Three Ways to Become a Better Trader

Talking Points:

• Traders should plan their approach, strategies, and risk management before ever placing a trade.
• Risk management protocols should be determined before the entry.
• Trading journals and logs can allow traders to track their progress more efficiently.

Trading isn’t easy… well, I should clarify that. Placing a trade is simple; it’s just a couple of clicks of the mouse and boom: You’re in the trade. But trading profitably isn’t easy, and for most of us that’s the sole and primary reason that we’re in markets in the first place.

In one of the greatest trading books ever penned, Market Wizards, Jack Schwager interviews one of the best traders (and deeper thinkers) of the modern era, Mr. Ed Seykota. In the interview, Seykota offers an eye-opening quote:

“Win or Lose, everybody gets what they want out of the market. Some people seem to like to lose, so they win by losing money.”

While it may initially sound difficult to imagine the trader that likes to lose, think about this for a moment. Trading can be fun, exciting, and potentially profitable; but rarely is it all three at once.

To prioritize profitability is to do all of the little things that so many new traders avoid doing, for whatever reason. In this article, we’re going to address the top three of these, along with showing you how to address each.

The Trading Plan

I’ll be the first to admit, creating a trading plan (and further forcing one’s self to adhere to said plan), is not an exercise in excitement. It’s boring, it can be frustrating, and retaining the discipline to actually adhere to the plan is not easy.

Most new traders will draw up a plan, only to discard it in the next couple of days because something about the plan ‘doesn’t feel right.’

Gut instincts and reactions are probably the most costly risks faced by traders. As humans, we’ve evolved to follow these instincts to keep us out of danger; but modern-day markets are not the Darwinian environment for which your survival instincts are honed. Quite frankly, markets can be dangerous but they’re far from predictable which is what can make reactions such a risky concept.

Think about this for a moment: Markets are unpredictable, and that much is a given. Any trade is, at-best, a simple hypothesis or a probability. How would your gut-instinct be able to predict the future or make any one trade more than a simple probability?

Traders need to build, and adhere to a well-thought out plan-of-attack when approaching a market. This functions like a trader’s constitution to ensure that any position taken on falls within a criteria with which the trader has decided they’d like to speculate. It also helps to eliminate the ‘gut instinct’ reactions that can inevitably cost the trader so much money.

Manage Your Risk Before Your Risk Manages You

The biggest disconnect for most new traders is the conceptualization of risk management. Most traders that come to markets think that you have to have amazingly high winning percentages to be a profitable trader.

This couldn’t be further from the truth.

Not only is having a high ‘hit rate (percentage of profitable trades v/s losing trades),’ difficult; given that markets are unpredictable it’s likely unsustainable.

This topic was investigated in-depth in the article series, The Traits of Successful Traders. In the research, The Number One Mistake Forex Traders Make was found to be inadequate risk-reward ratios. In many cases, such as GBPJPY in the below chart, traders were losing more than $2 on losing positions for every $1 generated on winning positions.

Taken from The Number One Mistake Forex Traders Make, by David Rodriguez

This type of money management is an exercise in futility. Traders would need to be right about 75% of the time to be able to squeak by with a profit; and even then – the risk of slippage or gaps can drain that minimal profit to give the 75% hit rate trader a negative profit line.

Sure, it feels good to close a winning position; even if it’s a small win. But just as Ed Seykota said in The Market Wizards interview: Everybody in markets gets what they want.

If you want to feel good, ok – taking small wins might help you accomplish that.

But if you want to work towards profitability, you’d likely be best suited to follow the advice of some of the best professional traders in the world; advice echoed in The Number One Mistake Forex Traders Make, and look to manage your risk before it manages you.

Traders should look for a minimum risk-reward ratio of 1:1; and are likely best suited looking for even more aggressive risk-reward ratios of 1-to-2 or better.

Track Your Results

An old quote from Yogi Berra goes like this: ‘You’ve got to be very careful if you don’t know where you’re going because you might not get there.’

Analyzing one’s progress when trading can be boiled down to a very simple denominator: How profitable have you been?

But to the trader that hasn’t yet been profitable, this can be extremely difficult to analyze because they don’t know the behaviors that are needed to find that profitability.

Keeping a trading journal, and a trading log can be hugely helpful in tracking that progress. It allows for the trader to utilize critical analysis to see what has, or hasn’t worked for them in the past.

In the journal, write down the ‘reason’ for taking each trade, along with your plan for that position. Where are you going to look to exit, or move your stop, or scale into or out-of the position.

When the trade closes, go back and note how the position performed.

The trading log is simpler, and can be done on any spreadsheet software. This is simply you marking each position taken along with initial risk amount, and profit targets; and when the trade closes record the gain or loss.

In time and with enough positions, this can allow you to calculate your winning percentage, you’re average size of win, and average size of loss along with a flurry of other statistical data points.

With this, you can then begin noticing trends or deficiencies that could amount to improvement in the trading plan.

In conclusion

All-in-all, the three things mentioned above aren’t necessarily fun. But – you have to decide why you’re in markets in the first place.

If you’re here to have fun, you should get comfortable with losing. But, if you want to be profitable, you have to prioritize what’s really important, and what should be secondary (like having fun).

In the long run, many professional traders have found being profitable (if not less exciting) is a heck of a lot more fun than continuing to lose money.

Oil: A Big Investment With Big Tax Breaks

When it comes to tax-advantaged investments for wealthy or sophisticated investors, one investment class continues to stand alone above all others: oil. With the U.S. government's backing, domestic energy production has created a litany of tax incentives for both investors and small producers.

Several major tax benefits are available for oil and gas investors that are found nowhere else in the tax code. Read on, as we cover the benefits of these investments and how you can use them to fire up your portfolio.

Striking Oil

The main benefits of investing in oil include:

• Intangible Drilling Costs: These include everything but the actual drilling equipment. Labor, chemicals, mud, grease and other miscellaneous items necessary for drilling are considered intangible. These expenses generally constitute 65-80% of the total cost of drilling a well and are 100% deductible in the year incurred. For example, if it costs 0,000 to drill a well, and if it was determined that 75% of that cost would be considered intangible, the investor would receive a current deduction of 5,000. Furthermore, it doesn't matter whether the well actually produces or even strikes oil. As long as it starts to operate by March 31 of the following year, the deductions will be allowed.

• Tangible Drilling Costs: Tangible costs pertain to the actual direct cost of the drilling equipment. These expenses are also 100% deductible but must be depreciated over seven years. Therefore, in the example above, the remaining ,000 could be written off according to a seven-year schedule.

• Active vs. Passive Income: The tax code specifies that a working interest (as opposed to a royalty interest) in an oil and gas well is not considered to be a passive activity. This means that all net losses are active income incurred in conjunction with well-head production and can be offset against other forms of income such as wages, interest and capital gains.

• Small Producer Tax Exemptions: This is perhaps the most enticing tax break for small producers and investors. This incentive, which is commonly known as the "depletion allowance," excludes from taxation 15% of all gross income from oil and gas wells. This special advantage is limited solely to small companies and investors. Any company that produces or refines more than 50,000 barrels of oil per day is ineligible. Entities that own more than 1,000 barrels of oil per day, or 6 million cubic feet of gas per day, are excluded as well.

• Lease Costs: These include the purchase of lease and mineral rights, lease operating costs and all administrative, legal and accounting expenses. These expenses are 100% deductible in the year they are incurred.

• Alternative Minimum Tax: All excess intangible drilling costs have been specifically exempted as a "preference item" on the alternative minimum tax return.

Developing Energy Infrastructure

This list of tax breaks effectively illustrates how serious the U.S. government is about developing the domestic energy infrastructure. Perhaps most telling is the fact that there are no income or net worth limitations of any kind for any of them other than what is listed above (i.e. the small producer limit). Therefore, even the wealthiest investors could invest directly in oil and gas and receive all of the benefits listed above, as long as they limit their ownership to 1,000 barrels of oil per day. No other investment category in America can compete with the smorgasbord of tax breaks that are available to the oil and gas industry.

Investment Options in Oil and Gas

Several different avenues are available for oil and gas investors. These can be broken down into four major categories: mutual funds, partnerships, royalty interests and working interests. Each has a different risk level and separate rules for taxation.

• Mutual Funds: While this investment method contains the least amount of risk for the investor, it also does not provide any of the tax benefits listed above. Investors will pay tax on all dividends and capital gains, just as they would with other funds.

• Partnerships: Several forms of partnerships can be used for oil and gas investments. Limited partnerships are the most common, as they limit the liability of the entire producing project to the amount of the partner's investment. These are sold as securities and must be registered with the Securities and Exchange Commission (SEC). The tax incentives listed above are available on a pass-through basis. The partner will receive a Form K-1 each year detailing his or her share of the revenue and expenses.

• Royalties: This is the compensation received by those who own the land where oil and gas wells are drilled. This income comes "off the top" of the gross revenue generated from the wells. Landowners typically receive anywhere from 12-20% of the gross production. (Obviously, owning land that contains oil and gas reserves can be extremely profitable.) Furthermore, landowners assume no liability of any kind relating to the leases or wells. However, landowners also are not eligible for any of the tax benefits enjoyed by those who own working or partnership interests. All royalty income is reportable on Schedule E of Form 1040.

• Working Interests: This is by far the riskiest and most involved way to participate in an oil and gas investment. All income received in this form is reportable on Schedule C of the 1040. Although it is considered self-employment income and is subject to self-employment tax, most investors who participate in this capacity already have incomes that exceed the taxable wage base for Social Security. Working interests are not considered to be securities and therefore require no license to sell. This type of arrangement is similar to a general partnership in that each participant has unlimited liability. Working interests can quite often be bought and sold by a gentleman's agreement.

Net Revenue Interest (NRI)

For any given project, regardless of how the income is ultimately distributed to the investors, production is broken down into gross and net revenue. Gross revenue is simply the number of barrels of oil or cubic feet of gas per day that are produced, while net revenue subtracts both the royalties paid to the landowners and the severance tax on minerals that is assessed by most states. The value of a royalty or working interest in a project is generally quantified as a multiple of the number of barrels of oil or cubic feet of gas produced each day. For example, if a project is producing 10 barrels of oil per day and the going market rate is $35,000 per barrel (this number varies constantly according to a variety of factors), then the wholesale cost of the project will be $350,000.

Now assume that the price of oil is $60 a barrel, severance taxes are 7.5% and the net revenue interest (the working interest percentage received after royalties have been paid) is 80%. The wells are currently pumping out 10 barrels of oil per day, which comes to $600 per day of gross production. Multiply this by 30 days (the number usually used to compute monthly production), and the project is posting gross revenue of $18,000 per month. Then, to compute net revenue, we subtract 20% of $18,000, which brings us to $14,400.

Then the severance tax is paid, which will be 7.5% of $14,400. (Landowners must pay this tax on their royalty income as well.) This brings the net revenue to about $13,320 per month, or about $159,840 per year. But all operating expenses plus any additional drilling costs must be paid out of this income as well. As a result, the project owner may only receive $125,000 in income from the project per year, assuming no new wells are drilled. Of course, if new wells are drilled, they will provide a substantial tax deduction plus (hopefully) additional production for the project.

The Bottom Line

From a tax perspective, oil and gas investments have never looked better. Of course, they are not suitable for everyone, as drilling for oil and gas can be a risky proposition. Therefore, the SEC requires that investors for many oil and gas partnerships be accredited, which means that they meet certain income and net worth requirements. But for those who qualify, participation in an independent oil and gas project can give them just what they're looking for.

14 Investing Ideas for 2014

So how can you invest in such uncertain times? Here 14 ideas from investment firms and advisors on what do in 2014.

1. Take a fresh look at income investments. After an exodus of more than $100 billion from bond funds so far this year, Robert Tipp, chief investment strategist of Prudential Fixed Income says, "People are giving up on a lot of potential income." That doesn't mean investors should jump back into long-term government bonds. But mutual funds made up of high-yield bonds can do well in a stronger economy. With rates still uncertain, most strategist advise staying in short- to medium-term bond funds (those that describe themselves as "low duration").

2. Make decisions that take new tax changes into account. 

The top tax rate has gone up to 39.6 percent on income. It kicks in on incomes above $400,000, and a new Medicare tax of 3.8 percent on investment income starts at the $200,000 level. "I don't think investors have fully absorbed these tax changes yet," says Vern Sumnicht of wealth advisory firm Sumnicht & Associates. Get professional advice on the complex tax code, Sumnicht says, but he warns: "Allocating investments purely for tax purposes is not the best economic idea unless you have a tax problem."

3. Prepare for a weaker dollar. The dollar has remained relatively stable this year, but the long-term downtrend might resume. Samson Capital's Lewis, a currency specialist, says 2014 will be a "weak dollar environment" due to a sluggish economy and still-low interest rates, which points to "commodity-friendly" investments and stocks of companies that earn income from abroad.

4. Rebalance in a way that reflects today's market. Maria Bruno, an investment analyst at the Vanguard Investment Strategy Group, says, "Rebalance your portfolio if you find your asset allocation has drifted by more than 5 percent." (Generally, it should be 60 percent stocks and 40 percent bonds, with a higher mix of equities the further you are from retirement.) With rates uncertain, "shorten the duration of the 40 percent bond portion," says Sam Stovall, chief equity strategist of S&P Capital IQ.

5. Make retirement account contributions as early in the new year as possible. Vanguard's Bruno says to do this "as early as possible in the year so you can start taking advantage of tax-advantaged growth." You can put up to $5,500, and $1,000 more if you are 50-plus as a "catch-up" contribution. (The deadline for the 2013 tax year is April 15.)

6. Try a seasonal approach. S&P Capital IQ's Stovall says using seasonal patterns can boost investing gains. The November to April period is stronger than May through October. "It doesn't mean 'go away in May,' as some people say," Stovall explains. The stock strategy: Be more aggressive in winter and spring with consumer discretionaries, industrials and materials. Get defensive in summer and fall with pharmaceuticals and consumer staples. Over the long term, the strategy has produced double the returns of the Standard & Poor's 500 index (6.7 percent vs. 13 percent since 1945).

7. Consider the global economy when you diversify.

"By not investing globally, you're missing out on an important diversification opportunity," Vanguard's Bruno says. Samson Capital's Lewis says it's especially important at a time when U.S. budget woes threaten a debt downgrade. Try to "diversify into strong balance-sheet nations with good governance," he says.

8. Look for good global brands that may be undervalued. Markets in Europe and Japan leaped over the past year amid signs of economic recovery. To find value, says Bill Mann, chief investment officer of Motley Fool Asset Management, seek "powerful global brands that have very little exposure to the local economy." He cited shoe and apparel maker Adidas as relatively cheap based on earnings estimates. S&P Capital Reports data shows Adidas's earning growth is projected to be twice that of similarly priced Nike next year.

9. Take some profits.

 Following this year's boom, some of those big stock gains might be getting stretched. "It's not a popular view, but I think it might be a good time to raise some cash. Lots of highly speculative stocks have been getting bid up," Mann says. "Leave some powder dry." Also, remember that you can recognize a tax loss on a stock that is sagging and reinvest in it after 30 days "if you think you still want it for the long term," says Gary DuBoff, managing director of CBIZ MHM LLC.

10. Don't let inflation fears guide your entire strategy. People have been waiting for a long time for inflation to heat up, and it hasn't yet. Wealth advisor Sumnicht says he thinks a flare-up may come this year and advises investors to hold "at least a bit of gold, even if it's just 2 percent of your holdings to keep your foot in the door" via exchange-traded funds like the SPDR Gold Trust ETF.

11. Beat-up emerging markets are worth watching. Emerging markets have been beaten up while the rest of the developed world has experienced gains. Jason White, T. Rowe Price equity portfolio specialist, says emerging markets underperformed major markets by 25 percent over the past year. T. Rowe's view, according to a company report, is that emerging markets' "long-term growth story remains intact and that valuations are at their most attractive levels in years." A diversified fund is a way to get into this hard-to-invest-in sector, and only in limited quantity.

12. Look for success stories that have wheels.

Two big winners this year have been the airline and auto industries. But have they risen too much? No, says S&P Capital IQ. Because airlines slashed costs during the severe recession, even small traffic gains go right to the bottom line. The sector is "poised to benefit from increased air travel demand, both business and leisure," according to S&P Capital IQ. It cited Fidelity Select Air Transport Portfolio as its favorite airline/aerospace fund. The auto outlook is similar: Cost cuts and improved sales are boosting results. Zacks Investment Research still rates autos as one of its top sub-sectors, and sees it boosting fourth-quarter profit 25 percent. But Ford and GM still trade at below-market prices-to-earnings levels.

13. Buy large-cap stocks for their double value. "Tweak your allocation more to the large-cap side for next year," Sumnicht says. These companies have the potential to boost dividends if inflation grows and to lift foreign earnings if the dollar weakens. He likes large-cap funds SPDR Dividend Yield ETF and First Trust Value Line Dividend Portfolio Trust.

14. View volatility as an opportunity. There is one virtual certainty for 2014. "There will be volatility," Sumnicht says. "With the political situation of the debt ceiling coming back again. It's not likely to lead to a default. I'd use it as an opportunity to buy equities."

Testing a trading strategy with backtesting software

Backtesting 30 trades manually with a demo account can help you decide whether a strategy is worth pursuing. However, if you are looking to trade a new strategy over a much longer term, then you do not want to have to wait for months before you can make a decision on whether to use the strategy on a real money account.

Different ways of backtesting a trading strategy automatically

This is where backtesting a strategy using software helps. You can get an idea if the principles of the strategy hold up over a longer term much more quickly. You can do this in two ways: using backtesting software or using a robot.

Using backtesting software

You can use special backtesting software, such as FOREX TESTER, that allows you to test a strategy over a longer period of time, using real historical data. This type of software allows you to rewind the historical market data and trade through a number of days, weeks or months by speeding up the time.

To find out more on how to acquire this software, you can go to the following:

Using a robot

An alternative to using backtesting software is to use a robot or an Expert Advisor. The robot would go through the historical data at a fast pace and mimic the trades that you could have taken using the strategy, allowing you to see what your results would have been like.

Considerations to bear in mind

Whether you use backtesting software, such as FOREX TESTER, or you use a robot to test historical data, you must bear in mind that past performance is not indicative of future results.

When you are testing a strategy, you should not be trying to see how much percentage increase you can make on your account or how much money you could make. The simple fact is that you will never know what the markets will do and so from one month to the next you will not know what kind of performance you can achieve.

When you are backtesting a strategy, you are seeing if the principles of the strategy will work with certain assets or in certain market conditions.

If, for example, you are looking to test a strategy that captures part of a trend and successfully filters out trades in a ranging market, then by testing the strategy using software, it will allow you to see if the strategy actually manages to achieve this.

If the results turn out to be unprofitable, then you may want to consider ways to filter out unprofitable trades and reduce losses. If the results turn out to be profitable, then you may have a strategy that you can work with in a live market environment.

Avoid curve fitting

However you must bear in mind that you should never tweak your strategy to the point where you achieve maximum profitability. This is known as curve fitting and means that you have optimised your strategy to achieve the maximum performance possible based on what has happened in the past.

Past performance is not indicative of future results

This will not help you in the future, because the conditions in the past that gave you a substantial performance on your over-optimised strategy will change, even if slightly, and you will not achieve the same results.

You need to stick to making sure that the principles of the strategy work and look to optimise your strategy in a live environment based on current market conditions, not past market conditions.

Backtesting is not exact

You should also be aware that there are other practical factors that can affect you results. First of all, different brokers have different price feeds and spreads. Using different brokers to test a strategy may produce different results.

Practical application will be different to backtesting results

There is also a difference between practicing a trading strategy and applying it in a real environment. In a live environment you are more likely to succumb to emotional influences. You are also likely to make mistakes or react more slowly when you are actually trading a strategy. You should be cautious as you will most likely not be able to execute trades as consistently as a robot does, or as well as you do in a practice environment.

Large position sizes can can change results

When you have a small starting capital, you are limited in the amount of volume that you can trade. As your account size grows, you can trade with more volume and increase your risk to get larger returns.

However, when your account becomes very large, this can produce a unique set of problems. For a start, in certain markets where the liquidity is very thin, you can actually move the price of the asset simply by placing your order.

This may give you slower execution speeds or you may not be able to get the exact price that you want. Using backtesting software over historical data will not take these factors into account, whereas in a live environment, they will be inherently present.

Backtesting is a means of deciding whether a strategy is worth pursuing or not

On the whole, backtesting using software can be very useful. Although it cannot generate a concrete conclusion as to how much you can increase your account by, or how much you can make in the future, it can give you a good basis as to whether your strategy will work or not.

By testing your strategy out over a longer period of time, you get a larger sample size and this makes the testing environment more accurate, leaving you to feel confident that the underlying principles that you built a strategy on, hold up over a longer period of time.

How To Choose A Profitable Share Or Forex Currency

The decision to buy something is relatively easy.

What, specifically, to buy is an altogether different problem. Before you drive your new car home, you have to choose a certain make, a certain model, certain upholstery, a certain color scheme.

You decide between six cylinders and eight, between regular shift and automatic transmission, and say yes or no to white walls, radio, heater, and a dozen other optional extras.

So with securities. Although there are only two major categories-bonds and stocks-to select from, the variations and refinements and optional extras are as numerous as they are confusing.

For many investors, one factor may be sufficient reason to determine a choice. The man of modest means will very likely find corporate bonds at $1,000 apiece too steep and their 3 per cent interest payment too small for what he is trying to achieve.

A wealthier investor might be fascinated by the potential in common stock but find that he would obtain a greater yield from tax-exempt municipals. All investors, however, will do well to become familiar with the various kinds of securities represented in corporate capital structures in order to understand their effect on each other and their bearing on the choice he eventually makes for himself.

The corporation is an entity marvelously adapted to the requirements of all parties involved. It developed in response to the needs of the business community for funds over and beyond its own resources to enable it to build, expand, and grow.

The basic, one-celled form of business life is the individual entrepreneur-the store owner who merchandises goods, the artisan supplying services, the small manufacturer-whose capital needs are met out of savings or through a modest bank loan.

Somewhat more complex is the partnership, the pooling of the resources of several individuals to share in a joint venture. Presumably the credit of the group is somewhat stronger than that of the individual. The partners also assume responsibility for management of their company, participate in all profits accruing, and are legally liable for all debts outstanding.

As long as firms remain relatively small, either type of organization is adequate. As opportunities for expansion present themselves, however, when new plant and equipment are required, when greater amounts of raw materials must be stockpiled, and branch offices and distributors underwritten, and personnel increased, the individual and the partners are hard pressed. Their surplus generally is too small, their normal lines of credit too limited to do the job.

Enlargement of the partnership is no answer. Outside investors willing to take on the mutual responsibilities of partnership, or to immobilize their funds in a partnership agreement, are hard to come by. In any event, the range of financial needs at this stage usually is so great that only by increasing the partnership to ridiculous proportions could they be met.

The solution? A public stock corporation. Ownership thereby is spread among as many hundreds or thousands of people as are willing to buy in, their proportional part of the firm being represented by the amount of stock or number of shares they hold. Their reward is likewise a proportional share of their firm's profits.

Their control is exercised through the board of directors they elect. And because their stock is a standardized, known quantity-and because there are stock exchanges they can readily withdraw from the company and sell their piece of ownership to someone else.

The corporation, once established and in being, is an impersonal thing of indeterminate duration. Directors and officers may come and go, investors may buy in and sell out, but the corporation has a momentum and life force which may enable it to run on indefinitely.

With the Forex picking one currency against another is also similar, but you have the benefit of using Forex software to help you nowadays which can sometimes be downloaded free.

Three Strategies for Three Markets

Talking Points:

• Traders should look to employ a complete approach when trading in any market
• Traders should focus their strategies on appropriate market conditions
• In this blog, we give three strategies for the three most prominent conditions

Traders have an affinity for entering positions. After all, that’s what we as traders are here for, right? To place trades?

But with time and experience comes the realization that placing the right trades is much more important than placing just any trade. And this is because our failures in markets actually cost us money. As famed speculator Jesse Livermore said in Reminiscences of a Stock Operator:

“After spending many years in Wall Street and after making a losing millions of dollars I want to tell you this: It was never my thinking that made the big money for me. It was always my sitting.”

Livermore realized what many professionals operating today know: That the entry into the trade is but a small part of the overall approach. Often more important is focusing the strategy on the correct market condition, much like we looked at in the article series, How to Build a Trading Strategy.

More important than finding a set of indicators that might work together some of the time is focusing the right strategy on the right market, managing the risk, and further managing the trade efficiently, and maintaining a strong trading psychology. We talk about risk management and psychology heavily in the article, The Complete Trading Approach.

In this article, we’re going to look at the strategy itself; and rather than looking at or for something to be a ‘holy grail,’ we’re going to look at three different strategies for three different market conditions, so that when you identify a condition such as a trend, range, or breakout – you’ll have a strategy to address that specific market.

The importance of matching the strategy to the market environment

One of the biggest determinants of a strategies success is whether or not the strategy is being applied in the correct market. This was a key study undertaken as part of the DailyFX Traits of Successful Traders series. In the second part of the series, David Rodriguez looked at a very simple strategy usingRSI entries. David looked at long entries when RSI crossed 30 on the 15 minute chart, and short entries when RSI came down and through 70.

As you might imagine, the strategy didn’t fare too well (shown in red in the below graphic). He then applied a time-filter so that the RSI strategy could only trade in the Asian trading session; a time when range-bound market conditions can be predominant. This entirely changed the success of the strategy. The time-filtered RSI strategy is shown in gold below:

Focusing a strategy on the optimal market can make a world of difference

Taken from The Best Time of Day to Trade Forex, by David Rodriguez

This is but one example of the impact that can be had simply from focusing the strategy, even if it’s a very simple strategy using just RSI.

But we can extrapolate this to include numerous time frames, currency pairs, or asset classes.

Traders can look to whatever market they’re analyzing to attempt to identify the current market condition; and then look to implement the strategy that is most optimal for that condition. Below are strategies for each of the three major market conditions.

Trends

Of the three major market conditions, trends are probably the most attractive to the biggest number of traders. The reasons are logical; if there is a general bias on the chart, we can look to simply ‘buy low, and sell high.’

This allows the traders to enter with lower-risk amounts; and if that bias that’s been seen can continue, then the trader can be looking at a very strong risk-reward ratio. If the trend is strong enough, the trader might be able to hang in the position and get a far larger profit target than originally anticipated.

This strategy uses two very common indicators: A 200 period moving average, combined with MACD.

Traders can use the 200 period moving average as a filter to define the trend, so that if prices are above the moving average only long positions are entertained; and if prices are below the 200 period moving average, the trend is classified as being ‘down,’ and only short positions are entertained.

Once the trend has been identified, traders can then look for entries with the MACD indicator. This strategy uses slightly different inputs for MACD than standard default inputs; using 21 periods for the short-term EMA, 55 periods for the longer-term EMA, and the standard value of 9 for the signal line.

Traders simply want to look for MACD crosses over the signal line, in the direction of the trend. Traders can look to close the position on the counter-signal; so if price is above the 200 period MA, the long position can be closed when MACD crosses DOWN and UNDER the signal line.

Created with Marketscope/Trading Station II

Ranges

Range-bound markets are generally less attractive to FX traders, and there are a couple of reasons for it. The potential profit from such a market is often smaller than that of a strong trend, or a breakout. And the potential risk may be higher, because if a trader is in a range, and prices break in the wrong direction against them – the potential cost could be enormous.

But, just as we had seen in The Best Time of Day to Trade FX, range-bound markets can still be profitable environments for traders if approached correctly.

Traders approaching range-bound markets need to make sure that they are employing a complete approach, utilizing risk management for every entry that they’re taking.

But, just as we had done with the trend strategy, we can use indicators to isolate and concentrate on environments with which we want to look. We outlined this strategy in the article, When the Market Gives Ranges, Trade Ranges!

For this purpose, ADX of 13 periods can be of great help. The Average Directional Index can be a phenomenal tool for grading trend strength; or more to the point for our concerns: ADX can help traders see a LACK of a trend.

Traders can look for values below 35 on ADX to define a range-bound environment. If values are below 35, traders can look to trigger in to the range; but if ADX is above 35, the trend can be classified as ‘too strong’ for range-trading.

Taken from When the Market Gives Ranges, Trade Ranges!

Traders can look to exit positions with the counter signal from CCI, so that long positions are closed as short positions are initiated with crosses down and under +100 (assuming that ADX is still below 35 at the time).

Taken from When the Market Gives Ranges, Trade Ranges!

Risk management can be done in a variety of ways in this strategy. My personal preference is to integrate price action to find swing lows to place stops for long positions, and swing highs to place stops for short positions. This way, if the range is broken, I can get out as early as possible.

But traders can also look to indicators such as Average True Range to assist with setting stops in this strategy.

Breakouts

Breakouts are, hands down, the most dangerous market condition for traders to approach. Price can break quickly in both directions, for OR against the trader. False breakouts can be abundant, and then managing risk is even more daunting.

Traders should approach breakouts with a degree of caution, looking to be even more aggressive when they hit a move, because the odds of hitting a breakout will generally be smaller than that of a range or trend.

And because a breakout is, in essence, just the opposite of a range, we can even integrate some of the logic from our previous strategy to look for breakouts.

Traders can, once again, look to the ADX indicator to filter trade opportunities; and if ADX is below 35, traders can look for breakouts.

Breakout positions can be entered via entry orders placed at the upper, or lower 21 period price channels (often called ‘Donchian Channels’ after famed speculator Richard Donchian).

Breakouts can be complimented by Price Channels

Created with Marketscope/Trading Station II

Risk management can, once again, be undertaken in a variety of ways. My personal preference is to look at price action. Average True Range can be a phenomenal way of looking for indicator-based risk amounts.

Whatever manner you choose for setting stops with this, or any breakout strategy; traders are often best advised to look for a minimum 1-to-2 risk-to-reward ratio.

Money management – protecting your capital

Money management is a concept that protects your trading capital from losing trades and it is the most important skill for trading. This lesson will demonstrate the importance of applying prudent risk management to avoid large losses that can lead to you losing your entire trading account.

Money management preserves your trading capital
Money management, also called risk management, is a core concept that you should start with immediately when you begin to learn and it should be the very core focus throughout your trading career. It will allow you to deal with performance downturns and it will preserve your trading account during these times, enabling you to carry on trading.

The core principle of money management is that you should only ever risk a very small portion of the money that you have to trade with on any single trade.

Many professional traders do not advocate risking any more than 1% to 2% of an account on a single trade.

Limiting your risk per trade to a maximum of 1-2% of your whole account greatly reduces the effect of losing streaks, as you will preserve the majority of your trading account.

Risking only 1% on each trade means you can lose twenty trades in a row and still retain over 80% of your starting capital. If you were to risk 5% per trade, after twenty losing trades there would be less than 40% of your original starting capital left.

The table below shows you the effects of only risking 1% or less on each trade against risking 5%:

After losing twenty trades, the account is reduced to $16,523 after risking only 1% on each trade; risking 5%, the account balance is reduced to $7,547.

After twenty trades, by risking 5% on each trade, the trader now has to make over 100% of the account just to get back to the original starting capital.

Simply by adhering to risk management, an account can survive longer drawdown periods and still be able to trade.

The risk reward ratio ensure that you gain more than you lose

The risk to reward ratio is how much capital a trader is willing to risk in order to gain the potential reward on the trade. You can use either a monetary value or pip value when calculating the risk to reward.

For example, if you are risking $1 to potentially make $2, the reward is divided by the risk and so the risk to reward ratio is 1:2. If you are risking 30 pips on a trade and have a 300 pip profit target, the risk to reward ratio is 1:10.

When looking to take a trade, you should always make sure that your potential reward is larger than your potential loss.

The following chart shows you a real example of how this may look. The chart shows the stop loss, shown as 1, the entry, shown as 2 and the profit target shown as 3.

The distance between the stop loss and entry, shown as 4 is 40.4 pips away. The distance between the entry and the profit target, shown as 5 is 88 pips away. This means that the risk to reward is over 1:2 for this trade.

Know where your stop loss and profit target is before you trade

Any time you consider entering into a trade, you should not only have pre-determined where your entry will be, you should also have pre-determined where your stop loss and profit target will be.

Once you know where your stop loss and entry point is, you can calculate the risk and potential profit on the trade.

As a general rule of thumb, you should aim for a risk reward ratio of 1:2 or better. If you maintain a risk to reward ratio of 1:2 then you only need one-third of your the trades to win to remain break even.

The risk reward ratio is closely connected to the percentage of your trades that end up winning. The risk reward ratio itself does not automatically mean success. Even a risk reward ratio of 1:4 does not help you if less than 20% of your trades end with a profit. So the risk reward ratio has to be seen as an aspect of an overall trading strategy, and not in isolation.

A great way to improve your effective risk reward ratio is using trailing stops, as they will make sure that in many trades that end of losing, your are losing less than the amount originally set for your stop loss.

Forex Investing Strategies

Forex is one of those areas that most people feel is complicated. In reality, it's like many other form of investment, a little knowledge can be dangerous. The good news for people out there looking for forex investing strategies is that there are enough strategies out there to meet any type of investment goal. You can be a simple long term investor, or you can sit and watch the market every day looking for profit at every turn. As long as you want to learn forex trading, you can find a method that's right.

Easy Strategies

Daily or Weekly Trend Following

One strategy that is a simple forex trading system is following the daily or weekly trend. Review the daily and weekly charts and find a trend that seems well supported and get in. The one caveat about this particular type of trading is that you moves that look small on the chart can span 100's of pips. This means that you need to trade small. Use a conservative allocation when you buy in and allow your trade to develop a bit. Set a reasonable stop and plan out a target. Beginners find this strategy easy because they don't need to watch the market constantly, they can trade when they have time.

Carry Trading

Carry trading is when you buy and hold a currency that pays a high interest rate against a currency that has a low interest rate. Each day a rollover is paid for the interest difference between the two currencies. The advantage of this is that even when your trade is not moving, money is deposited into your account daily. Also, since most forex trades are leveraged, you get paid on the size of your trade, not just the size of your capital.

The downside to carry trading is that typically the interest differentials are not that much compared to how much risk you are taking. Also, currency pairs that are good for carry trading typically have a strong reaction to any news that presents risk to the global markets. In other words, as long as things are good, these pairs will rise and pay. If something goes wrong, sometimes unexpectedly, they will plunge very hard and very fast. If you are over leveraged, you can blow up your account in a blink.

More Complicated Strategies

Day Trading

The forex market is always moving. 24 hours a day, 6 days a week. Although the most active forex trading times are specific, the forex market is always moving at least a little. Depending on what you like to trade, you can really pick and choose your time.

Most day trading strategies revolve around forex technical analysis, which has it positive points. The market can be very technical and if you have a sharp eye and a plan, you can catch it and take some profit from it.

Fundamental Trading

Some investors have a more old fashioned approach to investment. They prefer to invest in something that they understand rather than looking for a signal on their chart. For this type of more cautious investor, fundamental forex trading works best. Fundamental trading is when you follow the news for a several countries and play the countries with strengthening economic trends, against the ones with weakening economic trends. This type of approach is pretty easy, because it looks at how things shape up over the long term. The complicated portion of it is learning to understand the economic reports and compare them to other countries.

While Forex trading can feel complicated, it's something that anyone with patience and the ability to learn from their mistakes can gain some skill at over time. It definitely takes some persistence. The system is designed in a way that frustrates most people. You need to step back, keep an eye on the big picture, and trade small, at least in the beginning. It's also smart to avoid those "100 percent accurate forex trading systems" on the internet until you have some experience under your belt.

Are You a Trader or Investor?

When you start investing in stocks, or anything investment-related (I am using this very generally as it can apply to anything from stocks to real estate) you first need to determine what your goal is. Are you looking specifically at investing for retirement or are you saving for your children’s college tuition? Or, are you trying to reach multiple goals? All of that needs to be looked at and considered before determining what your investment goal is. If you find yourself with multiple goals, one great way to attack this is to think of your investment portfolio as a pie which you can divide up into pieces. Then, you can assign those pieces to the specific goals you have, making it possible for you work towards achieving them. We have one part of our portfolio where I am heavily investing in stocks and trading more often, but also have a very large portion of our portfolio in more traditionalbuy and hold investing where we’re in index funds and a few solid dividend paying stocks that is geared towards our retirement planning. This requires a bit more work, but it works with our needs and goals. One big key is determining what your goals are and realizing that these goals will likely change over time. In fact, I can pretty much guarantee it in most cases. It is therefore very important to keep a somewhat active eye over your investments. That does not have to mean watching it daily, but it also does not mean buying and forgetting.

What is a Trader?

Now that we have addressed goals we can move on to the distinction between what constitutes a trader and an investor. Keep in mind that I am speaking generally here and am not intending to criticize one over another, just trying to give a basic description of each. That said, a stock trader is someone who is actively trading stocks on a regular basis. Whether they’re day trading a handful of stocks or dozens of stocks, their approach is much more short term in nature and they’re seeking to grow their investment portfolios by taking advantage of short term swings while holding stocks from as little as minutes at a time to maybe a day or so. They’re generally professional traders, or at the very least, someone who is somewhat well versed in regards to investing in stocks or options. Ultimately, a trader is someone who is much more speculative than the average retail investor and is much more comfortable with the inherent risk of being in the stock market. I will say that if you’re investing in stocks and wanting to be more of a trader, make sure you know what you’re getting yourself into to make sure it fits with your risk appetite, not to mention the costs associated with more regular stock trading.

What is an Investor?

If the stock trader is the hare, then an investor (generally speaking) is the tortoise in the stock market. Whereas the trader is looking at the short term view of things, the investor is keeping their eye towards the end result. They choose to view investing in stocks, or mutual funds/ETFs, as a marathon and not a sprint. They’re generally going to be someone who is closer to a buy and hold investor, or someone who is more apt to stay the course when it comes to their investments. Ultimately, an investor is someone who is going to look at the nuts and bolts of a company and stick with them, not being spooked because something changes, but will roll with the punches because they have a good feeling about the given investment choice they’ve made. Think of an investor as someone who is investing in stocks for retirement and actively adding to their positions on a regular basis while rebalancing their portfolios to best allocate their investments.

Investing in Stocks Takes Work, Regardless of Your Approach

My desire to not really paint one or the other in a bad light as they both have their shortcomings and benefits. Whichever you consider yourself, investing in stocks takes time and work – it just might look a little different depending on your approach. If you’re uncertain which camp you fit in to, then I encourage you to go back and analyze your goals, nail down what helps you sleep at night and determine what your knowledge level is. The sad fact is that too many retail investors fail to do any of this analysis, open a brokerage account and just blindly start investing in stocks on a whim. I spoke with too many investors to count on a daily basis who did not know which they were and unfortunately too many betrayed their ultimate goals as a result. I guess part of that goes back to not having a solid investment plan and allowing fear to be their guide when it comes to making investment decisions. I know that if you’re just starting out investing in stocks that it can be overwhelming to determine what you should do or where you should start and that is fine, though do not allow that to hold you back. Sit down and spend some time educating yourself on investing, determine what your goals are and determining if you’re more of an investor or trader. That time spent will serve you well as you start down the road of investing in stocks and will benefit you and your portfolio in the long run.