subject: Forex Trading And The Three Steps To Financial Success [print this page] Imagine if you could find or create a forex trading system that gave you a specific entry point, with a specific risk, that made a specific number of pips and then exited the trade. Imagine if it did this every time. You would be able to start with a small amount of money, use maximum leverage and make a fortune in a short period of time. Forex brokers would not like you however and before long you would not be able to find a place to trade.
This of course, is not the case, trading is a risk. Huge losses can occur overnight. To overcome this traders for years have developed theories along two avenues of thinking whether it be stocks, bonds, derivatives or currencies; fundamental and technical analysis.
Benoit Mandelbrot, the Sterling Professor Emeritus of Mathematical Sciences at Yale University discusses this in the opening pages of his recent book, The (mis)Behavior of Markets, a book much revered by best-selling author Nassim Nicholas Taleb who wrote Fooled by Randomness. New and old forex traders would do well to pay attention to Mandelbrot's thoughts.
In his book, Mandelbrot points out that fundamental analysis focuses on the "becauses" of the market. Because this happens, that happens and because that happened this happened. If one knows the cause then one can forecast the event. Implied in this is what we see every day from analysts who try to take into account all the events that are happening in the world and logically interpret the future. Causes, Mandelbrot points out, are obscure like in the recent subprime market bubble or more recently, the dramatic run up of the Euro against the dollar when the ECB provided relief to the member banks of the Eurozone. The retail trader trading forex would not have known either was about to happen.
Perhaps this is why so much time is taken to develop trading systems that seem to give the day trader, for example, more control through charts and charting techniques. This is called technical analysis.
Mandelbrot has this to say about technical analysis:
"This is a craft of recognizing patterns, real or spurious - of studying reams of price, volume, and indicator charts in search of clues to buy or sell. The language of the chartist is rich: head and shoulders, flags and pennants, triangles . . . it truly thrives, however in the currency markets. There, all "forex" houses employ technical analysts to find "support points", "trading ranges," and other patterns in the tick-by-tick data of the world's biggest and fastest market."
Mandelbrot calls it a funhouse of mirrors and financial astrology that sometimes works but is not a foundation on which to build a . . . risk-management system.
Does this mean that the forex trader cannot trade successfully?
Not at all. One of the things that has been missing from trading in any trading market is data that supports a trading system. In other words when a trade alert occurs is it at the right place? What is the drawdown expected to be? What risk should the trader take? Is it at the right time of the day? Most forex traders do not have this information about the system they trade which puts them at a serious disadvantage.
Consider a baseball manager managing his team in an important game without the statistics that help make his decisions. Imagine NASA sending a spaceship into space without the data that is required to make certain that it can be done safely? Consider a large speculative bank that has not done its homework. Every day we do things that require statistical data and yet we trade our money with none or very little. When we do, we are gambling and although gambling can bring a high, it never brings sustained results.
Here are three ideas that traders can use to help mitigate this problem.
First, find a trading method that signals a trade algorithmically. In other words, you have a system that alerts you when to trade. It is not up to you to read the tea leaves. You have created or are using a system that has rules that have been programmed into your charting software that tells you when to trade.
Second, your system should have data that supports when it is best to trade. For example a trading system should trade when there is momentum in the market. The system I use knows exactly what time of day when it is most advantageous to trade. Anyone who trades a system should know when their specific system is best traded.
Third, the system should have a specific target in which success can be measured. If that does not exist than risk cannot be measured and the trader is building a system on hope.
If these three items are taken to heart, trading the forex market can be a rewarding experience and the patient trader will make money on a consistent basis. Failure to do this will most likely bunch you into the trading group that does not win consistently and does not maximize daily, weekly, monthly and yearly profits.
