Most people that take up trading Forex fail and lose money. Sad but true, which it pays to keep in mind, if you ask yourself “are there any good answers why most people fail?”. My job as a writer, as I see it, is to try to give you, the reader, some information which you can use to hopefully prevent yourself from becoming a long-term Forex loser. The most important information I can give you is whether market prices are predictable to some extent, and if so, what methods seem to have some predictive ability.
It’s a well-observed fact, with a lot of academic backing, that if the price of something is higher than it was a few months ago, statistics say the positive odds lie in betting on a continuing advance. This is an “edge” that can be exploited by even the newest traders with ease. The difficulty with this method lies in the fact that any mechanical strategy based on such “trend following” is bound to encounter long periods of loss. Additionally, Forex currency pairs tend to trend less strongly than stocks and commodities. So, it makes sense to ask, are there other, perhaps better “edges” which can be applied to Forex trading?
The answer I give is a cautious “yes”. Forex rates, most of the time, on shorter time frames, tend to revert to their average. This means that if yesterday the price went up, today the price is most likely to go down, in simple terms. However, making money out of this is not as simple as it sounds, as the expected profits are so small that they are more than covered by the cost of trading (spreads and/or commissions).
There is a way forward here – identify support and resistance levels where the price is more likely to reverse. These can be traded in two ways: either by placing limit orders at the levels and waiting for them to be hit, or by observing how the price behaves when one of these identified levels is touched, and entering a trade if the price reacts there in an encouraging way. This is the basis of my free daily signals and analysis on seven major Forex currency pairs published most days at Daily Forex.
Over coming days, I am going to be writing more about trading support and resistance. This is just an introduction, and I will conclude by saying that this method, if mastered, has two great advantages:
- It will get you an early entry with a tight stop loss, meaning good trades are likely to produce extremely good reward to risk ratios. This means that even if a large majority of your trades are losers, you can still make a very healthy profit if your winning trades are making gains of 500% or even 1000% of your risk.
- It can be used under all market conditions, provided it is adapted right. For example, a currency pair in a very strong bullish trend requires that you look for likely support levels only, and that you are more aggressive in determining probable support than you would be if the pair was ranging. If a currency pair is in a tight range, you look for reversals at either edge of the range, and keep conservative profit targets.
It is hard to do, but remember that the more regular you can make your profits, the better your final profit will be under sensible money management systems. More on this topic over the coming days!