What was my friend doing wrong?
After spending a few hours talking to him, reviewing his system and listening
to his trading experiences I came to the following conclusions.
There were THREE MAJOR problems with his trading method:
1. His Trading "System"
- His system was producing way too many entry signals
The efficiency (profitability) of the system is not based on the QUANTITY
of signals that it produces. It is based on the QUALITY of entry signals
that it produces. The entry signal needs to put probability of a trade moving
into your desired direction on YOUR side. His signals were working AGAINST him.
- His system was relying on lagging indicators
Most of the indicators that his system was using were so called lagging indicators.
Basically, it means that he was always the last one to enter a profitable trade
and the last one to get out of a losing trade.
- His system was not clearly defined
The system needs to have a clear set of entry and exit rules. It can not be left
up to the trader's discretion to decide when to enter the trade and when to get
out. In the real, professional system, you MUST enter the trade when the signal
occurs, because that is where your winning edge is in the long run.
2. His Mind Set
- He was always stressed out when his real money was inside the trade
You can not and should not trade with "scared" money. You can only trade with the
money that you can afford to lose. That will make you calm and therefore less
likely to make a bad judgment.
- He was getting out of winning trades too early
Even when his entry signals were good he was not able to extract maximum profit
from them. The MANTRA is "let your profits run". It is not "cut your profits short".
You need to extract MAXIMUM profit from EVERY single trade in order to be
profitable in the long run.
3. He did not pay attention to SENTIMENT
The forex market sentiment is the "collective" and intuitive opinion or better
to say "gut feeling" that is formed inside the forex trading community regarding
the future direction of a given currency pair (EUR/USD, USD/CAD, GBP/USD,
etc...). I'm sure that all of you who are already involved in the forex market have
noticed that sometimes, when market sentiment is negative for the particular
currency, even the best news can do nothing more than temporarily stop the negative
direction of that currency. For example, let's say that current opinion is that Central
Bank will rise interest rates by .25 points on the next meeting. And they actually raise
it by .50 points. If the sentiment for that particular currency was bullish or even
neutral, it would definitely trigger that particular currency to go higher. However,
if the sentiment was negative, all that would happen is that sell off of that
currency would stop for short period of time and then it would resume.
So, why is the sentiment important?
Sentiment is by far the most important tool at the hands of forex trader.
Why is it so? Because it gives to the forex trader a clue when NOT to take
particular trading signal. The power of successful forex trader is to know
when NOT to participate in the trade.
How this applies to you?
Let's say that you own a trading strategy that generates either bullish or bearish
signals for the particular currency pair. Sentiment will help you determine whether
to take the signal or to stay on the sidelines. If the signal is bearish but current
sentiment is bullish, you DO NOT take the signal. If the signal is bullish but current
sentiment is bearish, you DO NOT take the signal. You only take the signal if it is
confirmed by current sentiment.
I hope that you have learned something from my friend's mistakes. Look inside your
INBOX over the next couple of days as you will find out HOW TO determine the
current sentiment...
Best Regards.
