A few weeks ago we published parts one and two of a series of articles explaining how to give yourself a realistic chance of turning $10,000 into $1 million by trading Forex. Here I covered the topics of how long it might take, money management, trading strategies, back testing, forward testing, and identifying low risk entries. In this, the final part of the series, I am going to explain how to determine which currency pairs to trade, how to control overall risk, and outline some more advanced strategies for exiting trades. Careful study of all of the three parts of this series should give you the opportunity to build your own complete trading strategy that will give you a realistic change of turning $10,000.
How to Decide Which Currency Pairs to Trade
There are basically two approaches that can be taken in deciding which currency pairs to trade at any given time.
One approach is to build a diversified universe of currency pairs, and trade them all according to the entry and exit rules of your trading strategy. For example, you might take the seven major global currencies and put all of the possible 28 pairings as instruments in your universe. The major advantage of this is that you will be exposed to every good move in the market and well diversified. However, the major disadvantage is that you might be wasting your time trading currency pairs that are not really going anywhere. If you do take this approach, it could be wise to use stricter rules for trade entries, for example only trading in the direction of the trend. It is also a good idea to take measures that ensure you do not have too many trades open in highly correlated currency pairs at any given time. I address this issue below in How to Control Risk. Below is a sample equity curve achieved over the past 6 years by this type of strategy:
An alternative approach is to take the same diversified universe of currency pairs, but only trade the ones that have the strongest momentum. This is known as “best of” momentum. For example, assuming you take the universe of 28 currency pairs I mentioned above, you could check each weekend to see which 6 pairs have moved the most over the past 3 months, and only trade those pairs, and only in the direction of the trend. The major advantage of this is that you limit risk and most of the time end up trading only what is hot in the market. The major disadvantage is that you can end up for quite long periods entering too late in the moves to make any profit, while missing out on the starts of any new, sudden directional moves. Below is a sample equity curve achieved over the past 6 years by this type of strategy:
It is clear that in recent years, a “best of” strategy produced better risk-adjusted returns.
Something else that can be tried with “best of” momentum is being prepared to trade currency pairs just before and after any major news announcements are scheduled. For example, it might be that the Australian dollar is doing very little, but that tomorrow the Reserve Bank of Australia will be making its major monthly policy announcement. In this case, you could try to trade the AUD against the weakest and strongest currencies during a short time window around the announcement.
How to Control Risk
It is important not to have too many trades open at any one time, especially in currency pairs that are highly positively correlated, and especially if you are trading a universe of currency pairs without any kind of “best of” filtering. You should have maximum limits for: total number of trades open at any time, total number of long/short trades open in any particular currency, total number of long/short trades open in highly positively correlated currencies. For example, you might say no more than 12 trades open at any time, no more than 8 trades open in highly positively correlated currencies (e.g. NZD and AUD, or EUR and GBP), no more than 6 trades open in the same direction for any single currency. It might seem that these rules are restrictive, especially when there is a strong move, but these restrictions are beneficial to profits in the long-term. It is usually the case that the first entry signal you get turns out to be the best trade in any case. Do not forget that you can always close some of an existing trade that is in profit and open a trade in one of the later signals if you really want to. The important thing is to keep a limit on your risk.
There is an additional element to risk: the risk of a sudden huge movement in a currency, such as happened with the Swiss Franc in January 2015. Such events are rare, but in these events stop losses can be completely useless. As an additional precaution to control your overall risk, you should avoid trading any currencies that are subject to a peg against another currency imposed by their central bank.
Advanced Exit Strategies
Exits are very difficult to get right. In a sense there is no “right” exit as no matter how skilled a trader you are, you will usually not be able to exit a trade at exactly the right time.
One of the most robust exit strategies you can use is a combination of deciding a minimum profit target, and then watching the price action once the target is hit. After the target is hit, watch for a failure to make a new high (in a long trade) or low (in a short trade).
An example is shown in the chart below. Say a long trade is made where the up arrow is placed towards the left. A major high is made where “1st High” is marked. There is then a deep pull back, and then at around the area where “Failure” is marked, it is starting to look like the attempt to make another high has failed, so an exit could be considered here. It takes some practice to identify major highs and lows, so I recommend practicing this technique with historical unseen price charts.
Before I wish good luck to anyone who will be trying to turn $10,000 into $1 million, I will just remind you that your choice of broker is very important. You will need a well-regulated Forex broker that provides good execution, and competitive fees. Usually, a deposit of $10,000 should give you a wide range of choice and VIP service.
Good luck and happy trading!