As I read through chat forums full of Forex traders describing their trading methods, it strikes me that it is extremely common to attempt to gain control over the trading process by adopting targets for just about every variable. While this can be productive, it is also possible to be too rigid when trading Forex. In this article I am going to examine common trading areas to which targets are applied, and evaluate the pros and cons of each to help you create a more flexible trading strategy if desired.
Number of Trades
It is very common to hear traders say that they will cease trading after winning or losing a certain number of trades per day. Whether this makes sense (or not) depends largely upon what type of trading is being undertaken. If it is scalping or very short-term trading, then this is just a psychological defense mechanism that would probably only limit the profitability of an effective trader. However, for swing or more long-term traders, such a rule is probably helpful, because if the first two or three set-ups fail quickly, a winning set-up becomes increasingly unlikely to form. Additionally, if losing trades occur at the same price area, it is probably not going to be a fruitful area in the very near future.
Of course, psychological devices may protect against catastrophic losses, even if they are not valid statistically, and if a trader’s nerves are shot from losing a number of trades consecutively, it is probably a good idea for them to stop trading at least for the rest of that session, until the recover psychologically.
Stop Losses
I frequently hear traders say they used fixed stop losses of X number of pips, sometimes differentially defined between currency pairs, sometimes not. Although this can work, it is a mistake, as stop losses should be defined either by technical measurements or simply volatility, both of which will vary. For scalpers who usually use extremely tight stop losses this may not matter so much, but for longer-term traders it becomes increasingly crucial to get stop losses right. While I am on the subject, I will go on to say that in Forex, the objective of stop losses is not necessarily to be “right”, but to make sure that you capture the really strong winners as tightly as possible, even at the expense of losing a higher percentage of trades taken overall.
Profit Targets
Fixed profit targets can make sense as a sound trading method should produce a certain number of winning trades over time. The important thing is for the profit targets to be neither too small nor overly large. Something in the region of double or triple the risk of the trade (from entry point to stop loss) is usually a good rule of thumb. However, it can also make more sense to follow the rhythm of the market, and let trades that are doing very well continue to run, at least until they show signs of turning. A productive compromise might be to take profits when targets are reached very quickly, as such moves in Forex are often spikes which quickly retrace, but otherwise to implement a trailing stop - but only once the price is close to the target. It also makes sense for profit targets to be based upon volatility, for example, if a stop loss is about one average true range of whatever time period is being used, for the take profit to be two or three times the same amount respects the current volatility pattern of the market and instrument being traded.
Pips per Day / Week / Month
It is very common to hear traders say they plan to make X number of pips profit per day or week or month. This is one of the most foolish attitudes you can possibly take in trading, and it is ruthlessly exploited by scammers who promise all kinds of unrealistic targets. It is hard to know where to even begin in deconstructing this. Firstly, there are times where you might be able to make a thousand pips in a month, and then there are other times when even the most experienced and agile traders will struggle mightily just to avoid a loss. Secondly, a “pip” might be worth twice as much in one currency pair as another, not to mention different trades should have different sizes of stop losses, so units of risk is a meaningful measurement, while pips is not.
It really makes sense not to have profit targets. What makes the best sense is being positioned to take advantage of what the market has to offer, and this is best done by being prepared to have a losing week or month if necessary. There are few trading practices more foolish than chasing arbitrary targets little or no regard to market conditions.
Risk per Trade
Many traders have a rule whereby they risk the same percentage of their account equity on each trade. This is a very good rule and it makes sense. One variation is to risk a little less on trades that look less promising and a little more on trades that look more promising, but not by too much. A good rule is to make sure your risk per trade is never so large that you get upset if the trade turns out to be a loser, but not so small that you do not care at all what happens. This amount can vary a lot according to individual circumstances.
Trading Particular Currency Pairs
I sometimes hear traders say that they trade only one or two currency pairs such as EUR/USD and GBP/USD which tend to be particular favorites. It is true that every currency pair has its own peculiar tendencies, and it is also true that depending upon time zone limitations, it can make good sense to prefer to trade certain currencies that are most active at that time. However, it is foolish to limit yourself. For example a few years ago there was an incredibly strong multi-month movement in the USD/JPY pair. It was easy to make money longing that pair, so why restrict yourself? What if your favored pairs are hardly moving, would you want to just sit by the side?
Conclusion
It is usually counter-productive to limit yourself too much in trading Forex. Traders will usually find greater success by adapting to market conditions than by pursuing fixed targets, although as we have seen, there are exceptions. Beginners may need to restrict themselves more as they can find they are too inexperienced to manage flexibility appropriately. A good answer for most traders is to start carefully and slowly become more flexible as you go along.