A Powerful FOREX Methodology
Chapter 4: A Powerful FOREX Methodology
When traders read or hear about a new FOREX secret, they tend to hope that it is a new indicator, a new system or some new psychological or emotional trick that will lead them to the Holy Grail of trading. Aside from the fact that such a Holy Grail is totally elusive, there is a much better and more successful way to trade profitably. This real secret to trading successfully is something that many traders have used to achieve success not only on the FOREX market, but also when trading stocks, commodities, options and futures.
Whether trading a methodology based on indicators, fundamental analysis  or using a robot, there is one item that is consistent to all of these techniques: YOU! One of the mistakes that new traders make is that they think they can learn a methodology or activate an automatic solution and simply sit back and watch the money roll in.
What such novices fail to take into account is the emotional and psychological aspect of trading. When learning a methodology or the best usage of a robot, many become caught up in what is known as the “right side” syndrome. This mindset involves the trader always studying the right-hand side of a trading chart in order to identify the entry and exit points of new trading opportunities.
However, as real life trading does not work in this way, this method of analyzing can provide a false sense of success. Without doubt, it is important to develop a very good understanding of a given strategy or automated solution and how its key components function. However, in order to attain long-term trading success with any trading market, and especially with FOREX, traders are required to not only see trades but to also believe that they will work.
Consequently, over the years experts have developed a very simple but powerful formula that, when applied to any methodology or robot, can turn it into a successful trading tool. Again, traders often make the mistake of spending an enormous amount of time researching the best methodology, indicators and robots that are capable of generating the optimum trading results, thereby falling into the trap of believing that if one trader has achieved success with the methodology or robot, they can as well.
One shortcoming that is prevalent with most present-day trading methodologies and robots is that they are not supplied with a technique that illustrates how to gain optimum results from using them. These tools are, of course, nearly always presented with comprehensive installation manuals explaining how to install them and adjust their key parameters. However, new users are often not shown how to achieve the best results from using their new tool or how to integrate it successfully into a trading strategy.
The formula that has been developed to overcome these problems and facilitate this implementation is again simple but very powerful. This methodology will allow a trader to be successful with any proven FOREX methodology or robot. In addition, this formula can be effectively applied to all other security markets that exist today anywhere in the world. The simple formula consists of the following four phases.
4.1 – Understanding the Primary Concepts and Objectives
Most traders certainly understand this first part of the formula, which is to gain a clear understanding of how a methodology or robot functions and learn how to tune it effectively by adjusting its key parameters. However, once they successfully complete this step, many traders start to trade straight away. Unfortunately, this is a serious mistake.
Instead, the major objective of this step of the formula is to encourage you to learn your trading strategy so well that you will be able to recite its main trading rules by memory. For instance, these rules should include well-defined entry, exit and stop levels for every position that you intend to open.
Every new real estate agent is taught that a home’s value is all about location, location, location. In comparison, new traders should realize that their chances of success depend on how much they memorize, memorize, memorize! Consequently, a trading strategy’s rules need to be spelled out clearly in words. The successful trader emphatically records ALL aspects of their trading rules and business practices in writing.
This is a very important step that has been eloquently summarized by Lee Iacocca, the former President and CEO of Chrysler Corporation: "The discipline of writing something down is the first step toward making it happen." In addition, Napoleon Hill, the author of Think and Grow Rich, appears to agree: "Reduce your plan to writing. The moment you have completed this task then you will have definitely generated a concrete form from your intangible desire.”
Many experts have concluded that a serious number of traders are initially unsuccessful because of they fail to perform the above step. In the world of trading, there are no real shortcuts to success and trying to learn a methodology and then trade it straightaway is foolish. This is the main reason why mediocre results are achieved by so many beginners.
The next two stages of this methodology deal with the above issues and are also very important in avoiding the many psychological and emotional pitfalls that traders can often fall into.
4.2 – Observing Your Strategy in Action Many FOREX experts emphasize the importance and power of screen time. In particular, there are two types of screen time. The first is the study historic charts in order to identify trading setups. The second is real-time, which involves being physically in front of a computer screen and observing, tick by tick, how trading situations develop.
Consequently, the second method allows traders to witness how a methodology or robot copes with differing market conditions. For instance, at any point in time a currency pair could be either trending or range trading. Being able to readily identify and distinguish between these two differing market conditions is a key for successful FOREX trading.
Therefore, the second stage of this methodology is not only about understanding why a strategy or robot has opened new trading positions but also determining why it did so during the prevalent market conditions. Just as important is gaining an understanding of why positions are not opened under different market conditions.
One of the best exercises that traders can undertake in order to study strategies in action is to print out numerous trading charts and mark them by clearly showing the entry, exit and stop levels for every position opened. For each one, the rules applied for that trade should also be recorded. Most novices note accelerated learning when they write their rules directly on the applicable charts.
The following example shows a technique that can be used to gain experience in analyzing charts quickly. Consider that you are studying a trading strategy that tracks the EUR/USD currency pair on a 5 minute chart, as shown in the next diagram. During the New York trading session (9:30 am – 4:15 pm EST), there are 81 bars on a 5 minute chart. In comparison with the daily chart, this is the equivalent to 81 trading days when screen time is taken into consideration.
There are approximately 260 trading days in a year. This means that three days of 5 minute charts would be the equivalent to one year of daily charts. As a result, a trader using the EUR/USD 5 minute chart for one year would acquire over 100 years of equivalent screen experience compared to a trader using the daily charts for one year. Some may consider this to be creative mathematics, especially when trying to define a trader’s experience, but this example is meant to encourage gaining as much screen time in the shortest period.
4.3 – Mental Preparation
This step is considered by many to be the most important one of this methodology. Traders who expend the necessary effort on this phase can significantly reduce the emotional and psychological difficulties that others often encounter.
Mental preparation is all about one’s trading mindset. Great traders have the ability to mentally rehearse all their trades and rules. These top traders train themselves to preview their potential trades in their mind before they actually occur. Most people say, "I'll believe it when I see it." In contrast, top traders, prefer to say, "I'll see it when I believe it."
One does not have to look far to see the power of mental rehearsal as it is very common in professional sports. For example, when attending skiing events, it is a common sight to see professional skiers mentally rehearsing their runs even before they have strapped on their skis. Golfers are another group of athletes that practice mental rehearsal. Jack Nicklaus was quoted as saying that he has never missed a putt in his mind.
These professional athletes have developed a process for mental rehearsal. They have done so because they clearly acknowledge the value in performing this task and believe that it assists them in being the top at their game. Similarly, we as traders want to be at the top of our game whenever we open new positions.
As these examples clearly demonstrate, there is great value in studying trading rules through your mind’s eye and taking new potential trades through mental rehearsal in a similar way to that employed by top performers as just described.
After going through the first three stages of this methodology, it is important to measure how successful you have been with understanding their concepts. This can be done by utilizing the key benefits of the demo accounts that many FOREX brokers allow their potential or full clients to use.
One of the most important points about trading a demo account is to be disciplined in using a methodology in exactly the same way as it was learned. No new ideas, such as new indicators, a new methodology or changes to the robot, should be introduced.
Rather, take notes of any new learnings related to the market, the methodology or the robot when trading your demo account. In short, record all new findings. However, before these learnings can be implemented into the overall trading plan, the process should be started over in order to systematically integrate new ideas into the trading strategy.
4.4 – Proving it really works
One of the main attributes of top professional FOREX traders is that they never stop learning about their markets, their brokers, their methodologies, other strategies, their charting software, their robots and most of all themselves. This methodology has been outlined in a linear fashion. However, in reality it should be presented in a circular format. This means that when reaching the last stage, a trader’s learning is not over. The greatest traders commit themselves to continuously cycling through all the stages.
One of the most awesome aspects of professional FOREX trading is that novices and experts alike can receive immediate performance feedback. There comes a time in every expert’s trading life when they start to struggle or go into a slump. This methodology can help any trader bounce back to peak performance very quickly.
All top traders, regardless of the market they trade, have a detailed checklist for reviewing new potential positions. Consequently, they know immediately if they are not following their own trading rules or if they are not mentally geared to trade the current market conditions. Additionally, top traders have the ability to constantly find new ideas, new ways to trade and new methods in order to increase their profitability by undertaking constant reviews.
4.5 – Attributes of a Successful Trader
A list of important features that many successful traders possess is as follows:
1. Commitment 2. Patience 3. Perseverance 4. Competence 5. Self-control
Let us now study these qualities in turn so that we can define why they are so important to trading. 4.5.1 Commitment Committing to some form of FOREX education should be an important aspect of any trading methodology. Developing a desire to learn as much as possible places a trader in a good position to launch a profitable trading career. When doing so, remember that there is a large quantity of free information that available on the internet.
The methodology communicated in this chapter will help to develop the attribute of commitment. The concepts should be mastered in order to accomplish this task.
4.5.2 Patience These days, many people do not take the time to acquire an adequate level of patience. They tend to be too focused on instant gratification. In particular, many FOREX traders squander their deposits because they do not wait until the market conditions improve. They allow their emotions to prevail over careful analysis of fundamental and technical considerations. For example, many cases occur when FOREX traders rush to sell after any bad news has been reported, only to regret their decisions if such information turns out to be unfounded. Again, the methodology herein will help in quickly developing the all-important trait of patience, thereby fostering a more professional approach to trading. 4.5.3 Perseverance FOREX trading is not an ideal pursuit for those who do not possess perseverance. This is simply because FOREX trading should be viewed as a business, and just as in any business venture, perseverance pay dividends in the end.
For instance, FOREX traders need to possess perseverance in order to develop trading strategies that will allow their profits to run even during volatile market conditions. Perfecting the art of implementing this methodology will result in continuously improving performance as time goes on.
4.5.4 Competence Any task can be broken down into a series of steps. Success generally hinges on the mastery of each of the component skills involved in a given activity. The first step of this methodology specifically focuses on this important aspect of trading.
Consequently, traders who study the information outlined herein will easily master the techniques required to satisfy this requirement. In addition, merging this new knowledge with the other steps of this simple methodology will result in a series of small, incremental victories that will eventually terminate in successful live trading.
4.5.5 Self-control Learning to control emotions is an important step toward trading FOREX profitably. For example, traders cannot cave in to greed, which is one of the easiest traps to fall into. The large daily turnover that FOREX possesses causes many traders to adopt a gung-ho approach that is more akin to gambling than utilizing professional trading techniques.
However, self-control is relatively easy to achieve by first studying and then practicing this methodology. The concepts within have been specifically designed to help traders control their emotions and trade in a businesslike fashion.
4.6 – Assessing and Testing Strategies
After defining a new strategy, most novices try to trade it straight away. As already been explained, this can be a mistake. Instead, it is best to use the methodology described in this chapter to first evaluate the performance of a new strategy in the following way.
As explained in 4.1, a thorough understanding of the new strategy and exactly how its main components function must first be gained. Specifically, the strategy should be learned so well that all its key parameters can be recited from memory.
Next, the strategy must be observed in action as defined in 4.2. This task can be performed by undertaking a thorough study of historical trading results for a given currency pair and time frame. It is important to go back in time as far as the trading platform will allow.
Use the entry and exit conditions of the strategy to identify every trade that it would have opened during this entire time period. Methodically record the results of each one, showing whether it was a loss or a win and the amount of PIPs gained or lost.
It is also useful to mentally rehearse as described in 4.3. Picturing how each trade will perform is an exercise that can result in a lot of insights. For instance, the actual results can be compared to the anticipated ones, which should then allow for the identification of improvements.
Finally, use the concepts outlined in 4.4 and 5.6 to trade the strategy using a demo account. Record the results and relevant details of all trades as recommended in 5.7. Learning and practicing the methodology in this chapter to then construct a FOREX strategy using the techniques explained in Chapter 5 is tantamount to creating a blueprint for success that will produce consistent profits.