Ashton Burbon, writer of many forex for dummies lessons, explains some key skills to learn how to become a day trader.
One of the sayings traders hear every day is “Cut your losses short and let your profits run”. It’s a lot easier to say that, than it is to do it. A very good way to deal with it, is to create a controlled approach to trading that requires an elimination of emotional decisions and discipline, which helps you maximize your profit and minimize you losses.
The majority of beginner traders fail because they usually rely on emotions when deciding to make a trade. Psychology plays a decisive role in trading and greed and fear make it almost impossible to make rational trading decisions, increasing the probability of failure. A trader might stop taking a loss because of fear. Learning to take a loss is essential to becoming a successful trader and the only safeguard for preventing major losses. Greed may guide to overconfidence, encouraging extra risk taking and a breakdown in discipline.
To be successful, you ought to treat trading like a business and, to make profits, learn how to control risk.
To begin, you should make a trading plan which consists of a money management strategy, to maximize your profit and limit you loss . Money management is risk management and is used to arrange and preserve risk capital and keep you in the game.
At a minimum, a trading plan must include a set of goals, a money management strategy that seeks capital preservation and plan for disciplined trading decisions. The plan should set risk/reward ratios, have tools for determining where to place stop losses and profit targets, necessitate continuing education and learning about the markets.
Setting of goals should include questions as to why you are trading and what you want from trading. If you don’t know what you want, the markets can be an expensive place to learn. Some people may trade for the excitement or the competition, others may trade as a hobby, but most often the goal is to make money and avoid major loss of capital.
Money management is a defensive concept and key to the difference between success and failure in trading. An efficient money management strategy helps set rules for how much to risk per trade and has two fundamental controls – discipline and capital preservation.
The amount of risk per trade is usually determined by a risk/reward ratio. The risk/reward ratio is defined as expected risk on a trade compared to expected return. The ratio is calculated by dividing the amount of profit the trader expects, i.e. the reward, by the amount he stands to lose if the trade moves against him, i.e. the risk. A good risk to reward ratio should generally not exceed 3% of capital and have a profit target of 3 to 1. Risk reward ratios are not set in stone and should be adjusted by your level of risk tolerance, current market environment and your trade entry and exit points.
Placement of a stop order is a main part of risk management and must be determined at the time a trade is entered. A stop loss order is a type of order which will facilitate both limit trading losses and lock in trading profits. Placement of the stop can be based on calculation of how much you plan to risk on trade, a breakeven point or by using tools like technical analysis. A trailing stop is used to protect profit or exit a market once a profit goal has been reached. Usually, profit targets are determined by risk\reward ratio. Most of the time, staying longer in a trade means you are increasing risk.
For the beginner trader, reducing position size, lowering the risk/reward ratio and shortening the length of a trade are good ways to preserve capital. This is important because trading often involves drawdown of capital. The goal is to use risk management to withstand these periods of drawdown and limit risk of large losses.
Ashton Burbon has written a lot of how to become a day trader lessons in his site. Check out his page for daily how to be a forex trader lessons, helpful tips and advice on how to be a trader, as well as weekly and daily forex outlook.