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One of the great things about being a Power Course Instructor is that I get to work with people who are really making a commitment to improve as traders. They have tried trading in a demo account and perhaps even a live account and have not done well, so instead of continuing to use the same approach, they decide to ask us for help.
One of the things they really want to know is what the difference is between a new trader and a professional trader.
Our answer is this:
New traders think about how much money they can make while professional traders think about how much money they can lose.
Allow me to explain. We see many new traders pull up a 15-minute chart and see that the RSI is below 30 and starting to move up and they interpret that as a buy. So they buy the currency pair, but the market moves against them by 20 pips.
The market then moves up to where they have a 10 pip profit and they lock in before that winner turns into a loser.
Nobody ever lost money by taking profits right?
After three winners in a row the trader is up by 30 pips and feeling good about their new career as a trader.
That is until the fourth trade when the market moves down 20 pips, then another 20 pips, then as the market moves down another 10 pips, the trader finally exits with a loss of 50 pips.
So after four trades, the new trader has won three for a total profit of 30 pips and lost one trade of 50 pips for a total loss of 20 pips. Many new traders win 75% of their trades only to lose money doing it. This is not what we have in mind.
On the other hand, a professional trader may identify a trade in the direction of the trend as seen on the daily chart and then move down to the hourly chart to pinpoint their entry and exit.
The first thing they do after having identified their entry is to identify the price where they will place their initial protective stop in order to limit their losses.
Since they know how many pips they are willing to risk on the trade, they also know how many lots they can open to keep the total risk on the trade to 5% of their account balance.
They also know that in order to be profitable in the long run they have to make more when they are right than they lose when they are wrong, typically twice as much.
They may only win half of their trades, but also may average 50 pips on the losers and average 100 pips on winners. So after four trades, they lose two for a total of 100 pips and win two trades for a total of 200 pips for a total gain of 100 pips. That’s good trading.
This money management strategy is called a 1:2 risk:reward ratio and is what we in the Power Course recommend to new traders.
For every pip you are willing to risk, you should look for at least two pips in profit. How can we do that without having to watch the market constantly? The FX Trading Station has the tools for us. The example below is what the entry order system looks like when entering a market order.
We can see that we are going to buy the EUR/USD at the current buy side price of 1.3787. We also have placed our initial protective stop at 1.3737 for a risk of 50 pips. Our limit order to take profits is set at 1.3837, for a potential gain of 100 pips.
I have also used the Trailing Stop feature in this example and have set it at 50 pips. This means that if the market moves halfway to my target of 1.3837, which is 50 pips, my protective stop will also move up 50 pips, which is the level where I bought the pair.
Now I am in a position to either make money or break even on the trade.
Not a bad position to be in. So the new trader wins three out of four trades and losses money while the professional wins two out of four trades and makes money. Money management is the difference. |
