). The idea is not to buy low and sell high, it is to buy high to sell even higher and to sell low to buy back even lower.

Currencies are paired and never talked about in isolation; they are relatively valued meaning its one against the other. So for example EUR/USD represents the value of a EURO against the dollar. When you buy the EUR/USD, you are anticipating that the EURO to rise against the dollar, so you are buying (going long) the EURO and simultaneously selling the dollar. The reverse is also true, when you sell (go short) the EUR/USD, you are anticipating that the EURO will fall against the dollar, so you are selling the EURO and buying the dollar.

Be abundantly blessed!