This article is about money management and trading psychology. This is the lesson that you never get with 99% of other Forex systems that you have come across.
I find it interesting that most of the systems out there dont include this because if they actually were successful traders, they would know that this was the key to success and to leave it out makes an incomplete system that wont work!! This tells me that the people that wrote them or are selling them arent traders at all. They are just in the business of selling HOPE!
Well, if you havent noticed yet, I am a trader, and I am different than the others. Dont get me wrong, there are honest trainers out there, I learned from one and I am eternally grateful to him.
So lets get on with this. First of all, this is my own interpretation of several sources, and the practices that have worked for me. Please read EVERYTHING you can find on trading psychology, and money management. There are a lot of slightly different views but overall, they are very similar and the main important points are all pretty much the same.
There are two main issues that cause 99% of the problems. Can you guess what they are?
If you answered FEAR and GREED, you are correct. These two emotions are probably responsible for 99% of the worlds problems as well but that is beyond the scope of this course ��.
So, now that we know what the big obstacles are, lets try and figure out how to overcome them. In the course of my lessons, I have listed a few but I will put them all together here in one place so that it is easier to follow, and perhaps make it easier for you to develop your own system to help you trade better.
We cant eliminate fear and greed. They will still be there in your heart and mind, but we can make some rules so that they dont interfere with your trading success. We can come up with systems and procedures to follow, since we KNOW ahead of time that fear and greed are major problems. Im sure you have heard the statistic that 95% of all speculative leveraged traders FAIL. This is absolutely true. Here is another statistic that I
believe100% of traders that dont know how to overcome fear and greed will FAIL. So does that mean that if I can teach you how to overcome these problems that your chance of success is 100%? Of course not. But I can tell you that you cannot be successful if you dont protect yourself from yourself.
In lessons 1-3 I have outlined a trading system. The first thing you must do, whether you follow my system, another system, or your own system is to follow the rules of the system WITHOUT FAIL. If your system calls for a certain entry point, do not enter until there is a signal to enter.
Systems are designed for a reason. That is why it is called a system. What do we learn from this? Patience. Perhaps the stupidest thing you can do is enter a trade on a hunch.
This brings us to our first FACT:
The odds are in your favor before you enter a trade. This is true for most trading systems. Void of fear and greed, if you follow each system exactly, you will profit. Some systems may offer better profits than others, but overall you should be able to profit with any system, IF you have no fear and no greed.
This brings us to THE BIG SECRET. Other than omitting trading psychology, other systems also dont tell you that you are playing a game of odds. Lets say for example that we are playing coin toss. Theoretically, for 100 flips of the coin, 50 will come up heads, and 50 will come up tails. Of course, the first 100 may be 55/45, but the more you play, the closer to 50/50 the numbers will get. Our system for coin toss is as follows: We play for 20 hours, and flip the coin exactly 5 times each hour, and for every heads that comes up, we get paid 2, and for every tails that comes up we pay 1. This should be a profitable system. After our game we see that heads came up 50 times and tails came up 50 times. (Stay with me here). So at the end of 100 tosses, we have paid 50 and received 100. A profit of 50.
So lets say that during our second game of
coin toss, we decide that we are going to let the flipper(hint: the market is
the flipper) keep flipping the coin for an hour while we take lunch but we are
not going to pay or be paid for those flips. During our lunch hour, heads comes
up 5 times in a row (which is theoretically possible, and not that unlikely).
And now we are back from lunch, and we are down 10 for the hour. Now, theoretically
the odds of 5 tails in a row coming up after 5 heads in a row are pretty good
because for every ten tosses, you should have about 5 heads and five tails. So
now we get 5 tails in a row and now we are down another 5, for a total of 15.
So not counting the 5 tosses during lunch, this leaves 90 tosses that we still
have to account for and lets say that they were 45 heads and 45 tails. Our
profit for these tosses is 45 (45x2 minus 45x1), now if we take away the 15
for the tosses we didnt take, and that string of losers, we are left with a
profit if 30. So lunch and 5 lousy spins cost us 40% of our profits.
Now this is theory but it absolutely applies to this market. If you are picky about what trades you want to take and what trades you dont want to take, you are MESSING
WITH THE ODDS. My point for this whole big story about coin toss is this: If the conditions are met, TAKE THE TRADE without hesitation. The odds are in your favor, but only if you take ALL of the trades that meet the conditions. When I say ALL trades I know the market is open 24 hours a day and you cant possibly take every trade. You need to pick a time frame and stick to that same time frame everyday and take ALL trades during that time frame.
I can tell you that in the month before I realized this (my first month of trading real money actually), my total profit was 92 pips. I had an idea of what I was doing wrong so I was keeping track of the trades that I didnt take along with the ones that I did. I included entry point, day, time, and whether the profit target was hit or if it was stopped out. Dont get me wrong, I was extremely happy to be in profit after trading for only one month with real money. But then I went back and looked at the numbers for what could have been. Guess what? Had I taken every trade that met my conditions, my profit for the month would have been 355 pips! I was not happy. But soon I realized that I had messed with the odds. After realizing what I had done wrong (or not done right in this case) I began to have more confidence in my systems. The very next month my total profit was 515 pips, or a 560% improvement just for taking all of the trades that met the conditions. I think that is enough said about that.
Sorry to stay with the coin flip game here but it actually works very well in teaching these principles. This brings us to
FACT #2. You do not need to know what is going to happen to make money. If we know that we are going to make 2 fifty times and pay 1 fifty times as long as we flip the coin, are we going to play? Of course! Well, all trading systems have similar odds. From my testing, I know that this system on average will produce 9 wins of 20 pips for every 1 loss of 40 pips (that number may vary but that is the maximum loss I ever take). So we know ahead of time that 9 wins at 20 pips is 180 pips, and minus the loss of 40 pips, leaves us with 140 pips profit. Now keep in mind that you may be 8 and 2 this week and 10 and 0 next week. We never know when a loss is going to come. We may even lose every trade for a week, but not lose a trade for the next 9 weeks. Believe me it happens. You do not need to know exactly what is going to happen, you just need to take every trade that meets the conditions and then count your profits at the end of the month/week/year etc.
This section deals
with money management as well as psychology. Back to coin toss for a minute. We
know that each win brings us 2. And we know that for each win in this trading
system we get 20 pips. We know that each tail that comes up costs us 1. And in
our system we know that each loss is 40 pips. If we know what our loss is going
to be ahead of time, we know what it is going to cost us to find out what is
going to happen. From this we can decide how much we want to risk based on our
FACT 3: You know how much it will cost to find out. I have decided not to ever risk more than 5% of my account on any one trade. So knowing that, I can figure out how many lots to trade ahead of time based on my account size. It may cost 250 in margin for a 1 lot position but this is not what we are risking, we are actually risking ten dollars times the number of pips in our stop. If our stop is 40 pips, we are risking 400. Now we know that we better have at least 8000 in our account to take a position of this size. If this trade turns out to be a loser, and our balance falls to 7600, we know that we cant afford to take that trade again because a loss of 400 is more than 5% of our balance. We would need to adjust our number of lots down accordingly to keep our risk <5%. We also dont want to increase our lot size to try and make up for that loss. Always reduce your risk if your account balance falls. The next thing we dont want to do is immediately increase our lot size after a winning trade. It is better to trade at the same lot size for 15 or 30 days at a time before increasing lot size. This allows the account to build steadily without large swings in either direction.
FACT 4: There is a random distribution between wins and losses for any given set of variables that define an edge. Your trading system is your edge, but you never know in what order your wins and losses will come. Be prepared for this and accept the losses, knowing that the odds are still in your favor.
This brings us to our final two facts.
FACT 5: Every moment in the market is unique. Yes we use pattern recognition to define our edge but there are so many variables in this market that it is impossible to ever have the conditions exactly the same as any other moment. You could play 100 games of coin toss and no game will have the exact same order of wins and losses, even though they may have similar outcomes.
FACT 6: Because of fact #5 we know that ANYTHING CAN HAPPEN. This is why it is important to follow the trade rules exactly and play the odds.
Every broker/trading system has a disclaimer that says basically do not trade with money you cant afford to lose. The best thing you can do when you open your real money account is to mentally consider that money GONE. If you are not afraid to lose it, you will save a lot of stress and your trading will improve. Only you can determine what you can afford to lose, so just dont put more in there than you are willing to lose. Compounding is an amazing thing that we will talk about in section 5, and the money will come if you follow the rules. If you start with less, it will just take a little longer but once again you will save a ton of stress.
FEAR AND GREED
1. I Objectively identify your edges. You have a system here that works, enough said.
2. I Pre-define the risk of every trade. We covered that in FACT #3.
3. I Completely accept the risk. Consider the money
4. I ACT on my edges without reservation or hesitation. Follow the rules and take every trade that meets the conditions.
5. I pay myself as the market makes money available. Take your 20 pips and be happy, or trail your stop. Even if you are compounding your account, pay yourself something out of your profits each month. It will make you feel better. (On a side note: I take 20 pips for every trade until I am up 200 pips for the month. I do not even think of trailing my stops until I am up 200. Once I am comfortably in profit, I start to look for solid opportunities to trail my stop and grab some extra pips.
Even if they only go 20 and then come back, I still make 5 pips. 20 of those still adds up to another 100 pips.)
6. I continually monitor my susceptibility for making errors. I read Mark Douglas book monthly, and make up sheets with my rules on them that I read daily. This helps me to see plain as day when I make a mistake.
7. I understand the absolute necessity of these principles, and therefore I never violate them.
I have included a sheet that you can print out to keep near your computer to read every day. Read these facts and rules every day even if you memorized them.
FOUR STUPID THINGS
The first stupid thing you can do is to close a position early because you think it is going to go against you. Just because you have an edge over the market does not mean that price will immediately shoot up or down to your target. Price will move up and down and will even probably move against you before it moves in your favor. If you let FEAR of LOSS get you, you will lose money. If the market is going to take you out, let the market take you out by taking out your stop. That is why it is there. The odds are still in your favor.
The second stupid thing you can do is to close a position early because you dont think (or you are AFRAID) that it wont reach your target. If you dont play the odds properly, you will not realize the full profit potential. What if in our coin toss game we decided that we were going to take our profit for a heads at 1 instead of the 2 that we were supposed to get paid? If you remember, our profit was 50 for the first game. If we had only taken 1 for each win, we broke even. That is a lot of effort for nothing. Even worse, if we make some mistakes along the way (we all know that we are perfect traders right?) as we did in game number 2 where our profit was 30, we can lose money by not taking enough profit. Remember that we had a 15 loss for our mistake and 90 spins remaining. If we had taken only 1 for each of our 45 winning spins we would have broke even, minus the 15 puts us down 15 overall instead of being up 30. The system is designed for a 20 pip target, GO FOR IT.
The third stupid
thing you can do is to get greedy. As I said in my sales material, if you had
shot for 30 pips instead of 20 for the trades I listed, the profit would have
been about half of what it was for taking just 20. Interesting how this whole
thing works, huh?
Just taking 5 or 10 pips can be considered GREED as well as FEAR since you are so afraid of loss that you get greedy for those 5 or 10 pips compared to the potential loss of 20-40 pips. Dont let it get you, follow the rules and be happy with your 20 pips.
The fourth stupid thing you can do is move your stop, believing that the market will eventually go in your favor. This is the fastest way to lose money. We are DAY traders. Yes the market may go in your favor but it may move 300 pips the other direction before it does, if it does. This could take weeks or months and you have a limited account balance. If 5% of your account is tied up waiting this position out, guess what. You are missing 20 other opportunities to make money instead of just sitting there waiting, down a hundred pips while you miss the opportunity to make 20 trades for 20 pips each. Maybe you break even, when you could be up 400 pips. JUST DONT DO IT.
THE BEST THING YOU CAN DO
Once you place your trade, and place your stop and limit, TURN YOUR COMPUTER OFF and go do something else. You are now in automatic mode, and the market will take you out, either for a profit or for a loss. This is the best way to eliminate the temptation to succumb to FEAR or GREED and do something stupid.
The rest is up to you. Only you can decide whether or not to follow the rules and believe in the facts. This lesson is the most important to your success and I hope you wont take it lightly. If you are trading and following the rules of your system, and not making money, you need to take a look in the mirror. It is not the system that is the problem, it is you. I am not trying to be harsh, but when I was not making money, it was not the system it was me so you are not alone. Dont give up, because you can be successful if you just work through and figure out the problem.
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