To be successful in trading, you need more than a winning strategy. You need to have the correct trading mindset to succeed over the long run. A trader with a winning strategy but who starts being overconfident about it may end up losing control and making mistakes. To be a winner, it’s important to have several edges against all the other traders. One of this edges is mental – you should think like a winner to become one. In this article, we present 9 characteristics of a successful trading mindset, which will give you some powerful insights to complement you as a winning trader.
1 – Flexibility
First of all, you need to be flexible and open-minded. Especially in Forex, given that the market is open 24h a day, you need to be flexible enough to trade during the London session, the New York session and the Tokyo session. A good opportunity may appear at any time, and you need to be ready to be there and catch it. Besides, open-mindedness is really important when analyzing a currency. Markets change fast, and what was true last week may not necessarily be correct this week. You should always keep your mind open to sudden changes that may occur.
2 – Find what works FOR YOU
There are some traders who prefer to risk more, others prefer to trade only during a certain session, others like to look only at fundamental analysis and some only trade on technical analysis. This means that each one of us should develop a strategy that is good only for himself. What has proved to be a winning strategy for your partner may not necessarily work that well for you. He may look at the market in a different way than you do, and the strategy will reflect that. In this sense, you should discover what is your trade profile and start working on a personal trading strategy or use a proven trading strategy that fits you.
3 – Don’t be overconfident when you win
We all know how it’s easy to become overconfident after a good winning streak. However, it’s crucial to maintain the same posture towards trading as always. If you become too confident and start being more relaxed about your trades, hoping that you’ll continue to win, you may end up losing what you already won because of your sloppiness. Basic mistakes can occur due to a lack of attention. Instead, you should “convert” your confidence into focus to keep having good results.
4 – Don’t lose your confidence after some bad trades
As important as not being overconfident when you win is to not lose your confidence after some bad trades. It’s usual to have some bad moments and enter on a losing streak. This doesn’t necessarily mean your strategy is failing or you’ve lost the plot. Even the best strategies happen to fail under certain market conditions, and losing is important to improve your trading. If you’re having troubles in being confident, you may want to check our article on 3 Ways to Boost the Confidence in Your Trading.
“Losing a position is aggravating, whereas losing your nerve is devastating.”
– Ed Seykota
5 – Don’t trade to get your money back
As we all know, it’s difficult to remain focused after a bad trade. Besides losing confidence, it’s usual to see traders getting angry and trying to recover what they’ve lost. First of all, don’t let your emotions interfere with your trading, that will only guide you to a poor performance. Second, don’t trade just to recover your losses, as you’ll probably end up losing even more. Instead, you should remain calm and recover what you’ve lost over a certain period of time and get back on track. Haste will not lead you to good decisions. Besides, getting into a confrontation with the market won’t recover your losses. Don’t be mad at the market, try instead to think about what went wrong and improve it.
6 – Don’t trade just for the money
This may seem a little bit strange since the majority of traders do it to earn some money. However, some of the greatest traders of all time, like it is the case of Ed Seykota, reach a state in which they “forget” about the money involved and are much more focused on being good traders than in the money they can make. Always thinking about money may prevent you from focusing solely on your analysis and making the right trades. Moreover, if you’re a good trader, the returns will eventually come.
7 – Be patient
One of the most important characteristics of a successful trader is being patient and wait for the right chance. The market is full of opportunities, you only have to be aware and get the right ones. Sometimes prices may be flat for a long period of time, without any major change worth trading. During this time you should not “force” any trade, simply wait for a better time. Some strategies work better under specific market conditions. By applying them in a different way, you may risk its failure. If you wait for the certain opportunity, you’ll have a higher chance of success.
8 – Trade with money you can afford to lose
In our article about money management, we give some advice about how much money you should put in each trade and how you can ensure a positive expected return. It’s crucial that you don’t risk too much in each trade given that, if things go against what you planned, you may end up losing more than you can afford. Take small losses and let your profits run. The more you lose in each trade, the higher your winning rate has to be in order to be profitable over the long run.
9 – Be realistic
The final characteristic of a successful trader is the ability to be realistic regarding your expectation. If you don’t already know how much money you should expect to make in Forex, our article may give you some help on that. No trader starting with 1000€ can expect to win like 10,000€ per month. Your account will grow slowly at the beginning and then the compounding effect will ensure you win more as time goes by. Keep a realistic expectation about what you can win and define your goals according to that view.
The Bottom Line
To be a successful trader, you have to get as many edges as you can, and the mental edge is one of the most important. The above-mentioned characteristics are some of the ones you should try to implement to improve your trading mindset. This will complement your strategy and turn you into a mentally strong trader, able to go through bad times and prosper on good ones.
As a retail trader, your orders will hardly have any influence on the overall market prices. However, when large investors such as commercial traders or professional traders place their orders, they will likely define where prices are heading. Therefore, it’s of extreme importance to find what these large traders are doing and to be on their side. In this article, we intend to explain how you can spot what the big players are doing, i.e., tracking the “smart money”, and take advantage of their actions.
What is the “Smart Money”?
So, what exactly is the “Smart money”? It’s the name we use to describe professional and large traders with a big amount of capital. In this category, we may find both institutional investors, investment banks and hedge/mutual funds. Not all funds can be considered professional since some of them lack the expertise or the size to truly impact markets. Besides, small funds usually do not have enough capital to place orders capable of influencing prices.
Besides being the traders with the largest amount of capital, these are also the traders with access to more information and knowledge about the markets. Note that both hedge funds and investment banks have huge teams of researchers continuously analyzing the market. They also spend large sums to have access to the latest news before the rest of the market. As such, the odds are that professional traders will spot some opportunities faster than the “average trader”. This is why it’s extremely important to know what they are doing. Due to the size of the organized actions of these traders, they are usually behind biggest price movements. Therefore, knowing what they are doing should be one of the first objectives of any trader.
Tracking the Smart Money
The most direct and efficient method to understand when these players act in simply by looking at a price-volume chart. Due to the large size of their orders, these traders are not able to hide their actions. There is a myth that says that because of dark pools, they are able to hide their actions. Some institutional traders do use dark pools, but they can only hide their orders during execution, which can be a matter of milliseconds. After the order is executed, there’s no way to hide it, as exchanges (and consequently Forex liquidity providers) will report it in the volume.
1- Interpret the direction of their trading
You’ll need to look at prices and volumes to know this. Our article about volume trading explains some ways to observe this. The important thing here is to see where there is a general and organized action, and various funds are buying or selling a currency consistently. You can see this in lower timeframes, like 1 minute, as well as in daily/weekly timeframes.
There are many supply/demand patterns, which our VSA indicator shows, and one of the most prominent SUPPLY ones is a wide range bar, closing on the lows, with volume above the average. The demand ones close on the highs instead. Even though these are wide range bars, many times the prices will continue trending, as you can see in the chart below.
2- Take a look at fundamentals
In long-term trading (daily timeframe and above), good fundamentals make it more likely for big traders to have an interest in a given currency. Traders should be aware when talking about “fundamentals” given that some economic measures like the GDP growth or the interest rate hikes, although important, are not a leading indicator. We frequently see these variables changing only after price corrections in the value of the currency. Traders are better off by looking to the increase of the spread of the interest rates or the movement of a related commodity. These variables are usually a good proxy for the fundamentals that drive currencies and often are leading indicators. In the image below, for instance, we can see how correlated are the AUD with the price of Gold. If the price of gold increases, large traders know that this will benefit the AUD and start buying the currency.
- Sentiment indicators such as COT report and SSI index will give you secondary information. Although it has its usefulness, COT report shows the actions of ALL large traders, even the ones that aren’t so good. Traders should, therefore, pay special attention to their analysis, because the report may have some lag in what comes to be a market turn. Traders should use the COT report mainly as a confirmation, or as a search mechanism for extreme values between large investors and hedgers. The image below presents some examples when the large spread was linked with a market turn
- On the other hand, the SSI shows the actions of small retail traders, which are usually wrong and in the opposite direction of smart money. In this indicator, look for historically high % of long positions to look for a short, and vice-versa for long positions. You can combine both information to be more confident about the right direction you should trade.
If you aren’t using volumes in your analysis, you are missing a big part of the picture. By showing the market’s activity, volume together with prices shows what the big traders are doing. Only these traders are capable of placing orders large enough, and in an organized manner, to sustain market trends, so you should look closely at what they are doing. By tracking the smart money, you can follow their actions and be on the right side of the price movement.
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“How much money can I make in Forex?” This is probably the first question a beginner makes, and it’s a completely valid question. Why invest my time and money into something, if I have no idea what the returns will be?
The truth is that Forex is an enormous market, with many interests behind. It’s usual to see brokers trying to “sell” the maximum they can as if it was like a gold mine, where you can get fast and easy results. In fact, beginners may have some trouble in finding viable resources. It’s easy to fall in the many traps in this business, and develop incorrect expectations since the start.
Returns and Risk is the Key
The returns you make, vs the risk you take, is really the key point. Even though it’s possible to have a 1000% return in one year, that would mean incurring in a lot of risks. To have this kind of returns, a trader would need to risk almost all of his account into one single trade. The problem of this way of trading is that it would be very difficult to survive over the long-run.
In the table below we present the bankruptcy probability or risk of ruin. On the top row it’s the win-rate and in the left column the risk/reward ratio per trade. As you can see, the key to winning in this game is to have a higher risk reward ratio. This will assure that, even if you have a low winning ratio, you won’t go broke in the long run.
So, for instance, a trader with a win-rate of 30% and a risk/reward of 1:1 has absolutely no chance of succeeding for long. However, if we keep this same win-rate but increase the risk/reward ratio to 3:1, the probability of bankruptcy drastically drops to 27%. Of course, the risk of going bankrupt decreases with an increase in the win-rate and in the risk/reward rate.
Given that the win-rate of an average trader is somewhere around 50%, a risk reward ratio of around 1.5 is sufficient to almost eliminate the risk of ruin. However, the best is to always aim for the best risk/reward ratio, to keep the odds on your side.
How Much Do The “Big Guys” Make?
To get a sense of what you should expect is to know how much the best in this industry make. The list presented below shows the annual return as from 2014 of top performing Forex Hedge Funds.
And how does Forex compare to other markets? The next image shows equities, commodities and other markets hedge funds returns between 2014 and 2016:
Some claim that it’s easier to make money trading Forex because of high leverage, which allows to take more out of a movement. But as you can see, the annual returns between top hedge funds are similar between different markets. This goes to show that it’s all about return vs risk: while leverage offers more potential return, it increases the risk in the same proportion, which makes it a meaningless factor to judge the results.
How much should you expect?
A realistic return for a solo trader is around 20-40%/year, on average. A trader can sometimes get 100%+ or more in a given year, but unless you are a full-time trading expert, you shouldn’t expect to get this type of returns on average. And if you think about it for a moment, even if you start with a small amount, with a 20-40% return per year, you can build a small fortune after a few years. This is because of the compounding effect.
The image below shows, using this calculator, how you can easily simulate how much will your account grow in the future.
For example, starting with $5000, and with a 40% return per year, your account will be worth $35.000 in 5 years, for a total return of 700%!
Now let’s assume that you even start with a more modest bankroll, such as $500, and you add $200 each month, with a 30% annual return. After 5 years, your account would be $30.000! Add more years and more money into the equation, and you can see how the compounding effect makes good traders become rich, even without having absurd yearly returns.
Taking a Look at a Scenario…
Now that you know how much is possible to get, on average, let’s take a look at a simple example.
Assume a scenario in which a trader has a $1,000 account and an average win-rate of 50%. An acceptable risk per trade is usually between 2-5% of your account in one trade. In this case, this trader would risk a maximum of $30 per trade. A 1.2:1 risk/reward ratio means the trader would place the target price at 1.2x the distance from the entry price of the stop-loss. If the stop-loss is placed 5 pips below the entry price, the target price has to be placed 6 pips above the entry price. This assures winners will be bigger than losers since the reward on each trade is 1.2 times greater than the risk.
With a limit of 2% per trade, this trader will only risk a maximum of 20$ per trade. This means he will lose $20 each time prices hit the Stop-Loss. On the other hand, he wins $24 if prices hit the Take-Profit.
Without commissions, growth profit would be $60 per month.
This is a 6% rate in a month, which can be considered very good. If we take into account compounding, a 6% rate per month means a 100% return per year! Of course, this is not a completely realistic return, as this example didn’t take into spreads and variability in each trade’s outcome. However, it gives an idea of the importance of having a higher risk/reward ratio. By doing this, any trader can aspire to have an expected return of 2-3 digits per year.
What Does It Take To Get Good Results In Forex Trading?
We’ve seen already how much is on the line if you have a good strategy. But what do you need to be successful in this game and achieve higher results? We consider these 4 points to be fundamental:
- Good market knowledge: It is essential to know how prices and volumes work, as well as which are the different players and what relations exist between markets. This will allow you to always be conscious of everything that’s happening around you and make you open the right positions.
- Have a probabilistic mindset: Trading is an unknown activity when it comes to the future. You can have several months with bad results but that doesn’t mean your strategy is failing. You need to keep developing your strategy to achieve better results in the future.
- Don’t think of trading like gambling: Forex is a business like any other. If you make good investments, you should expect a good return. If your attitude towards trading is to gamble like in a casino, the chances are, that you’ll end up blowing up your account!
- Consistency: Once you develop a good strategy, take advantage of it to be consistent with your results. A good strategy enables to achieve consistent returns over time.
The Bottom Line
Wrong expectations about returns usually lead to taking a lot of risks, which translates into a higher probability of losing the whole account. All traders, especially beginners, should be aware of how much they can get and what are their limitations. A trader who claims to have returns of 300%+/year on a consistent basis by trading Forex can only be a genius or a liar, and there are very few geniuses! The very best traders who are able to have outstanding returns for a long period of time usually have returns that don’t even match 100% per year.
The final takeaway is on the importance of establishing a strategy with a higher risk/reward ratio. A higher ratio allows you to lose more trades than you win and still earn money. This will give you an advantage over time.
Volumes are one of the most important aspects to look for in trading, even though it’s one of the most overlooked ones. Most traders don’t use volume, and most of the ones who do, don’t know all the ways volumes can help them. Volumes can tell you what you can’t find in prices, such as the relative number of traders that are selling or buying. In this article, we will see what differences between volumes exist and how volume trading can help you in better understanding market trends.
What Are The Differences Between Volumes?
There are two main types of trading volumes: trade volume and tick volume. But what are the differences between them?
This is the most common type of volumes. It is widely used to refer to the total amount contracts/shares traded in a given period.
Volume tells investors about the market’s activity and liquidity. Higher trade volume means higher liquidity, which leads to a better order execution.
In the Forex market, as it is a decentralized market, it’s impossible to keep track of the size and amount of all contracts traded in a given period. In this sense, as an alternative to trade volume, traders look for tick volume. Tick volume is the number of price changes in a time interval. The main difference is that tick volumes represent how many times the price changed in a given period, and not the real bid/ask volume. We assume that, if prices change 100 times in only 5 minutes, there’s higher activity than if prices only change 50 times.
In decentralized markets like Forex, tick volumes act as a good proxy for the real amount traded. Usually, the most price changes in a given period, the larger the number of transactions that exist. This would imply a higher volume. We made a study on the relationship between volumes vs. tick volumes, and turns out they are quite closely correlated. Check more here.
What Information Do Volumes Give Us?
Volume trading is a strategy that can be very useful since volumes can lead or confirm major price movements. Before opening a position, you may want to look at trading volume to see where the money is flowing to. Volume levels can also help traders decide what are the best times for a making a transaction.
High volume during a large price movement may signal the strength of the trend. Volumes may act as a leading or a laggard indicator. When there’s high supply volume during an uptrend or high demand volume during a downtrend, this may signal a trend reversal before the reversal actually occurs. On the other hand, high volume can also show strength and confirms price movements – it’s all about the context.
Volumes usually indicate what large traders are doing, namely if they are buying or selling. Large traders, as explained in this article, are the ones capable of moving prices. Therefore, the best is to be on their side and benefit from their actions. By looking at volumes alongside price action, you can identify if there’s higher demand or supply at certain points.
Volumes also allow identifying key levels of accumulation and distribution and congestion zones. These are zones where there are a lot of demand and supply and traders may face above-normal resistance. Price By Volume Indicator, which we explain below, can help traders looking for these key levels
How to Use Volume in Trading?
1. Trend Reversion
Many times we see volume spikes preceding price. A decreasing volume in an uptrend is usually a sign that it may be coming to a reversal. Traders should wait for a confirmation of prices to close positions or go short.
In the chart below you can observe how major moves in prices or price reversions were always accompanied by volumes higher than normal. An analysis of volume in this situation would help traders identify these movements of prices.
2. High volume with little price movement
This is another pattern that usually shows in the market when there is professional distribution going on. This action means that even though there is buying pressure from weak or hedging traders, there are professional traders selling, and thus they keep the price in a tight range. Many great bull markets in history ended up with this kind of pattern, which is most reliable when the market is at new highs.
3. Confirmation of a price movement
A rising market usually sees rising volume. Higher volume is a sign that the trend is healthy and likely to continue. Increasing price and decreasing volume shows a lack of interest and may warn a potential reversal. Traders may use this information to decide if they are going to open a position during an uptrend or if they prefer to wait given the low levels of volume.
Strong volume confirms a successful breakout. If the breakout occurs under high volume, this is a confirmation that traders are bullish/bearish and the price movement is likely to continue. If the breakout happens under low volume, this may signal a lack of interest and a higher probability of being a false breakout. Before opening a position, traders should look to volumes to understand if the breakout will be successful or if the buying/selling pressure is not strong enough.
Price By Volume
Trade volumes appear at the bottom of the chart. However, Price By Volume (PBV), also called Market Profile, is an indicator plotted on the vertical axis. The indicator shows how much is the trading volume in a certain price range. This information helps traders understanding where are the major congestion zones, as well as resistances/supports. This indicator is mostly useful in very short-term time frames, such as 1 minute. We already wrote an explanative article about this indicator, which you can read here.
The chart below shows the price ranges with higher volume. Traders should expect some resistance/support or congestion areas near these levels.
You can download this indicator here.
Go Further with VSA
These are only some well-known indicators used in volume trading. However, they do not give you important information like if there’s buying or selling pressure. By looking only at these indicators, you only have an idea of generic levels to pay attention to. A complete volume spread analysis implies looking at demand/supply patterns, to identify the best time to buy and sell. By knowing if there are many traders selling/buying, you can anticipate important price movements.
The Bottom Line
Volume is a powerful tool to analyze the market and predict where prices are likely to go. Traders should use volumes to see what large traders are doing and follow their lead since that usually is where the money goes. However, volume only provides insights and traders should not use it right away as trade signals. Prices ultimately confirm what volumes already said and vice-versa. Traders should always wait for a price/volume confirmation and only then open positions.
“Should I trade Forex?” This is a question a lot of traders may have already asked themselves. Although there’s no right answer, there are many pros and cons to bear in mind. In this article, we are going to talk about benefits and disadvantages of trading. You can find which are the main advantages of turning Forex trading a source of income and the drawbacks of doing it.
Choose when to trade
It’s you who decide when to enter and exit the market. This is an important advantage since you can choose to trade only when the odds are in your favor. When the market is too volatile and there is a lot of uncertainty about the future, you can simply withdraw from trading. Besides, if you trade during your free time, you can easily adapt to changes in your working hours. Since Forex market is open 24 hours during weekdays, you can trade even if the trading session from your region is already closed or didn’t open yet.
No need to rely on someone else
A major advantage of trading for a living instead of having a usual job position is that you don’t need to rely on another’s work to perform well. Many times, you may find yourself dependent on what your colleagues do and that may lower your performance. In trading, you are only dependent on yourself. You can easily create your own strategy and test in your own way. Of course, you can and should share your thoughts with other traders to exchange points of view. However, ultimately, you can always disagree with what others say and do it your own way.
You don’t have a boss
Besides not having to rely on what others do, you also don’t need to answer to anyone. Have you already thought about not having to listen to your boss asking what you have already done? What about your annoying colleague which is always telling you to do things differently? With trading, all these problems disappear. Suddenly, you’re on your own. You trade when you want in the way you want and no one will control your actions. There’s a feeling of freedom which cannot be found in a regular job.
The fact that there’s no such thing as an “authority” also means there’s no outside pressure. We all know how stressful it can be to always have your colleagues or your boss pressuring you to perform better. Fortunately, none of these happen in trading. The only pressure that exists is the one you put on yourself.
Market and trading opportunities will always be there
There are more than 100 pairs which you can trade 24h a day. Opportunities will always exist independently of the trading session. You can choose the session you prefer to trade in and be sure there’ll be a chance to make money. Besides, you will always have a second chance. If you have a bad trade or miss a good trading opportunity, the market will provide you another chance to perform better. If you have a bad day, the market will always be there tomorrow and opportunities will come for you to recover.
Entry cost is low
All you need to trade is a small amount of money and to open an account in a bank or brokerage house. You may have to pay a small execution fee and the spread but no more than that. This is a great advantage of forex trading over stock trading since commissions are usually higher when trading stocks. Besides, commissions are not fixed like in stocks and futures. As commissions are in percentage, this does not negatively impact accounts with a small capital.
There is of course expensive equipment and software that you can buy to help you in trading. However, it’s possible to trade using simple strategies and achieve good results without a significant investment.
Access to free information
In stocks and futures, where exchanges are centralized and controlled by big companies, you’ll have to pay for any extra you may need. Whether you need intraday data, fundamental news, depth of market, in other markets, it always comes with an associated cost. But in Forex, you can easily have free access to this kind of data in any timeframe, for the last dozens of years. The main problem is not accessing information, but filtering what’s important or not.
This easy access to a lot of information is also relevant if you want to test a strategy. Some platforms like Metatrader offer you a tester in which you can backtest a new strategy and see what are the results.
We already discussed some major advantages of Forex trading. However, there are also some major cons for you to keep in mind.
There’s no fixed salary
One of them is not earning a fixed income per month. The money you earn will depend solely on your performance during that month. This means you can earn a lot in one month, not earn nothing at all or even lose money. If you prefer to earn a fixed income in spite of how well you perform, it may be better to not depend only on trading to pay your bills!
It’s a risky activity
The market is constantly changing, and your performance will depend directly on how well you adapt to this changes. So, if you’re risk averse, trading may not be right activity for you. You need to be constantly attentive to what’s happening in the market to not be caught off guard. It’s very important to know how to deal with uncertainty and be able to manage your account having that into consideration. Improving your knowledge by knowing what are the Intermarket relationships or what money management strategies exist to protect your capital can help you to overcome this problem.
It can become stressful
The amount of uncertainty and the pace at which prices change may become very stressful. It’s very important to keep calm even when the market is going against you, otherwise, you may end up taking wrong decisions. Being able to withstand high levels of stress is one of the major requirements to be a successful trader.
This may be particularly evident in scalping. Since scalpers try to get profit from small changes in prices, they need to act really fast to catch the beginning of the movement. This may become very stressful since they need to be very attentive to open and exit their positions really fast.
The Bottom Line
Overall, it will always come down to your own personality and interests. If you’re the kind of person which can handle stress easily and even like a bit of uncertainty, maybe Forex trading is the right activity for you. If you’re tired of your job, you may even think about trading for a living, if you’ve been consistently successful in the past.
However, if you prefer not to be dependent on uncertainty and like to be sure that you’ll have a fixed amount of income at the end of the month, maybe trading is not for you, at least for a living. You may want to trade more conservatively in your free time. This way, you can do something you like without being too exposed.
In yesterday’s post, we analyzed 3 pairs that could be headed to take a hit: USD/CHF, EUR/GBP, EUR/JPY. However, both EUR/GBP and EUR/JPY dried up on volumes, and they didn’t reach the target levels. The confirmation as a break of a low volume bar / SR level is especially important when the background is neutral/adverse.
In USD/CHF, we were looking for a possible LONG position reaching the trendline/support at 0.969.
In the chart we can see that there were low volumes near the support, giving a confirmation for a LONG trade during the London session. And why? This is because there is plenty of buying at this level, so any low volume bar is showing lack of supply in a critical zone.
As the New York trading session closes, we found 3 potential trading opportunities to follow and possibly trade during the Tokyo session or tomorrow’s London. These opportunities are in USD/CHF, EUR/GBP, and EUR/JPY. Below you can check the current market background, short-term trend and nearest supports/resistances for each pair. As always, we are using VSA, and associated indicators, for a supply/demand view of the market.
Read the 25/May Update here: https://www.analyticaltrader.com/market-update-final-remark-on-ny-closing-session/
Short-term trend: Down
This is a pair to observe in case it rebounds after touching the upwards trendline. The market is currently in a downward sloping trend with low volume, showing a lack of supply to further continue the trend. If the trend rebounds and breaks the previous bar high near the 0.9705 level on high volume, we may be heading for a rally in the late Tokyo/early London session. Traders should look for low volume near the trendline and a fast price movement as prices break the already mentioned level.
Short-term trend: Down
In this case, we see a short-term uptrend that seems now to be starting a reversion. There were already many weak VSA signals in the current and above timeframes and the trend is now down. If it breaks the most recent trendline, may look for a SHORT position on high volume showing strong supply. This may constitute a good trading opportunity to open a short position since there is no strong support nearby.
Short-term trend: Down
EUR/JPY may be a good trading opportunity even before the opening of the Tokyo Session. The trend failed to break the near resistance and bounced back. We’re now at a crucial zone where the market has been trading sideways. If prices continue the downward trend, there may be room for a SHORT position with a take-profit near the mid-term support. There has been distribution recently and the high volume bar denotes supply near the resistance
Volume spread analysis is a school of thought that believes volume plays a crucial role in understanding moves of prices in financial markets. This text will highlight 5 core arguments that solidify this basic premise.
1- Technical analysis is not enough.
An argument in favor of technical analysis is the idea that the securities’ prices may not be linked to their fundamentals. The behavior of financial markets is frequently a result of momentum, confidence, and sentiment. In this sense, traders analyze security price chart to know what is the upside and downside potential.
However, reading the market solely from prices is insufficient. Markets move on supply and demand, and so, volumes are also an important part of the equation.
Volume Spread Analysis is a good way to understand how the concepts of supply and demand influence prices. It allows spotting imbalances between buyers and sellers by looking at prices and volumes.
VSA helps traders understand what the major players are doing and benefit from their actions. When a small trader buys or sells a pair, he/she certainly will not influence the price. However, when a big bank trades millions of a certain currency, this will probably move the market up or down. Usually, these big traders have more information and knowledge about the markets, so it is wise to be on their side. Through volume analysis, traders can know if market makers are buying or selling and take advantage of their positions.
2- It’s all about perceived value.
Fundamental analysis states that we can always grasp the intrinsic value of a financial instrument – stocks, currencies, commodities, etc. An assessment of the economy would allow traders to explain oscillations in prices.
On the contrary, volume-based traders say that to fully know what goes on in the markets, we should rely on perceived values instead of intrinsic value. And what does perceived value mean? This is how different professional traders view a financial instrument. And this is always contextual and acquired through an analysis of volume.
Below you can find the evolution of the price to book value since 2000 of the S&P 500. This metric is considered an approximation of the perceived value. It’s possible to see how traders permanently evaluate companies above their book value, taking in mind other analysis besides the fundamental one.
3- Price and volume are inter-related.
Past prices are an important aspect to understand moves in financial markets. However, the analysis of price is not enough.
A lot of technical analysis theories say we can solely rely on the analysis of price to understand the next move. These can take the form of different theories: Dow theory, Elliot wave theory, harmonic theory, candle-based trade, etc. The bottom line for all these traders is that everything is reflected in prices and different patterns.
Volume spread analysts say that the analysis of price is incomplete. We need to understand where the money is and where it will be in the future. Only then we can try to predict what is going to happen in the markets.
4- The cause of moves is volume.
We already dismissed fundamental and technical analysis as the sole explanations for moves in financial markets. Now, let’s look at how volume spread analysts justify these moves.
In their opinion, we need to look at prices in relation to volume. It is only this interconnection between price action and volume that justifies moves in financial markets.
In the chart below you can observe how major moves in prices or price reversions were always accompanied by volumes higher than normal. An analysis of volume in this situation would help traders identify these movements of prices.
5 – It’s all about understanding the role of different traders in the market.
The 5th core idea is that different kinds of traders carry different sorts of information – and we can base our trading strategy on this idea.
Volume spread analysis tends to emphasize three different types of traders: retail, commercial and professional. Retail traders are those who have small accounts and tend to trade erratically. They do not have any particular trading strategy and traditionally tend to buy and sell when the uptrend/downtrend is exhausted.
Commercial traders are investment banks whose function is to place orders in the market to satisfy clients’ needs. They can also function as market makers. These traders have an impact because they often carry large orders, which usually cause volatility. However, they don’t have any strong rationale supporting their trading decisions.
Professional traders are large traders that are in the game to win, and they are behind most trends. These are the types of traders that volume spread analysis tends to be concerned with – the successful volume trader is the one that detects what these traders are doing.
The following chart illustrates the power of large traders in moving the markets. On the left side, large traders reduced their positions, which caused a downside movement in prices. Prices traded sideways while these traders had stable positions and, when they started buying, prices moved upside. A small trader aware of what large traders were doing could follow their steps and take advantage of this information.
The ultimate goal in trading is to have the highest return for the minimum level of risk. Money management is the calculation of risk and reward in any trade, to maximize efficiency. In this article, we explain why money management in Forex trading is truly important to improve your results and what strategies you can adopt. Find out why it’s important to know your risk profile and how you can manage risk vs reward accordingly.
Money Management – The Basics
Every trader is different. As such, the way different traders manage their accounts will vary a lot. However, independently of the type of trader, there are some common principles of money management in Forex trading that apply in every situation.
- Determine how risky is the trade – This one is especially important for risk-averse traders, but also apply to others. Before opening a position, you should always evaluate what are the risks involved. You don’t want to lose all your account in just one trade, so always evaluate the worst case scenario first. There are some trades which are simply not worth the risk since the expected return is relatively low. These trades should be avoided.
- Determine how much risk are you willing to take – Once you assessed the risks of the trade, it’s time to decide if you are willing to take that risk. Some traders prefer to take larger risks in exchange for a higher return. Others prefer to have smaller but safer profits. Understand what type of trader you are, and develop a strategy according to that.
- Check the relation between risk and reward – Finally, after deciding if you are willing or not to bear a higher risk, you should see what’s the expected return for that level of risk. It’s not worth it to trade a pair which has the same reward as another pair but is riskier. Always choose the trade that offers the best risk-reward relationship.
Many traders fail because they do not create a strategy according to their risk profile. When a risk-averse trader tries to use a more aggressive strategy, he will probably let his emotions control his actions. As explained in our article about trader’s mentality, this is because some traders are less willing to bear major drawdowns. They will probably end up closing their positions at the wrong time, which will make the strategy ineffective.
According to your risk profile, you should set up a maximum amount to each trade. In order to protect your capital, it’s highly recommended not to use more than 5% of your account in one single trade. This simple rule can be very helpful in case the trade goes against you. By risking only a maximum of 5%, you can be sure you’re not going to blow off your account in one single trade. Although the 5% is a standard measure, some traders may find it better to establish a lower percentage, like 1% or 2%, which is also fine.
To calculate these values, you can use the FXPro’s calculator. In Stop Loss Take Profit Amount, you can select the pair you want to trade and place the respective levels of Stop-Loss and Take-Profit. The calculator will automatically give you the Drawdown and the Profit according to the lot size.
Managing Risk and Reward
As already mentioned, an efficient trade is the one that maximizes reward to a certain level of risk. But how can you do this? In fact, there are some strategies worth noting to manage risk against reward.
This is a widely known and used ratio to evaluate the relationship between the risk of a trade and its expected return. If you’re trading a pair which is at 0.9 and you place a stop-loss in 0.85, you’re risking 0.05. On the other hand, if you believe the pair is going to 1, your expected return would be 0.1. In this case, the risk/reward ratio is 0.05:0.1 = 1:2. This means that you can make a profit even if just you win more than 33% of the times!
Define your stop-loss before opening a position
Stop-losses are important to set a limit to your losses. The location of your stop-loss may vary according to the amount you’re willing to lose if the trade goes wrong. However, there are some simple techniques to define its location. Generally, stop-losses should be placed a little bit under the closer support. This will guarantee that it will only be triggered if there’s a breakout. If the trend touches the support and rebound, you will benefit from this reversion. You can also know more about the support/resistances indicator here and download it here.
As mentioned above, it’s recommended to define a stop-loss before opening a position. However, to protect your capital while the trade is open, move the Stop-Loss as the trade goes on. If you already have a profit from an open trade, don’t risk to lose it all if the trend reverses. As the trend goes up, establish new SL levels closer to the current price, below the most recent short-term support. In this way, you won’t lose everything in case there is an abrupt reversion.
The Bottom Line
Any successful trader should be aware of how money management in Forex trading is essential to get better results. Traders should know what is their risk profile and define a strategy according to it. Compare the risk of a trade against the return to check its efficiency and guarantee the best reward. Ratios like the Risk/Reward are very useful to do this, as well as defining a Stop-Loss and move it during the trade.
The NFP is due in some hours, and we found 3 potential trading opportunities before and after the release, in NZD/USD, GBP/USD and USD/JPY. Below you can check the current market background, short-term trend and nearest supports/resistances for each pair. As always, we are using VSA, and associated indicators, for a supply/demand view of the market.
Short-term trend: Down
NZD/USD may be a solid trading opportunity for a late Tokyo Session or early London. We’re approaching a major news announcement and, if NZD/USD retraces after the announcement, it may be a good buying opportunity near the long-term support at 0.68500. If prices touch the resistance and bounce back, traders may open a long position, which will be reinforced in case there are demand signals. Low volume bars during a downtrend near a resistance may also anticipate a trend reversion.
Short-term trend: Neutral
In this case, we see a long-term downtrend and prices near the upper bound. After the news, in the case of GBP/USD appreciates and touches the trendline, it may be a good opportunity to short. This is because there was distribution before, and if NFP doesn’t change things radically, it could give a shot to trade GBP/USD.
Short-term trend: Up
There are no supports, neither resistances nearby. However, we saw an uptrend that was broken with high volumes during the US session. News about US employment are due in a few hours and it will bring some volatility. In case prices approach the trend line from below, it may become a short opportunity. Look for low volume bars approaching the trendline.
The NFP will dictate what happens next, but by being alert to what’s happening now, we can better plan our trades.