Money and Risk Management.
Before you start trading, you have to understand that money and risk management is the most important step to take as a trader. The number one reason for traders losing all their money, is the lack of a proper money and risk management strategy.
As a general rule, you should not take risk more than 5% of the capital you invest on a single position. Some traders are comfortable to risk as much as 10%, but you should never exceed this amount. Below is a useful guide that shows the maximum volume (lot) to open on a single position, according to how much money you have invested and according to your stop-loss (examples of 10-pip and 15-pip stop loss are given.
It is highly recommended to choose a green and maybe a yellow area, but to avoid red.
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Low Risk (1-5% of Capital)
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Medium Risk (6-10% of Capital)
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High Risk (More than 10% of Capital)
Gold is more risky to trade due to high volatility, however, more profit (or loss) can be made in relation to the margin needed in comparison to currency pairs. Below is a recommended risk strategy for trading gold.
Risk - Reward Ratio.
Another integral part of your money management is the risk-reward ratio. After choosing the amount of risk you are willing to take for each trade, you should then choose the appropriate reward to justify this risk.
For example, with a 10-pip risk on a 0.1 lot trade, your risk is $10 (10x$1). Some of the possible risk-reward ratios are the following:
• Take Profit at 10 pips, risk-reward is 1:1 ($10 risk, $10 reward)
• Take profit at 20 pips, risk reward is 1:2 ($10 risk, $20 reward)
• Take profit at 30 pips, risk reward is 1:3 ($10 risk, $30 reward)
The higher the risk reward ratio, the less successful trades you need in order to be profitable. For example:
• For 1:3 ratio, you need to win 1 out of 4 trades to break even
• For 1:2 ratio, you need to win 1 out of 3 trades to break even
• For 1:1 ratio, you need to win half of your trades to break even
However, the higher the risk-reward ratio, the more difficult is to win a trade since you need more pips in order to close the position.
The risk-reward ratio to choose depends on your trading style. Scalpers usually prefer lower ratios, while day traders prefer higher. In any case, your ratio should never fall below 1:1 (the risk being higher than the reward).
Don’t stick only to lower timeframes.
No matter what kind of trader you are and on what timeframe you prefer to trade, it’s very important to always have the big picture. For example, looking at the 5 minute chart of AUDUSD below, it is clearly that the pair is going up, therefore we should go buy.
However, if we look at the bigger picture with a 4-hour chart, we see that the pair is actually now going down.
Even if you prefer to trade in the lowest timeframes, always check what the general trend is, by looking at several higher timeframes.
Follow the trend.
There is a famous saying in the trading world, which is “Trend is your Friend”. While by just following the trend is not a guarantee that you will make profit, it increases your winning probabilities immensely.
One simple and effective way to see on what direction is the trend, or if there is no trend at all, is to use a Simple Moving Average on a high timeframe. If prices are above the Simple Moving Average line, then there is an uptrend, if they are below there is a downtrend, while if they more or less in the middle then the pair is ranging (no trend).
Here are 3 examples of pairs are in an uptrend, downtrend, and ranging.
Uptrend
http://www.fxnet.com/media/documents/trading-strategy-tips-for-forex-beginners-uptrend_1.png
Downtrend
http://www.fxnet.com/media/documents/trading-strategy-tips-for-forex-beginners-downtrend_1.png
Ranging
http://www.fxnet.com/media/documents/trading-strategy-tips-for-forex-beginners-ranging_1.png
Use support and resistance.
If you were only allowed to choose one tool to trade, then that would have to be support and resistance. This very basic but at the same extremely important tool is a must on every forex chart.
Support shows a price level where prices find difficulty to fall below, and are likely to bounce off. Resistance is the opposite; a price level that prices find difficulty to climb above. While within a char there can be a lot of support and resistance lines, it is very important to remember the more times prices bounce off a support or resistance line, and the higher the timeframe the line is drawn, then the stronger the line is… Another important thing to remember is that when a support lines is penetrated, it is very likely to act as a future resistance line. The same applies for resistance lines; when they are penetrated, they will likely be future support line.
One of the most popular uses for support and resistance lines is to use them as entry points, take profit and stop loss targets. See the following examples for strong support and resistance lines.
Resistance line: http://www.fxnet.com/media/documents/trading-strategy-tips-for-forex-beginners-resistance-line_1.png
Support Line: http://www.fxnet.com/media/documents/trading-strategy-tips-for-forex-beginners-support-line_1.png
Learn Basic Price Action Analysis.
No matter what trading system you use and what type of indicators you have on your charts, everything comes from price action. The most popular tool for displaying price action in forex charts is the candlestick. Before you even consider start trading, you must first learn how to read candlesticks and their various formations. Having a basic knowledge about candlestick price action will not only allow you to understand what is happening on the charts but also how to predict future price movement.
To learn more about candlestick reading and candlestick patterns please click here.