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How Do You Make Money In Forex Trading?
This is a question that most people would like to know so we could all be millionaires… If only we had a crystal ball! Making money in forex takes time, patience and practice. Education is key and understanding the functions of the market is essential! This is why a website such as Everything Trading can help hone your trading skills and help you learn from other traders.
Many people prefer to trade currencies because of its 24 hour nature, it requires a lower level of capital while offering exciting opportunities with the leverage provided. The key component of making money is to have a strategy that works which uses effective risk management. A trader has to be comfortable taking manageable losses and letting the profits run. All successful traders have strict risk management rules and this is possibly the most crucial element of trading profitably.
How do I use effective risk management?
The first thing is that for each and every trade there needs to be a plan of action. Some key questions to ask when weighing up a trade are… How much am I willing to risk on this trade? Where is my stop loss? What is my upside or target price? Many seasoned professional traders set themselves rules and they set risk:reward ratios. A common risk to reward ratio that is said to be a standard rule of thumb is 1:3. This means that for every $1 or £1 of risked loss, there is $3 or £3 of reward or profit. When using this ratio even if the trader gets 33% of trades correct, they will still achieve break even in their account. Anything else on top of that is a bonus as its profit!
Another rule of thumb is that on any one trade you should set up strict limits to risk a percentage proportion of the total equity in the account. For example if one has a $10,000 account, then it may be that only 1% is risked per trade therefore in this example, the maximum risk or downside on the trade would be $100 ($10,000 * 1%).
Devising a proper strategy
Some traders take years to hone their strategies which allow them to trade profitably on a consistent basis. Strategies can be based off technical charts, fundamentals, or quick moves during economic news. Successful traders usually formulate their strategy after practicing and fine tuning the strategy.
To formulate the strategy a trader may look at technical indicators, find excellent risk/reward price levels in the market and then rank the strategy based on two very important factors – the win rate and risk/reward ratio. A win rate is the percentage of trades which garnered a return or profit. If a trader makes money on 6 out of 10 trades in a day then the win ratio would be 60%. If the same trader uses a risk reward ratio of 1:1 by risking $1000 to make $1000 then they would have made $6000 on profitable trades and lost $4000 on the trades that went negative. Therefore a profitable day of $2000. Not bad for a days work!
How much money should a trader make?
A bonus of trading forex is that brokers allow leverage to amplify trade sizes. While this also amplifies profits it also can amplify losses so should be used with great care. If used in the proper manner, when one is trading a $5000 account the buying power can be amplified 30,50 or 100 times depending on the leverage the broker gives you. Using the $5000 account we have a trader who trades 1% risk on every trade therefore risks $50 per trade while also trying to capture $100 profit so a 1 to 2 risk/reward ratio. They place 6 trades per day and have a win percentage of 50%.
For this scenario the trader trades 100k lot trades and tends to have a stop loss of 5 pips ($10 per pip * 5 pips = $50) and upside of 10 pips ($10 per pip * 10 pips = $100) – see article on pip costs. As the win rate averages 50% from 6 trades per day, this is on average 60 winners on 120 trades per month (20 trading days per month). The 60 winners generate $6000 in profit (60*$100 profits) and the 60 losers generate $3000 in losses (60*$50 loss). Therefore using this strategy the monthly profits are $3000 per month on the $5000 account or 60%. This monthly return is unbelievable compared to other markets and the fact that the trader is only correct with profitable trades 50% or half the time makes it even more powerful! Not every trader is as fortunate however by using the numbers above you can see the potential of the forex market.
Best time of day to make money trading forex
When trading a forex pair for two to three hours a day during an active time (see: Best Time of Day to Day Trade Forex) it’s usually possible to make about five or six round turn trades (this is both the entry and exit) using the above risk management parameters. As mentioned above there is usually 20 trading days in a month so a trader should be able to find 100-120 excellent risk/reward trading opportunities from trading just a couple of hours a day. If the trader wants to trade more then there are many more opportunities throughout a usual 8 hour working day especially when trading the full London and New York sessions.
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The most important thing about making consistent profits in the forex market is to have tried and tested risk management practices. Risk management is easier to review when calculating win rates and risk/reward ratios.
All trades should have a specific entry and exit level which follows the set rules of risk and reward ratios. Devising a strategy takes time but the risk management considerations never change. Once these risk principles are ingrained within the strategy a trader has a much better chance of being successful, which is what we are trying to help with!