Why Trading Forex Now Beats The Stock Market

You’ve likely heard the term “Forex” lately — it is becoming the hottest market today, attracting more and more traders around the world. As the stock markets continue to meander, I believe that the strong trends in the forex market will continue, which means this is one of the best times to engage the foreign currency markets as an added investment vehicle to your portfolio.

Over the past few years, I’ve had the opportunity to teach thousands of new and experienced traders the pitfalls of trading foreign currencies and to help them discover the right way to attack these markets.

Today, however, I want to share with you the key reasons you should take advantage of the potential that exists in trading foreign currencies and going forward, I’m going to share more detailed strategies with you.

What is Forex?

Forex stands for Foreign Exchange and is the trading of one currency against another.

At its simplest, trading foreign currency involves two currencies that are traded simultaneously, called a ‘pair’. For example, the EUR/USD pair, trades the Euro against the US Dollar. In this example, a buyer of this pair would ‘buy’ the Euro and simultaneously ’sell’ the US Dollar.

Forex trading takes place through major banks, market makers, and brokerage houses around the world, who together create a marketplace for trading currencies on a near 24/7 basis.

The Forex market is almost always “open”; it is the 7-Eleven of the trading world. It is the largest financial network in the world with a daily average turnover totaling trillions of dollars.

Until recently, the foreign exchange markets were dominated by the big brokers and major banks around the world. Today, the ‘little guys’ have gotten in on the action — and the growth in currency trading has increased from $1.9 trillion to nearly $3 trillion in that short space of time (that’s the average daily turnover in the markets – a 50% growth in turnover).

Why Should You Trade Forex?

First, the Forex markets are highly liquid (in the major pairs) and have a strong tendency to ‘trend’ regardless of what is happening in other markets (stocks, commodities, bonds).

That liquidity also creates constant volatility — and the volatility is where the ability to profit from those trends happens. The greater the volatility, the greater the profit potential (be advised, however, the greater the risk, too).

Second, the stock markets have been beaten down, rallied, fallen, rallied again — and there are strong indications that another ‘fall’ is coming. The uncertainty in these markets is unnerving for buy and hold investors and traders alike.

In the Forex markets, however, traders don’t have to worry about “bull” or “bear” markets — the currencies are always in a trend (whether up, down or sideways) and frequently, when one set of pairs is trending one way, another set of pairs can be trending the opposite way. In addition, there are no restrictions to selling short a pair like there are for selling short stocks.

Furthermore, the financial upheaval driven by the credit crisis and the massive government responses I believe means investing or trading in the stock markets will never be the same – but these same events are helping to create even greater opportunities in the Forex markets.

As interest rates are cut or raised, economies grow or slow, jobs are gained or lost — each of these factors impacts the future value of a currency pair; and as these and other economic factors change, they affect the swings in volatility.

Forex trading is not without risk – and frankly, most people approach the Forex markets completely wrong. I believe the current economic and financial conditions make this one of the best times to take on Forex trading, but only if done correctly.

How Most Traders Incorrectly Approach Forex Trading

While doing research on the current state of the Forex trading landscape, I discovered something surprising:

Losing Forex traders appear to be enamored with ‘winning percentages’ when selecting a forex trading method.

The irony in that statement should be obvious — if the ‘winning percentage’ of the forex method is so important, how can these traders still be net losers?

Because, I believe, winning percentage is the wrong concept to focus on. In fact, I find winning forex traders look for methods that have winning percentages closer to 50-60%. And, they also have one more ’secret’ that losing traders DON’T have.

The difference will probably surprise you – and it’s a big difference, too. The answer should have been obvious, but it isn’t for most traders.

Ask yourself this question: How is it possible that a forex trading system that wins 90% or more of the time can end up a net loser?

The answer?

Losing trades. BIG losing trades. Here’s what I’ve discovered many of those systems (or robots) that claim 90% winning trades aren’t telling forex traders:

When their systems ‘win’, they are making a high number of very small gains.

But when their systems ‘lose’? They wipe out all of the gains and a good percentage of the trader’s account balance, too.

Still, traders flock to these automated systems because, after all, something winning ‘almost’ 100% of the time must be good, right? Not really, no.

See, what most traders don’t get is that the reward to risk ratio in those high win percentage systems is upside down. Traders risk too much capital for too little profit potential.

That’s poor risk management and leads to one becoming a ‘losing’ trader.

Let me illustrate an example, using a ‘typical’ Robot (or automated) trading system, making 5 trades:

Trade 1 – gains 8 pips on 20 mini lots (+ $160)
Trade 2 – gains 8 pips on 20 mini lots (+ $160)
Trade 3 – gains 8 pips on 20 mini lots (+ $160)
Trade 4 – loses 80 pips on 20 mini lots (- $1,600)
Trade 5 – gains 8 pips on 20 mini lots (+ $160)

This is standard practice for automated systems out there that don’t employ risk management. They set stop losses that are far too wide given the reward ratio. Here it’s 10:1 (risking $10 to win $1 – does that make sense?)

Say you had a starting account balance of $10,000 — at the conclusion of these 5 trades, your account balance would be $9,040.

That’s a 9.6% loss even though you ‘won’ 80% of your trades!

We haven’t factored in lot or position size yet, either. I would expect it to be obvious that the trader above is taking on far too much risk. Keep in mind, too, that trading with an automated or robot method, you are unlikely to be able to stop that 80 pip loss unless you happen to be watching it unfold.

Of course, that robot is supposed to make you money ‘while you sleep’ – isn’t it? (That’s what they promise, anyway)

The bottom line is if you aren’t managing risk in every single trade, from determining the correct lot and position size to the right points for your stop losses and your exit strategies, you will NEVER join the elite 5% of successful Forex traders.

Here’s the Forex ‘Secret’

Let’s illustrate a ‘winning’ trader using a Forex trading method (not a robot), who only wins on 60% of their trades, and see if you note right away what their ’secret’ is:

Trade 1 – gains 43 pips on 10 mini lots (+ $430)
Trade 2 – loses 30 pips on 10 mini lots (- $300)
Trade 3 – gains 29 pips on 10 mini lots (+ $290)
Trade 4 – gains 19 pips on 10 mini lots (+ $190)
Trade 5 – gains zero pips on 10 mini lots (+$0)

Again with a starting account balance of $10,000 — this trader would have made a 6.1% gain ($610 net), as opposed to the first trader’s nearly 10% loss.

Yet, this trader only ‘won’ 60% of the time? What happened?

This trader ‘broke even’ on 1 of the 5 trades. No gain. No loss.

What the ‘winning’ trader does is eliminate risk as quickly as possible, thereby ensuring infinite reward (until they liquidate their position). To do this, these traders take aggressive action to move their initial stop losses up to the breakeven point from the outset of a trade, set an initial profit target and, once they are able to eliminate the risk side in the trade, they will manage the profit side of the trade by scaling out in stages at predetermined profit points.

In this way, once the trader has been able to ‘erase’ the risk side, they can focus solely on the profit side – with the worst case scenario being a ‘zero’ gain trade (or, break even).

Now you may not be able to eliminate risk in every single trade; but breaking even on just 1 in every 5 trades can have a significant and positive impact on your account balance.

So, don’t let yourself be fixated on the ‘winning’ percentage of a trading method. As you’ve just seen, that doesn’t guarantee you can be a net winner. Instead, put risk first and profit second. I think you’ll be surprised at the results.

Optimal Profit Strategy for Forex Traders

As we’ve just shown, when it comes to trading Forex, traders typically focus on when to enter the trade, but pay too little attention to protecting their initial position AND too little attention on how to manage and exit the trade.

This is a critical mistake, yet it is one of the simplest concepts in trading.

It should go without saying that as soon as you enter the market with a new position, an initial stop order should be entered to protect the position against an adverse move in the market or an exit strategy should be employed to cover the trade if the market closes adversely. If such a move occurs, as is often the case, you want your position liquidated and to be out of the market with a minimal loss.

The consequences of failing to do this are simple: you will not be successful at trading.

In fact, every trade you put on, you should plan to lose, so that you are sure to place your stop loss order or cover the trade on an adverse close. Otherwise, what would have been a small loss turns into a big loss, turning the entire risk/reward ratio against you.

That being said, where should you place your stop loss? The short answer is, “Where you don’t expect the market to go”; or, more specifically, where the assumption in putting on the trade is no longer valid.

For example, if a long position was entered into after an uptrend or breakout market traded back down to support, an initial stop could be entered below the recent low because if the market does go there, support (as defined by that low) would have failed, and there is no longer any reason to be long the market – so get out! Don’t wait around for it to come back in your favor because the odds are against it.

If the market goes in your favor once the initial stop is in place, then you need a set of rules that will allow you to exit the market profitably. This poses a real dilemma. If you exit too soon, you may secure a small profit, but miss out on all those big moves that occur (and the big profits that go with them). On the other hand, if you wait too long to exit, the market may reverse and take away all of your open profits and even put you into a loss position.

So what do you do? Well, the first thing is to realize that there is no method that can forecast whether or not a particular move will:

* Go against you immediately
* Go up only a little before going back down
* Go up a lot in your favor

For example, after you enter a long trade in an uptrend, there’s absolutely no way to predict what will happen next (contrary to what the so-called “gurus” tell you). Because of this, you absolutely need an exit strategy, because the risk of loss is significant no matter how carefully you plan your entries and exits.

The Optimal Profit Exit Strategy

The following is the very best exit strategy that I believe possible when trading the Forex markets. I call it the Optimal Profit Exit Strategy.

It’s a strategy that scales out of a trade in two steps. This strategy is first and foremost about taking an initial profit as soon as appropriate, thereby “taking some money off the table” and reducing the risk in the trade at the same time.

So, don’t let yourself be fixated on the ‘winning’ percentage of a trading method. As you’ve just seen, that doesn’t guarantee you can be a net winner. Instead, put risk first and profit second. I think you’ll be surprised at the results.

Optimal Profit Strategy for Forex Traders

When it comes to trading Forex, traders typically focus on when to enter the trade, but pay too little attention to protecting their initial position AND too little attention on how to manage and exit the trade.

This is a critical mistake, yet it is one of the simplest concepts in trading.

It should go without saying that as soon as you enter the market with a new position, an initial stop order should be entered to protect the position against an adverse move in the market or an exit strategy should be employed to cover the trade if the market closes adversely. If such a move occurs, as is often the case, you want your position liquidated and to be out of the market with a minimal loss.

The consequences of failing to do this are simple: you will not be successful at trading.

In fact, every trade you put on, you should plan to lose, so that you are sure to place your stop loss order or cover the trade on an adverse close. Otherwise, what would have been a small loss turns into a big loss, turning the entire risk/reward ratio against you.

That being said, where should you place your stop loss? The short answer is, “Where you don’t expect the market to go”; or, more specifically, where the assumption in putting on the trade is no longer valid.

For example, if a long position was entered into after an uptrend or breakout market traded back down to support, an initial stop could be entered below the recent low because if the market does go there, support (as defined by that low) would have failed, and there is no longer any reason to be long the market – so get out! Don’t wait around for it to come back in your favor because the odds are against it.

If the market goes in your favor once the initial stop is in place, then you need a set of rules that will allow you to exit the market profitably. This poses a real dilemma. If you exit too soon, you may secure a small profit, but miss out on all those big moves that occur (and the big profits that go with them). On the other hand, if you wait too long to exit, the market may reverse and take away all of your open profits and even put you into a loss position.

So what do you do? Well, the first thing is to realize that there is no method that can forecast whether or not a particular move will:

* Go against you immediately
* Go up only a little before going back down
* Go up a lot in your favor

For example, after you enter a long trade in an uptrend, there’s absolutely no way to predict what will happen next (contrary to what the so-called “gurus” tell you). Because of this, you absolutely need an exit strategy, because the risk of loss is significant no matter how carefully you plan your entries and exits.

The Optimal Profit Exit Strategy

The following is the very best exit strategy that I believe possible when trading the Forex markets. I call it the Optimal Profit Exit Strategy.

It’s a strategy that scales out of a trade in two steps. This strategy is first and foremost about taking an initial profit as soon as appropriate, thereby “taking some money off the table” and reducing the risk in the trade at the same time.

Here’s an example from two recent moves in the EUR/USD – in both cases, I applied my Forex Profit Accelerator method to identify the potential trade, and my Optimal Profit Exit Strategy to show how to manage the trade while its ongoing.

PT1 = Profit Target 1 (your first exit point)
PT2 = Profit Target 2 (your second exit point)

PT1 in the chart above exits ½ of your position at a pre-determined profit target. The profit target is modest, but enough to make the trade worthwhile and the specific level is also dependent on the overall method being used.

Once that initial profit target is hit, you should move the initial stop up for the remaining 1/2 of the position to the lowest low of the past 3 bars for an uptrend trade or the highest high of the past 3 bars for a downtrend trade.

As you can see, in the example above (from my Forex Profit Accelerator method), the first trade would have exited PT1 with a profit of 135 pips (or $1,350 on a standard lot trade) and the second trade would have exited PT1 with a profit of 130 pips (or $1,300 on a standard lot trade).

You’re now out of 1/2 of the trade (in each instance) with a very nice profit and at the same time you are prepared to ride the market as far as it wants to go in your favor for the remaining 1/2 of your position.

PT2 allows you to continue to ride an existing market trend with the remaining ½ of your original position, but you protect it by a trailing stop always based on the lowest low of the past 3 bars (for an uptrend trade).

As the market continues to move up, you would move the stop up with it. This locks in a significant portion of the remaining open profit but also gives the market enough room to trade down a bit without shaking you out of the trade if it moves higher.

As the example chart shows, this added profits of 243 and 191 pips, respectively to the winning trades – an additional $2,430 and $1,910.

With this strategy you should be prepared to take advantage of the market after entering a trade no matter what it does. And that’s a big deal.

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Best Forex Pairs To Trade

When first learning to trade Forex, you should focus on the best Forex pairs for trading. By best, we mean those pairs that are widely traded, have the most liquid markets and have sufficient price movements (or, volatility) to be worth trading. The following pairs are consistently recommended as best for trading in the Forex markets for meeting these requirements:

- EUR/USD (Euro/US Dollar)

- GBP/USD (British Pound/US Dollar)

- USD/JPY (US Dollar/Japanese Yen)

- USD/CHF (US Dollar/Swiss Franc)

- USD/CAD (US Dollar/Canadian Dollar)

- AUS/USD (Australian Dollar/US Dollar)

By limiting yourself to these pairs you can: reduce the amount of time spent searching for potential trades; locate stronger and better trends developing among fewer pairs; and, make it easier to get into and out of a trade quickly.

You can go a step further, as well, and limit yourself to the two most liquid and widely traded pairs: EUR/USD and GBP/USD.