Why Forex trading psychology is so important

If you have traded the Forex market for any amount of time you have probably realized that it’s a very psychologically intense profession. Meaning, your mental state and your ability to control it, are of paramount importance to succeed long-term in the markets. Many traders come into the market “running and gunning” without giving a second thought to how their psychology might affect their trading or how they can effectively manage their mindset as they trade. However, the reality of the situation is that unless and until you decide to attain the proper Forex trading psychology, you will never succeed long-term in the markets.

• Money management directly affects Forex trading psychology

Perhaps the most significant factor that affects your Forex trading psychology is your forex money management plan, or lack thereof. Traders who don’t manage their money properly, inherently induce an improper trading mindset because they become too attached to any one trade. When you mismanage you’re trading account money by risking too much per trade or by over-trading, you are simultaneously assigning too much importance to each trade, and this causes you to become frustrated and emotional. Once you become emotional there is no telling what you might do; enter numerous trades for no reason, add on positions to your current trade for no reason, or even go “all in” with your trading account. The point is that it’s a very slippery slope that leads to full-blown emotional trading when you don’t manage your money properly. So, the most important way to manage your forex trading psychology is to manage your money correctly on EVERY single trade.

• Planning your trades

Another very important part of attaining and maintaining the proper Forex trading psychology, is having a comprehensive Forex trading plan. You need to know what you are going to do in the markets before you do it. Otherwise, you are basically going into “battle” with no war plan, and this is just a very silly thing to do. Just like in real war, you cannot know “for sure” what the enemy is going to do, and so the only thing you can do is control yourself as good as possible by pre-planning all aspects of your trading, most traders don’t do this, so if you are one of the few who do, you will likely be one of the few who does not trade emotionally and thus makes money in the end.

• Tracking your trades

The next thing you need to do in order to properly manage your emotions as you trade the market, is properly track your trades in a trading journal. No matter what forex strategy you are using, proper tracking of trades is of paramount importance to your long-term success. The reason why, is because you need to be able to see via tangible evidence how you are doing as a trader. If you are trading in a disciplined and controlled manner, your trading journal will reflect this, and the fact that you have physical evidence of it will cause you to want to continue to trade disciplined. If you are trading undisciplined, you will also be able to see this via your trading plan; this will then (hopefully) cause you to want to change your trading habits to become a more consistent trader.

Different Forex money management strategies:

• Percent R model –

The percent risk (R) model says that traders should risk a fixed percentage of their trading account on every trade they take. The theory behind this risk management model is that when a trader hits a losing period they will be trading a smaller position size since their percent risk will now be smaller in dollar terms, thus theoretically helping to limit their losses. When their account increases in value they will risk a larger dollar amount since the fixed percent risk of their account will now be larger.

In theory this model sounds pretty good. However, what many people don’t tell you about the percent R model is this; after a series of losing trades it is going to take you a very long time just to get back to your previous account balance since you will be trading a smaller position size each time you lose. What this means for most traders is a cycle of over-trading, because after a large drawdown they are stuck trading a much smaller position size and it thus takes them a long time to get back to where they were.

Most traders become frustrated once they realize they are trading much smaller position sizes after a series of losers and just end up over-trading to try and “make back” the money they lost. So, essentially, the theory behind trading a lower position size as a percentage of your account after a drawdown doesn’t really hold up if you end up over-trading anyways, and most traders who submit to the percent R model end up over-trading after losing periods.

Also, if you follow the percent R model, after a series of losers if you starting winning again, you will actually be significantly limiting your gains because your percent R is now a much smaller dollar amount than it was before. So, the problem with this forex money management model is that it can subtly induce over-trading and it also limits your winning trades after drawdown periods. On the positive side, if you can actually follow this model, it will work to limit your losses in periods of losing trades, but you must then be OK with trading a much smaller position size when you start winning again, and this can sometimes be quite frustrating and keep you stuck in perpetual cycle of over-trading.

• Dollar R model –

In the dollar risk (R) model, traders risk a set dollar amount on each trade rather than risking a percentage of their account on each trade. This dollar amount depends on your personal risk tolerance as well as your overall financial situation. Most traders who follow the dollar R model will aim to keep their trading account balance near the same level most of the time by withdrawing profits each month.

One of the advantages of the dollar R model is that after a series of losers you are not trading a drastically smaller position size, so when you start winning again it will not take you very long to get your trading account back up to where it was previously. The flip side of this is that you have to be very careful to not over-trade, because you can easily blow out your trading account if you are trading too much and risking a set dollar amount.

Indeed, the fixed dollar R model is for traders who have a firm handle on their trading mindset and discipline. Traders who have truly mastered their forex strategy know exactly what they are looking for in the market, so they never fear losing the money they have at risk because they know they are just executing their pre-defined trading edge. You will first have to learn some effective forex strategies and really master them, then you’ll have to make sure you have enough discipline and fortitude to not over trade, when you reach this point you will want to employ the dollar R forex money management model.

What are the major categories of Forex trading strategies? What are the differences between them and which ones are effective and which ones aren’t? This Forex trading lesson will cover these topics and hopefully give you some solid insight so that you can choose the best Forex strategy for you.

• Forex trading strategies based on indicators

Many traders use indicators to analyze price movement in the Forex market. Forex indicators seem to be favorite tools of beginning traders especially. While indicators can be useful, for the most part they are simply distractions that cover up the most important data of a market; it’s price movement.

Certainly, moving averages have their rightful place among useful Forex indicators; they are good trend analysis tools and they also help identify support and resistance levels. But, most of the other indicators out there are simply showing overbought or oversold conditions. The problem with this is that it means by their very nature most Forex trading indicators are simply top and bottom-picking tools. This creates a natural tendency for beginning traders to try picking tops and bottoms rather than learning to trade with trend. So, while there are some good indicators out there like moving averages, many of them are simply confusing tools that actually make trading more difficult.

• Forex trading strategies based on software systems

There are a lot of trading software systems and Forex robots out there on the market right now that make pretty big claims. While some of these may indeed be worth-while trading edges, the problem with them is that they don’t teach traders to actually read a price chart and trade for themselves. You really don’t want to start thinking that your trading system is the “holy grail”, and many of these forex trading robots imply this, whether indirectly or directly.

• Forex trading strategies based on reading “raw” price charts

Learning to read and trade off of a “raw” price chart, without indicators or trading software, is another trading strategy that many traders employ. Unlike the other two categories of trading strategies, trading off of a raw price chart seems to have very little downside or negative effects. Some traders like to combine price chart reading skills with indicators. This is fine to do as long as you don’t let the indicators take precedence over the price movement. The opinion of this website is that learning to read a price chart and the natural price action that occurs on it should be the corner stone of any traders’ trading toolbox. Even if you choose to trade based off indicators or trading systems, knowing how to read the natural price movement of a market is only going to help.

• Conclusion

Whatever Forex trading strategy you ultimately decide to use should be one that fits with your personality and daily schedule. Some traders are more geared towards using indicators or trading software while others are more geared towards learning classic technical analysis techniques. Whatever you decide to do just make sure you manage your risk properly and that you have a solid understanding of the underlying price dynamics of the Forex market.

The best forex strategies are obviously going to be ones that are truly effective; that actually provide you with a high-probability trading edge in the market. This edge should be something that can be used in any market condition; trending, consolidating, quiet or volatile. The problem with most mechanical trading systems or strategies is that they simply do not provide you with the flexibility and adaptability required to trade the ebbs and flows of the Forex currency market. So, what you want to look for is a trading strategy that gives you a clear and definable trading edge, but this trading edge also should not be too rigid; it should be useful in any market condition. One of the best Forex trading strategies that meets this requirement is price action trading.

Next, the best Forex strategies are ones that are not too complicated. The Forex market is all about price, so adding too many bells and whistles over top of the natural price action on a price chart, can actually work against you by over complicating the process of analyzing and trading the market. The Forex market provides you with all the data you need to analyze it, you just have to learn how to read it. Traders who choose to try and learn to trade based off indicators and trading “robots” are really doing themselves a big disservice because they are not learning how to trade off price. Trading off price movement alone is the most uncomplicated way you can trade, and it also will make any other Forex strategy or system you choose to use much more effective.

Finally, beginning Forex traders often fall prey to scammers and good internet marketers who want them to pay thousands of dollars for a piece of trading software or some indicator-based trading system. Keep in mind, there is some very good free Forex trading information on the internet that you can learn from to get the basics down. Make sure that if you decide to purchase a trading course or any Forex trading education product, that it is actually teaching you an effective trading method. You don’t want to spend money on basic Forex information (this info is widely available for free). Ideally, you want to learn from an experienced Forex trader who is teaching people the same Forex strategies that he or she uses themselves. Learning to trade effective Forex strategies that are not complicated and not too expensive, from an experienced trader,  is the best way to learn how to trade.

Do you want to improve your Forex trading right now? I’m sure you do if you are reading this, or you are at least interested in Forex trading, either way this is an excellent article for you to tread. I am going to talk about two things you can do to improve your trading immediately. These are “real” and practical Forex trading tips that you can implement right away. Ready? Ok, here we go…

• Only trade with money you can afford to lose

This one seems obvious I know. But, you would be surprised how many beginning and aspiring Forex traders do not trade ONLY with money they can TRULY afford to lose. The reason why this is so important may seem obvious; you don’t want to lose money that you actually NEED for any other life purposes. BUT, there is another more subtle reason why only trading with money you can truly afford to lose is so vitally important to long-term trading success…

That reason is that when you trade with money that you should not be trading with, it sets off all kinds of emotional reactions in your mind that otherwise would not be there. For example, you are very likely to get too attached to every single trade if you are trading with money you should not be trading with. This is going to cause you to over-analyze your trades and market variables, which will inevitably result in you “meddling” with your trades and messing them up. So, if you want to obtain and maintain the proper Forex trading mindset, you REALLY need to make sure you are only trading with TRULY disposable income.

• Stop over trading and over leveraging

Over trading and over leveraging are the “evil twins” of all trading mistakes. If you commit these two trading mistakes even on an irregular basis, you are probably not going to survive in the markets very long. A related note to point number one above is that if you trade with money you should not be trading with, you are a lot more likely to over trade or over leverage your trading account, because you will feel pressure to succeed due to the stronger emotional attachment to your money.

The main insights into over trading and over leveraging that I can give to you are these: Over trading is usually a result of jumping back into the market after a losing or winning trade. Losing trades tend to make you want to “ make back” the lost money, and winning trades tend to give you a sense of over-confidence which causes you to jump back in to try and make even more money, this is greed. So, we can see that over trading is a result of improper emotional control in the markets. So, you’ll have to devise away to stay objective and calm even after winning and losing trades; if you don’t you will lose money, period. One good way to help keep your emotions in check is to keep a Forex trading journal.

Over leveraging, or over risking, is equally as dangerous as over trading. The main insight into over leveraging that I can give you is that it usually happens for the same reasons discussed for over trading, but there is another one as well… Forex traders tend to over leverage when they become too confident in their Forex trading strategy; they think they have spotted a trade setup that just looks so “perfect” that they cannot resist “loading up” on it. It only takes one of these “perfect” setups that you have “loaded up” on going against you to kick off an avalanche of trading mistakes that can destroy your trading account faster than you think.

Click the following link for more information on How to Improve Your Forex Trading

• The REAL value of simplicity…

While it IS true that you really must understand how to manage your Forex trades properly, there is real value in trading with simple Forex trading strategies. One of the best ways to trade is to simply strip your chart of all unnecessary and confusing lagging indicators. Learn to tread the natural price action that occurs on your chart, unencumbered by foggy over-lays that are simply one more variable open to interpretation. There is real truth in the “less is more” mentality as it applies to Forex trading. Obviously, you must acquire a certain level of trading skill and knowledge, but there is a point where you can actually hurt your trading results by being too involved.

What many traders who get caught up with looking at and interpreting lagging indicators fail to realize, is that indicators are just another representation of price movement, albeit in a more vague and mysterious format than just plain old price action. So, by learning to trade with simple price action Forex trading strategies, the aspiring trader can forego all the confusion and over complicatedness of lagging indicators, trading software, and the like. Also, price action trading lends itself much more easily to managing trades successfully. Meaning, it’s a lot easier to manage your trades when you aren’t trying to decipher eight million colors and lines all strewn about on your price chart.

• Forex trade management is key…

The key ingredient to long-term Forex trading success is proper management of your trades. Most traders end up “screwing up” their trades by meddling in them after they are live. This means, they do things to their trades out of emotional impulse instead of pre-planned logic. The most effective and practical way to overcome this problem of trade over-involvement, is to simply pre plan as much of your trade as possible. In this way, you are basically pre-managing your trade, BEFORE it goes live, rather than trying to micro-manage it on a whim as the market action is unfolding. So, the most important aspect to successful Forex trade management is simply to do as much of your planning as possible before you are in the market. This is the best way to avoid the emotional trading errors that plague so many traders.

There are some common characteristics that any worth-while Forex trading education will possess. Some of these include the following:

• The best forex trading education will teach a truly effective Forex trading strategy that has worked for many traders in the past. There is no sense in trying to “reinvent the wheel” when it comes to trading, go with what works, don’t guess or fall prey to the latest Forex trading “robot”

• Forex trading education should come from a source that is trusted and respected and that clearly knows what they are talking about. You don’t want to learn from a source that you cannot identify or that seems “shady”. A good clue to whether or not a source is genuine is if they offer any quality free information and email support, if they do provide these services it probably means they are willing to stand behind their trading education.

• There is no need for a quality Forex education to cost thousands of dollars or be overly-complicated. The best trading educations are typically concise yet comprehensive, and not too expensive.

• Make sure the particular trading strategies being taught are of interest to you, because you don’t want to try and learn a trading strategy that you don’t enjoy or that seems unnecessarily difficult to implement or understand.

The importance of obtaining a proper Forex trading education can really not be stressed enough. It is very surprising how many traders think they can succeed in the markets without building a proper foundation of Forex trading knowledge. Everyone knows that making money on a consistent basis in the markets is not easy to do; therefore it only makes sense that you need to be properly trained if you want to get your trading career started on the right track. In every other profession in life we need training and education prior to excelling at it, and this principle applies equally to trading the forex markets; you need proper training.

It’s important to learn profitable Forex trading strategies because there are many trading strategies and systems floating around the internet that are just scams. Trading software “robots” and indicator-based trading systems typically do not work nearly as well as they are advertised and are almost always way over-priced. It’s much better to learn how to fish for yourself in the markets rather than blindly eating a fish someone else caught for you. In other words, you need to obtain a quality Forex trading education because you aren’t going to learn anything of value by blindly entering spoon-fed trading signals with no theory behind them.

Trading is often perceived as complex, and as a result many traders look for complex Forex trading strategies, when in reality they are simply over-complicating something that really can and should be quite simple. Professional traders know that profiting with simple trading strategies is the best way to trade the market because they have long since figured out that complicated trading strategies simply make it more difficult to profit in the market.

Simple Forex trading strategies include things like price action trading and other basic or “classic” technical analysis methods. These methods have been around since financial markets began for a reason; they work. However, no trading strategy will work without the proper amount of discipline to control one’s emotions and manage one’s risk in the market. It is discipline that tends to separate winning traders from losing traders, not the particular trading strategy being employed. For this reason, it is wise to trade with simple Forex strategies; because they help keep your trading screen and your mind clean from confusion and clutter, thus helping to foster the correct market mindset.

Through the proper use of risk reward and money management, a trader can make money in the market with a very simple trading strategy. Thus, it is mainly the money and trade management aspects of trading that determine whether or not a trader is profitable, not so much the particular trading strategy being used. This is where many aspiring FX traders get into trouble; they concentrate too much of their time and energy on finding the fanciest looking and sounding trading system or strategy, instead of mastering their own emotions and learning to be disciplined.

What aspiring Forex traders really need to realize is that they need to develop a way of thinking about the market instead of employing some mechanical trading system. The primary reason why mechanical systems don’t work is because traders end up relying too much on the system and not enough on managing their risk and emotions. Mechanical systems simply give entry and exit points, you still must control how many lots you trade, and you can always over-ride the system, so they really don’t teach traders how to think about the market in a way that allows them to make sense of all market conditions and think in terms of risk to reward per trade setup.

The trick is to develop a simple concept to trade the market with a high probability edge; your Forex strategy needs to be simple, flexible, and effective. It does not need to be complicated, expensive, or difficult to implement, instead you want to learn how to think about the market in a way that gives you a perspective which allows you to spot high probability entries in any market condition. Most mechanical trading systems only work for a little while in one market condition, but since markets constantly ebb and flow and change from trending to consolidating, volatile to calm, you need a trading strategy that will give you the ability to adapt yet not confuse you in the process.

So, if this is the case, then a logical question to ask is what Forex pairs to trade? The answer is that you should stick to the “majors”, these are the currency pairs of the world’s biggest economies; the U.S. dollar, the euro, the British pound, the Australian dollar, the New Zealand dollar, the Canadian dollar, the Japanese yen, the Swiss franc, and the Chinese Yuan, although currently China does not “float” their currency on the international exchange, meaning they artificially control it, so you can’t really trade it.

When learning to trade the Forex market you need to stick to the major currency pairs, trade your Forex strategies on these pairs before you attempt to trade any of the “crosses” or “exotics”. The primary reasons for sticking to the majors are that they offer better liquidity and lower spreads; they also have more stable trends. So, no matter what Forex trading strategy you are trading with, you will be doing yourself a big favor by learning to “master” it on the major Forex currency pairs before you try trading any other instruments.

You may also want to follow gold and silver as you track the major currency pairs. Gold and silver are considered to be international currencies because they are precious metals and are considered safe-havens in times of economic turmoil. They are also commodities and have an influence on the value of the U.S. dollar, which is the most widely traded currency of them all.

Most importantly, make sure you know the best Forex pairs to trade your Forex strategy on before you begin demo or live trading. Don’t make the mistake of trying to trade pairs with wide spreads or poor liquidity, many aspiring traders make these mistakes and they are very simple to avoid. Check out more of the articles on this website to learn more of the basics of Forex trading.

Higher time frames are inherently more reliable and easier to trade than their lower time frame counter parts. This is because the higher up in time frame you go the more the random “market noise” of the lower time frames is smoothed out and clarified. Think of the forex market like a giant puzzle, and the lower in time frame you go the more the pieces of the puzzle get scattered and moved around, making it harder to see the complete picture of what price is trying to tell you. As you move up in time frame the overall price “picture” becomes clearer and easier to trade. This means any forex strategies that you are trading on time frames under 1 hour, will be made more reliable and thus more accurate on the higher time frames. You will trade less often on the higher time frames, but this is a small price to pay for more consistent trading results and a smoother equity curve. Note; “higher time frames” are generally defined as the 4 hour chart and above.

• Obtain effective forex trading education

If you don’t know where you are going, how can you ever get to your destination? You need to actually obtain training and working knowledge of a specific forex trading strategy before you begin interacting with the market, whether it’s on a demo account or on a live account. Many traders begin trading with no real trading strategy education behind them; they basically are just trading randomly. You can put yourself ahead of all of these traders by obtaining quality forex trading education in a proven trading strategy and from a reputable and trusted source.

• Be realistic

This point might seem a little vague, but it is very important that you are realistic with yourself about all aspects of your forex trading. For example, if you are trading with $500 in your trading account, you simply cannot expect to make $2,000 a month. Many traders begin trading and they have unrealistic expectations about how much money they can make given the amount of money they have available to trade with. While it is possible to get lucky and hit a few big winners while you are over-leveraged, this habit will always come back to bite you many times harder than you expect. If you want to improve your forex trading right now, you need to pull your head out of the clouds and come back down to reality and realize that if you are effectively managing your risk on every single trade, you simply are not going to make a lot of money really fast unless you have a lot of money to start with.

• Eliminate emotion

Probably the most important thing you can do right now to instantly improve your forex trading is to make a conscious effort to eliminate emotional trading mistakes from interfering with your forex trading progress. There really is no simple way to do this; it takes mastery of your own mind in essence. One thing you can do is work on pre-defining every single interaction you have with the market, if you do this there will be no way you can operate from an emotional mindset, but you have to make sure that you actually follow through with your pre-defined trading interactions, and this can often be the toughest part. Make sure you are trading with forex strategies that give you a realistic chance at remaining calm and collected as you trade, this means using forex trading strategies that are simple yet effective.