Why do hundreds of thousands online traders and investors trade the forex market every day, and how do they make money doing it?

Trade pairs, not currencies - Like any relationship, you have to know both sides. Success or failure in forex trading depends upon being right about both currencies and how they impact one another, not just one.

Knowledge is Power - When starting out trading forex online, it is essential that you understand the basics of this market if you want to make the most of your investments.

1. The main forex influencer is global news and events. For example, say an ECB statement is released on European interest rates which typically will cause a flurry of activity. Most newcomers react violently to news like this and close their positions and subsequently miss out on some of the best trading opportunities by waiting until the market calms down. The potential in the forex market is in the volatility, not in its tranquility.
   

2. Unambitious trading - Many new traders will place very tight orders in order to take very small profits. This is not a sustainable approach because although you may be profitable in the short run (if you are lucky), you risk losing in the longer term as you have to recover the difference between the bid and the ask price before you can make any profit and this is much more difficult when you make small trades than when you make larger ones.
   
3. Over-cautious trading - Like the trader who tries to take small incremental profits all the time, the trader who places tight stop losses with a retail forex broker is doomed. As we stated above, you have to give your position a fair chance to demonstrate its ability to produce. If you don't place reasonable stop losses that allow your trade to do so, you will always end up undercutting yourself and losing a small piece of your deposit with every trade.
   
4. Independence - If you are new to forex, you will either decide to trade your own money or to have a broker trade it for you. So far, so good. But your risk of losing increases exponentially if you either of these two things:
   

   Interfere with what your broker is doing on your behalf (as his strategy might require a long gestation period);
   

   Seek advice from too many sources - multiple input will only result in multiple losses. Take a position, ride with it and then analyse the outcome - by yourself, for yourself.
   

5. Tiny margins - Margin trading is one of the biggest advantages in trading forex as it allows you to trade amounts far larger than the total of your deposits. However, it can also be dangerous to novice traders as it can appeal to the greed factor that destroys many forex traders. The best guideline is to increase your leverage in line with your experience and success.
   
6. No strategy - The aim of making money is not a trading strategy. A strategy is your map for how you plan to make money. Your strategy details the approach you are going to take, which currencies you are going to trade and how you will manage your risk. Without a strategy, you may become one of the 90% of new traders that lose their money.
   
7. Trading Off-Peak Hours - Professional FX traders, option traders, and hedge funds posses a huge advantage over small retail traders during off-peak hours (between 2200 CET and 1000 CET) as they can hedge their positions and move them around when there is far small trade volume is going through (meaning their risk is smaller). The best advice for trading during off peak hours is simple - don't.
   
8. The only way is up/down - When the market is on its way up, the market is on its way up. When the market is going down, the market is going down. That's it. There are many systems which analyse past trends, but none that can accurately predict the future. But if you acknowledge to yourself that all that is happening at any time is that the market is simply moving, you'll be amazed at how hard it is to blame anyone else.
   
9. Trade on the news - Most of the really big market moves occur around news time. Trading volume is high and the moves are significant; this means there is no better time to trade than when news is released. This is when the big players adjust their positions and prices change resulting in a serious currency flow.
   
10. Exiting Trades - If you place a trade and it's not working out for you, get out. Don't compound your mistake by staying in and hoping for a reversal. If you're in a winning trade, don't talk yourself out of the position because you're bored or want to relieve stress; stress is a natural part of trading; get used to it.
    
11. Don't trade too short-term - If you are aiming to make less than 20 points profit, don't undertake the trade. The spread you are trading on will make the odds against you far too high.
    
12. Don't be smart - The most successful traders I know keep their trading simple. They don't analyse all day or research historical trends and track web logs and their results are excellent.
    
13. Tops and Bottoms - There are no real "bargains" in trading foreign exchange. Trade in the direction the price is going in and you're results will be almost guaranteed to improve.
    
14. Ignoring the technicals- Understanding whether the market is over-extended long or short is a key indicator of price action. Spikes occur in the market when it is moving all one way.
    
15. Emotional Trading - Without that all-important strategy, you're trades essentially are thoughts only and thoughts are emotions and a very poor foundation for trading. When most of us are upset and emotional, we don't tend to make the wisest decisions. Don't let your emotions sway you.
    
16. Confidence - Confidence comes from successful trading. If you lose money early in your trading career it's very difficult to regain it; the trick is not to go off half-cocked; learn the business before you trade. Remember, knowledge is power.

The second and final part of this report clearly and simply details more essential tips on how to avoid the pitfalls and start making more money in your forex trading.

1. Take it like a man - If you decide to ride a loss, you are simply displaying stupidity and cowardice. It takes guts to accept your loss and wait for tomorrow to try again. Sticking to a bad position ruins lots of traders - permanently. Try to remember that the market often behaves illogically, so don't get commit to any one trade; it's just a trade. One good trade will not make you a trading success; it's ongoing regular performance over months and years that makes a good trader.
   
2. Focus - Fantasising about possible profits and then "spending" them before you have realised them is no good. Focus on your current position(s) and place reasonable stop losses at the time you do the trade. Then sit back and enjoy the ride - you have no real control from now on, the market will do what it wants to do.
   
3. Don't trust demos - Demo trading often causes new traders to learn bad habits. These bad habits, which can be very dangerous in the long run, come about because you are playing with virtual money. Once you know how your broker's system works, start trading small amounts and only take the risk you can afford to win or lose.
   
4. Stick to the strategy - When you make money on a well thought-out strategic trade, don't go and lose half of it next time on a fancy; stick to your strategy and invest profits on the next trade that matches your long-term goals.
   
5. Trade today - Most successful day traders are highly focused on what's happening in the short-term, not what may happen over the next month. If you're trading with 40 to 60-point stops focus on what's happening today as the market will probably move too quickly to consider the long-term future. However, the long-term trends are not unimportant; they will not always help you though if you're trading intraday.
   

6. The clues are in the details - The bottom line on your account balance doesn't tell the whole story. Consider individual trade details; analyse your losses and the telling losing streaks. Generally, traders that make money without suffering significant daily losses have the best chance of sustaining positive performance in the long term.
   

7. Simulated Results - Be very careful and wary about infamous "black box" systems. These so-called trading signal systems do not often explain exactly how the trade signals they generate are produced. Typically, these systems only show their track record of extraordinary results - historical results. Successfully predicting future trade scenarios is altogether more complex. The high-speed algorithmic capabilities of these systems provide significant retrospective trading systems, not ones which will help you trade effectively in the future.
   

8. Get to know one cross at a time - Each currency pair is unique, and has a unique way of moving in the marketplace. The forces which cause the pair to move up and down are individual to each cross, so study them and learn from your experience and apply your learning to one cross at a time.
9. Risk Reward - If you put a 20 point stop and a 50 point profit your chances of winning are probably about 1-3 against you. In fact, given the spread you're trading on, it's more likely to be 1-4. Play the odds the market gives you.
   

10. Trading for Wrong Reasons - Don't trade if you are bored, unsure or reacting on a whim. The reason that you are bored in the first place is probably because there is no trade to make in the first place. If you are unsure, it's probably because you can't see the trade to make, so don't make one.
    

11. Zen Trading- Even when you have taken a position in the markets, you should try and think as you would if you hadn't taken one. This level of detachment is essential if you want to retain your clarity of mind and avoid succumbing to emotional impulses and therefore increasing the likelihood of incurring losses. To achieve this, you need to cultivate a calm and relaxed outlook. Trade in brief periods of no more than a few hours at a time and accept that once the trade has been made, it's out of your hands.
    

12. Determination - Once you have decided to place a trade, stick to it and let it run its course. This means that if your stop loss is close to being triggered, let it trigger. If you move your stop midway through a trade's life, you are more than likely to suffer worse moves against you. Your determination must be show itself when you acknowledge that you got it wrong, so get out.
    

13. Short-term Moving Average Crossovers - This is one of the most dangerous trade scenarios for non professional traders. When the short-term moving average crosses the longer-term moving average it only means that the average price in the short run is equal to the average price in the longer run. This is neither a bullish nor bearish indication, so don't fall into the trap of believing it is one.
    

14. Stochastic - Another dangerous scenario. When it first signals an exhausted condition that's when the big spike in the "exhausted" currency cross tends to occur. My advice is to buy on the first sign of an overbought cross and then sell on the first sign of an oversold one. This approach means that you'll be with the trend and have successfully identified a positive move that still has some way to go. So if percentage K and percentage D are both crossing 80, then buy! (This is the same on sell side, where you sell at 20).
    

15. One cross is all that counts - EURUSD seems to be trading higher, so you buy GBPUSD because it appears not to have moved yet. This is dangerous. Focus on one cross at a time - if EURUSD looks good to you, then just buy EURUSD.
    

16. Wrong Broker - A lot of FOREX brokers are in business only to make money from yours. Read forums, blogs and chats around the net to get an unbiased opinion before you choose your broker.
    
17. Too bullish - Trading statistics show that 90% of most traders will fail at some point. Being too bullish about your trading aptitude can be fatal to your long-term success. You can always learn more about trading the markets, even if you are currently successful in your trades. Stay modest, and keep your eyes open for new ideas and bad habits you might be falling in to.
    

18. Interpret forex news yourself - Learn to read the source documents of forex news and events - don't rely on the interpretations of news media or others.
    

by : John Gaines
online trading, currency trading, financial service

Position Sizing™ and your personal psychology are the two most important aspects of trading and they are probably the two most neglected topics. Chapter 14 of the second edition of Trade Your Way to Financial Freedom, is all about helping you understand the importance of position sizing.

Before we discuss this topic, let me give you some important background information. I tend to think of trading systems by the distribution of R-multiples that they generate. And the average R (or mean R) of the system's R-multiple distribution is the expectancy of the system. It tells you what to expect from the average trade.

So let me give you a simple trading system, one that is probably much simpler than any you'd trade. Twenty percent of the trades are 10R winners and the rest of the trades are losers - 70% are 1R losers and the remaining 10% are 5R losers. Is this a good system? Well, if you want a lot of winners, then it certainly isn't - it only has 20% winners. But if you look at the average R for the system it's 0.8R. That means on the average, you'd make 0.8R per trade over many trades. Thus, when it's phrased in terms of expectancy, it's a winning system.

Let's say that you made 80 trades with this system in a year. On the average you'd end up making 64R - which is excellent. If you allowed R to represent 1% of your equity (which is one way to do position sizing), then you'd be up about 64% at the end of the year.

I frequently play a marble game with this R-multiple distribution to teach people about trading. The R-multiple distribution is represented by marbles in a bag. The marbles are draw out one at a time and replaced. The audience is given 100,000 to play with and they all get the same trades.

So let's say we do 30 trades, and they come out as shown in the table:

R-Multiples Draw In A Game
-1R	-5R	-1R
-1R	-1R	-1R
-1R	-1R	+10R
-5R	-1R	-1R
-1R	-1R	+10R
+10R	-1R	-1R
-1R	-1R	-1R
-1R	-1R	-5R
-1R	-1R	+10R
+10R	-1R	+10R
+8R	-14R	+30R

If you look at the bottom row, you see the total R-multiple distribution after each ten trades. After the first 10 we were up +8R, we then had 12 losers in a row and were down 14R after the next 10 trades. And finally we had a good run on the last 10 trades, with four winners, getting 30R for the ten trades. Over the 30 trades we were up 24R. And if you divide 24R by 20 trades is gives us a sample expectancy of 0.8R. Thus, our sample expectancy was exactly the same as the expectancy of the marble bag. That doesn't happen often, but it does happen.

Now let's say that you are playing the game and your only job is to decide how much to risk on each trade or how to position size the game. How much money do you think you'd make or lose? Well, in a typical game like this, 1/3 of the audience will go bankrupt (i.e., they won't survive the first five losers or the streak of 12 losses in a row); another 1/3 of the audience will lose money; and the last third will typically have made a huge amount of money - sometimes over a million dollars. And in an audience of say 100 people, except for the 33 or so who are at zero, I'll probably have 67 different equity levels.

That shows you the power of position sizing. Everyone in the audience got the same trades, those shown in the table. Thus, the only variable working was how much they bet or their position sizing. And through that one variable we had final equities than ranged from zero to over a million dollars. That's how important position sizing is. And by the way, I've played this game hundreds of times, getting similar results each time.

Position sizing is that important and I'd suggest that you take a look at chapter 14 of my book because many people have told me that it turned their trading around, making them winners instead of losers. Next week, I'll tell you a lot more about position sizing - how to do it and what its purpose is.

Dr. Van K Tharp
TradingEducation.com

Ray Dalio explains the various strategies on offer for those who wish to hedge their currency exposure – the prudent thing to do when international exposure reaches 15 per cent of a portfolio.

Investing internationally is a package deal. One gets two exposures – the underlying asset and the currency – wrapped into one. These exposures, however, are separable through currency hedging. International investors can and should decide first, how much of each to have and second, how to independently manage these exposures.

Making these decisions, creating a currency hedging plan, is prudent when the international exposure reaches 15 per cent to 20 per cent of a total portfolio. Failing to do so leaves a large, inadvertently acquired, unmanaged risk in the portfolio. The purpose of this article is to provide a basic overview of the key issues that investors should address in developing a hedging strategy.

A general rule to bear in mind when creating your hedging strategy, you should follow the same steps you would follow to decide on any exposure in your portfolio: most importantly, you should decide on the appropriate strategic exposure to foreign currency and whether this exposure should be actively or passively managed.

What should the strategic exposure be?

Phrased differently, assuming no market view, how much foreign currency exposure should I have in my portfolio? The process you should use to answer this question should be the same as the process you use to determine your asset allocation mix. It should be based on the expected returns, risks and correlations of currencies.

Once you have decided on the amount you want to keep in your portfolio, the hedge ratio you set should be the amount that leaves you with your desired net currency exposure. For example, if you determine that you would like to have 10 per cent of your portfolio exposed to foreign currency, and you currently have 20 per cent, you would set a benchmark of 50 per cent hedged. Rather than determining the appropriate percentage to be hedged, you should determine a desired strategic currency exposure and hedge to achieve it. That hedged amount will be your benchmark.

So what is the right strategic exposure to have? As mentioned, that depends on your assessment of the expected returns and risks of currencies, as well as the expected correlations with other exposures in the portfolio. Because currency movements are zero sum – for one currency to go up, another must go down – it is probably best to assume that the expected return is zero, although the actual return might be quite different. This simply means the expected return is zero. The standard deviation of a typical currency portfolio has been about 11 per cent over the past 25 years, which is also a reasonable assumption going forward. The correlations with the other assets in the portfolio depend on the assets, but in general are quite close to zero.

Where will plugging these numbers into a portfolio optimiser take you? While there are a wide range of outcomes depending on unrelated factors (such as the choice of assets in your overall portfolio), there are some common outcomes. Generally speaking, analysis will lead investors to hedge away currency risks, such that the amount left is not greater than 10 per cent to 15 per cent of the portfolio. If your international investments equal 20 per cent to 30 per cent, that might lead to normally being 50 per cent hedged. If your international investments comprise only 10 per cent to 15 per cent of your portfolio, you might opt to remain unhedged.

There are only two characteristics which are unique to currencies that you need to understand to solve for the right strategic exposure:

1. it costs money to hedge and
2. currency exposures are incremental to other exposures, not instead of them.

Concerning the first point, the expected return of being hedged is slightly less than that of being unhedged because of the transaction costs of hedging. These are typically five to 10 basis points (if done passively), so it should be assumed that a hedged portfolio will have a five to 10 basis point lower return than an unhedged portfolio. Given this, you need to assess incremental benefit, what is it worth to reduce or eliminate an exposure that has a standard deviation of 11 per cent and no expected return? One typically sees that risk reduction from hedging occurs in a non-linear way; the benefits of the first 25 per cent or 50 per cent of hedging are much greater than those coming from next 25 per cent or 50 per cent. For this reason, it is rarely the case that being 100 per cent hedged is appropriate.

Regarding the second point, because currency exposures are incremental to other exposures, not a replacement for, lower risk is achieved by having less currency exposure versus more.

Currencies have little or no correlation with other assets in the portfolio. One might think that this is a reason to keep them (i.e. remain unhedged) because they would diversify, hence reduce a portfolio’s risk. In fact, the reverse is the case: having significant currency exposure in a portfolio increases risk, even though currencies are uncorrelated with other assets. This is because currency exposure is additive to other exposures. Normally replacing a higher correlation asset with a lower correlation asset reduces risk because there is a substitution of risk while total exposure is unchanged. When you increase overall exposure (e.g. buy gold futures as an overlay on a portfolio), the effect is to increase portfolio risk, even if the correlation were negative. Similarly, when reducing currency exposure, you will almost certainly reduce portfolio risk, despite currency’s low correlations.

There is only one other point that should be made before concluding the discussion of strategic exposure: the time horizon is relevant. The longer the time horizon, the less risky currency will appear because over a long enough time horizon, its effect on the return approaches zero. If time horizon is a consideration, it is important to understand how long you must wait to be unconcerned about currency risk. Based on past currency movements, in order to be 90 per cent confident that currencies will have an annual return of less than -1 per cent to +1 per cent, you would have to wait 325 years. For most investors, that is too long to patiently accept the unhedged currency risk.

Once desired strategic exposure is determined, you should focus on benchmark exposure and the hedge ratio that gets you there. There are four possible benchmarks – 100 per cent unhedged, 100 per cent hedged, partially hedged (e.g. 50 per cent) and option hedged. All four can be obtained passively. Option hedged benchmarks (e.g. buying puts to hedge the currency exposure) are sometime used instead of a partially hedged benchmark where the investor is more inclined to have currency losses come in smaller, more frequent doses than larger, infrequent amounts. These hedges should not be used as an alternative to fully hedged or fully unhedged benchmarks because they will systematically deliver either more or less currency exposure than is consistent with your strategic objective.

If you choose an option benchmark, it is essential that the one you pick is consistent with your strategic objectives. For example, some options are consistent with a 50 per cent hedged objective, while others are not. Their deltas, sensitivity to price changes, will be broadly equivalent to desired hedged ratios. When choosing an option hedge instead of a corresponding partially hedged benchmark (e.g. 50 per cent), it is also essential to measure the actual performance in relation to the passive option hedge, not the partially hedged alternative. That is because options have different systematic risks than their corresponding partial hedges. For example, options will do better when the markets move a long way directionally. If an active manager is operating to an option mandate, but is being measured against a 50 per cent hedged benchmark, the differences in returns of the manager and the benchmark will be the systematic risk and the manager’s alpha combined. As a result, one cannot distinguish how well the manager is performing from how well options are doing relative to the 50 per cent hedged. For example, a manager could outperform the fixed hedge ratio but underperform the option hedge alternative, giving the mistaken impression that the manager added value when in reality he did not. That is why the benchmark should always be the investor’s passive alternative. For most investors, the option hedged strategy is inconsistent with strategic objectives.

Active or passive?

The only purpose of active management is to add value to the strategic exposure’s passive return. The ‘active’ vs. ‘passive’ decision should be made for currency the same way it is made for other markets: based on expectations for value-added. This statement is true for all managers, whether managing to a fixed benchmark (100 per cent hedged, 100 per cent unhedged or partially hedged), or an option hedged benchmark. The investor should specify the benchmark and study the manager’s performance relative to it.

Investors should also understand and assess how a manager attempts to add value. There are only two ways to add value: fundamentally and technically. Tactical deviations from a benchmark might differ (e.g. price direction, interest rate carries, volatility, etc.), but a manager’s approach to making this bet will be fundamental, technical or some mixture of the two. Fundamental analysis is based on the belief that there are cause-and-effect relationships that need to be understood in order for pricing anomalies to be sensibly identified and acted upon. Technical analysis is based on the assumption that past price relationships are indicative of future price relationships. Whether betting on price, volatility or anything else, managers follow one or both approaches. In assessing currency managers, like any other manager, you should decide on which approach is more consistent with your own investment philosophy.

Since you would only hire an active manager because you expect they are likely to add value, it is worth knowing how they have added value in the past. Brian Strange of Currency Performance Analytics conducted a comprehensive study of currency manager performance in 1998. He studied the performance of 158 currency overlay mandates managed over a 10-year time frame and determined that currency overlay managers have added considerable value, about 1.9 per cent per year on average. Since then, several follow-up studies by other consultants have arrived at the same basic conclusions.

When examining individual managers, it is often difficult to compare their value-added (alpha) because virtually no two client mandates are the same. Judging performance against hedged and unhedged mandates is made additionally difficult by the effect that the market’s direction has on the alpha. For example, managers who are operating to an unhedged benchmark will find it easy to add value when foreign currencies are falling, while managers who are operating to a fully hedged benchmark will find it tough. To achieve the best perspective concerning the managers’ ability to add value, you should examine performance across mandates.
In summary, the alternatives an investor must decide between are expressed in figure one.

An investor’s benchmark can be either a fixed hedge ratio (e.g., 50 per cent hedged) or an option hedge. Active managers can be hired to beat the benchmark, or passive managers can be used to match it. When you are able to check the box that best suits your objectives, you will have moved most of the way toward having a currency hedging plan. Selecting specific managers and deciding on other aspects of the mandate (e.g. is cross-hedging appropriate) is also required, but these choices will be vastly easier to make once you have made the core strategic decision.

Ray Dalio is president and chief investment officer of Bridgewater Associates.