If there is one unnecessary thing that seems to run as undercurrent through the retail foreign exchange industry, it is the human need for complexity. Too many traders cram numerous indicators onto their charts, and spend their time wading through vast amounts of historic price data for complex recurring patterns in the hope that they will stumble across the answer to their financial freedom. My personal opinion is that this need for an elaborate approach is rooted in the in the idea that if it is easy, why isn?t everybody doing it? Well, it is not easy, and that is why not everybody is doing it, but the difficulty has nothing to do with complexity.
The key to foreign exchange trading is consistency. The simpler the approach, the easier consistency becomes. The approach must produce results, of course, but many approaches do. The reason that 85 percent, 90 percent, 95 percent?or whatever the figure is at the moment?fail, is that their approaches are so complex they are nigh on impossible to implement consistently.
So how do I maintain consistency? Through simplicity. I learnt early on that I, and I suspect many others, will never develop an immunity to emotion. When I win, I am delighted. When I lose, I am frustrated. I also learnt early on that the only way to overcome this weakness flaw human trait was to set simple and easy to follow strategy rules. By doing so I can enjoy winning, and justify my frustration at losing, but keep this completely separate from my trading operations.
All this, of course, is not what people are interested in. The only thing newer traders want to know is how you trade, and how they can do it too. For this, I cannot blame them?who cares how I feel? My exact methods are described in my Diary of a Currency Trader, but in an attempt to keep things within the proverbial nutshell, here goes:
I like to describe the way I operate in the foreign exchange markets as risk management with a bit of analysis thrown in. The risk management is what drives long-term profitability. The analysis sometimes shifts the odds in my favour.
First then, a look at my analysis. I base my own approach on a handful of simple one, two or three candlestick patterns. These patterns turn up time and time again and produce profitable results when they do. Ask even the newest of traders and they will be familiar with the patterns I look for, yet very few of those asked will trade them. I combine these patterns with key historic price levels?levels at which price has reversed in the past?to increase the likelihood of the pattern completing in my favour. I only trade daily charts, as these are the charts on which the key levels are most likely to hold. Furthermore, I only trade the major pairs, because these are the pairs that the majority of technical traders watch. The more technical traders watching a pair, the more important the key levels and the patterns become. Finally, I never manually exit a trade. I set my stop losses and profit targets, and let my trading software close me out when price hits either one.
This brings me nicely to my risk management. Risk management is the foundation of my strategy. Every pattern I trade has a predetermined entry level and stop loss. If a pattern completes at a key historic level, I calculate that pattern?s risk based on these two prices. I then look through recent price action. If the distance price must travel to reach the next key level outweighs my risk, I enter the trade. If it does not, I move on. This simple calculation guarantees me a positive risk to reward ratio on every trade. A positive risk to reward ratio means my analysis can be wrong more than it is right, and I still maintain long-term profitability. In the notoriously hard to predict currency markets, the ability to be wrong most of the time and still make money is priceless.
And that?s it. No MACD, no Bollinger and no Ichimoku. Just my risk management, my patterns and myself.
Diary of a Currency Trader is Samuel J. Rae's no-nonsense, full disclosure look at his approach to trading the forex markets (£15, Harriman House).