Many people begin trading Forex, stock, commodities or other instruments in the hope to make money and build capital by taking a reasonable risk. Very often they are disappointed with the results, and wonder why they cannot become a profitable Forex trader. However, it can be done, provided that you do some homework to build a good plan and stick to it. This can put the odds on your side. It requires patience and steady nerves above all else. In this article, I am going to explain what you need to consider in making a plan to turn an initial deposit of $10,000 into $1 million, and how to give yourself the best chance of achieving this goal. In short, how to become a profitable Forex trader.
How Long Does it Take to make $1 million?
The best place to start is with an understanding that you need to allow yourself a reasonable length of time to achieve your goal, and not just for the obvious reasons. For example, turning $10,000 into $1 million requires an overall increase of 9,900%, and that is leaving aside the entire issue of taxation of any gains. For any trader, achieving such an astronomical positive annual performance is a very tall order, but that is what you would have to do to reach $1 million within a single year. However if you allowed yourself 10 years, and compound every year, you would need to make “only” 58.49% each year. That is still very tough, but it is not a completely unrealistic annual return in terms of taking a reasonable risk. If you become a profitable Forex trader, it is possible to achieve an annual return in this area. The point to consider is that you need to allow enough time for your profits to compound and grow exponentially. Compounding is essential for exponential growth and this is something that needs to be factored into your trading strategy/ies, money management essentials, and risk management method.
The second time element which is less well understood derives from the fact that you cannot make a really huge gain in the market unless the conditions are very strongly in your favor. For example, if you are buying stocks, you are really going to need a big, strong bull market to come along, no matter how good your stock picking and market timing is. Now, the longer the time horizon you can allow yourself, the greater the chance there is that you will be in the market when the kind of conditions you need to make money will occur.
Money Management Essentials
In another article I outlined some money management essentials that every trader should consider, covering the very important question as to how to determine how much money you should risk on each trade. It is very important to take a reasonable risk. That article concluded that it is generally advisable to use a risk management method that risks a percentage of your equity per trade, primarily for the purpose of protecting against the risk of ruining your account. However, very aggressive account growth might require a more aggressive money management and risk management strategy, such as risking a fixed amount per trade regardless of recent results and your account equity. At periodic intervals when the account has significantly grown, the calculation can be rebased so that the amount risked rises. This may give the advantage of allowing a faster recovery from losing streaks, provided they have not been overly disastrous.
It is important to understand that your money management essentials must tie in with your trading strategy, especially its method of determining when to take profits.
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Excellent Trading Strategies
It is important that you use very robust trading strategies that can produce truly excellent results. Take a long-term view and don’t worry that there are going to be inevitable losses along the way. What you really need above everything else is a combination of something that produces small but fairly consistent profit, with something that will occasionally produce big winners. This is because you need to be exposed to “lumpy” profits but you need also to try to keep your equity curve from falling too steeply. This can best be achieved by trading a trend-following strategy and also a range-trading strategy.
If you are a very good discretionary trader and you can achieve this by making your own trading decisions, then go for it. Bear in mind though that in wealth-building, you want to use methods that are not too picky, as some regularity is important: pure candlestick trading might be inadequate. However there is no doubt that most traders, especially newer traders, are going to be better served by using a mechanical trading system or systems, and maybe using some discretion to pass on entries that fit the criteria but look really bad, or in deciding when to take profits.
A Trend Following Strategy’s Trade Entries
Some kind of trend-following element is essential for relatively easy but “lumpy” profits. The best way to determine which currency pairs are going to go up or down is by determining which have higher or lower prices than compared to both 1 month and 3 months ago. Here is a little secret: in recent years, the USD, and to a lesser extent the Euro, have trended more consistently and strongly than any other currency. This may be due to fundamentals, or alternatively it might be that the global reserve currencies have propensities to trend steadily.
Trading in the direction of the 3 month movement gives a winning profitable edge. Entries for such a strategy work best not as breakouts or pull-backs, but on pull-backs that have already begun to turn strongly back in the direction of the trend. Do not try to buy cheap or right at the new high, it is OK if the price is trending the same on all time frames from hourly and above.
For example, a strategy which would enter a long trade upon a crossover of a fast EMA past a slower SMA, while the price is above longer-term simple moving averages, all filtered by the price being above its levels from 1 months and 3 months ago, will produce an edge on all the major USD pairs over the past 15 years, with the exception of the USD/CHF pair.
Another possible additional filter is to use a “best of momentum” filter where you trade only those currency pairs that have moved the furthest over the past 3 months, say the top five or six currency pairs.
A Trend Following Strategy’s Stop Loss Levels
Stop losses are best placed as a function of volatility, i.e. as the average true range (ATR) of the last X days. The ATR of the past 20 days is commonly used. You may wish to use anything from half the ATR to 3 times the ATR (the latter is the classic amount). However for Forex, 3 times is probably too large to capture anything except the very largest trends. The ATR is probably a better measurement but whether you use half, one, one and a half or whatever, it all tends to even up over time. What is most important is to be consistent.
A Trend Following Strategy’s Take Profit / Trade Exit Methods
Take profit targets / trade exits are a more problematic subject. There are several alternatives:
Trailing stop losses / trailing take profit – read more.
Slowly moving up stop losses and letting all profitable trades be taken out by hitting stops eventually. Support or resistance levels may be used in a discretionary way, or the high / low of the past X days, for example. This can help let the big winners run without exiting prematurely.
Moving your stop loss to breakeven at a certain point. This can protect against unnecessary losses, but must be used with extreme care, as moving your stop loss to breakeven too quickly will lead to getting stopped out of big winners just before they get going. It is very common for the price to re-test a common entry zone before taking off. If you are going to move your stop loss to breakeven, it is better to either do so after a fixed period of time (not less than 48 hours), or after a certain amount of floating profit has been achieved.
Fixed profit targets by multiples of risk, usually with scaling out. For example, if you know that historically the positive expectancy of a trend-following strategy only begins at 3 units, you might decide to take partial profits at 3 units, following by more at 5, 10 or whatever.
Time-based exits can work surprisingly well, usually with scaling. For example, take partial profits at 1 month from entry, 3 months, 6 months etc. This can also help limit losses, where the price is below the entry level after 48 hours, but has not yet hit the stop.
Other Trend Trading Issues
You may want to have a maximum number of trades that may be open at any one time and in the same direction regarding any one currency. Although this may limit total overall profits, it can help you trade more profitably as:
When the market is flat, you won’t be opening new trades all the time when there are small whipsaws.
It limits the maximum possible amount you can lose in the event of a major market reversal and/or wild market conditions.
Trend Trading can be difficult psychologically because you have to be prepared to sit still and hope that winning trades grow and grow without panicking and taking profits too early. You also need to keep going through losing streaks, which might test your faith in your strategy.
A Range-Trading Strategy’s Trade Entries
A range-trading strategy is good for small but relatively consistent profits, hopefully going some way to smoothing out the losing streaks that trend-following strategies go through.
As it is known that the USD and EUR tend to trend, it is worth considering only trading this kind of strategy with non-USD and possibly also non-EUR currency crosses.
These currency crosses tend to range i.e. revert to the mean, especially on a weekly basis. Therefore a good entry signal might be given by a strong up or down week whose range is say at least 1.5 times greater than the average true range of the previous 4 weeks. There is an edge in trading the following week in the opposite direction.
Below is a sample long entry, showing an hourly chart where the 5 period EMA crosses above the 10 period SMA, while the price is above the 40, 240, and 1,200 period simple moving averages. Entry points are marked:
A Trend Following Strategy’s Stop Loss Levels
There are a few possibilities. First of all, you could just enter the trade at the beginning of the following week, with a stop loss of X times the 4 week ATR, or some other multiple. Alternatively, you could try to enter after overbought or oversold conditions reverse in the desired direction
A Trend Following Strategy’s Take Profit / Trade Exit Methods
Time-based exits tend to work best here. Just close any open position at the end of the week, as the strategy is based on weekly mean reversion.
You might want to add your own view on economic fundamentals as a filter, perhaps by slightly increasing the size of any trade entries that are in the same direction as your fundamental outlook. For example, it has been shown that currencies with higher interest rates tend to rise against currencies with lower interest rates, at least over the short-term.
Before you commit to a long-term wealth building strategy, make sure that you back test the strategy or strategies that you are planning to use. Take care not to assume that the past is going to be too similar to the future. The purpose of a back test is to give you an idea of the probabilities of various scenarios happening. For example if you back test 15 years of historical data, you can extract a few thousand hypothetical years of results from that, and see that you had X% change of making Y% profit or loss in an average year.
It is vital that you see what the worst results were over a long period of time. You can use this as a safety margin and plan how much you will risk per trade (your risk management method) based upon these statistics. You can also use it as a rough guide for what you can expect to go through in the future.
Make sure that you leave a recent year or two out of your back test. Then, finalize the strategy and “forward test” it on that year or two. If the results are wildly different from what your back test indicated, this suggests that your strategy is over-optimized.
This might seem like a lot of work, but if you are planning to make money and risk your savings, this might be the most important financial thing you ever do in your life. You will need to be sure that your trading plan works, otherwise you will risk giving up through self-doubt arising during losing streaks. In trading, it is the traders that do their homework that usually win in the end. You can do a lot of this testing with excel. It might be worth paying a computer programmer a few hundred dollars, if that is going to help you make a million in the long run!
You might ask, if it is possible to turn $10,000 into $1 million in 10 years, how about turning $1,000 into $1 million? This is sadly going too far, unless you use your judgement successfully at a really fantastic level, and are prepared to take extremely high levels of risk. Turning $1,000 into $1 million is practically unheard of. Jesse Livermore did achieve this feat in relative terms, turning 500 shares into something like $100 million in the 1920s. However it tends to be forgotten now that he went bankrupt several times in the process, and was only able to come back because of wealthy benefactors lending him money. So before you try to turn $1,000 into $1 million, consider whether anyone is going to give you another $1,000 when you blow your account!