How to trade in the financial markets, FXTM´s Thalassinos explains
- Written by Andreas Thalassinos, head of education at FXTM
It is widely known and well admitted by beginners and advanced traders alike that the existence of a sound trading system in a trader’s arsenal is imperative to trade the financial markets with potential success.
A sound trading system is not just any trading system but rather a trading system that has been tested thoroughly and capable of reaping gains out of the market while at the same time being designed to keep losses short.
Moreover, a sound trading system is based on trend, that is, a trend-following trading system. A trend-following system is preferred over other methodologies since a trend is more likely to continue in the prevailing direction rather than reverse. Furthermore, precise rules are needed to define the exact entry and exit of a trading position.
Many hours and days are spent on exploring the best entry point in the market. Beginners are prone to get carried away into a “non-ending” research in the pursuit of discovering the “holy grail” of entries!
Numerous indicators and oscillators are explored and combined to be examined under the traders’ microscope. The results are rather disappointing. In fact, trend-following traders’ goal is to identify a trend in its infant stage of development as early as possible.
As a matter of fact, traders require the necessary knowledge and practical experience to identify high-probability reversal patterns in a “blink of an eye”. These price formations are easily recognised and identified on the price charts. Namely, these are Head and Shoulders, Double Top, Triple Top and their corresponding inverses, that is inverse Head and Shoulders, Double Bottom, and Triple Bottom.
Of course, speaking of reversals is very important to stress the fact that the existence of a prevailing trend is imperative before traders start looking for any reversal in the market. This is a common trap to most beginners.
Protective Stop Loss
A sound trading system should always cater for protecting traders’ capital. An initial stop loss is a technical stop loss based on the corresponding reversal that triggered the entry into the market.
More precisely, a short entry into the market would require an initial stop loss at the top of the reversal pattern.
Whereas, a long entry into the market would require an initial stop loss at the bottom of the reversal pattern.
Needless to emphasize more the importance of stop loss. It is there to protect the trader form sudden and unexpected price movements.
It is the concept of profit that differentiates beginners from professionals. While beginners struggle to discover the “best” entry into the market, professionals pay closer attention to take-profit techniques.
Undoubtedly, the most generous take-profit technique is a reversal in the opposite direction. This will yield the maximum profits.
Once the reason for being in the market ceases to exist then any open position(s) is closed and potential profits are booked. But how often that set up may appear on the price chart? Unfortunately, not that often to justify its sole use. Consequently, another disadvantage of this technique is the big drawdown. This of course may also have possible side effects on traders’ psychology and discipline with disastrous outcomes.
Another take-profit technique, is trailing the stop loss as the market moves in the direction of the prevailing trend. Obviously, potential profits will be less than the previous technique but it will ensure less drawdown.
A similar technique is to set predefined take-profit levels and lock-in profits as they are reached. Predefined levels may be calculated by many ways one being the Fibonacci levels, that is 1.618, 2.618 and 4.236. These latter techniques will yield less profit but will ease the big drawdown which is so important to the traders’ psychology.
Combinations of the above would also be possible with unlimited permutations.
Trading the financial markets require a sound trading system based on trend with precise entry and exit rules. Stop-loss is imperative to protect the traders’ capital even though beginners find it difficult to accept losses.
The concept of take-profit is equally important to keep a manageable drawdown and peace of mind apart of the obvious goal of increasing one’s capital.
In contemporary markets where high volatility and unexpected price movements are not rare, a trading system that boasts higher percentage of wins over losses is preferred despite the smaller profits.
Preservation of capital is king. Tomorrow is another trading day!