fxcm-traits-of-successful-traders-guide

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fxcm-traits-of-successful-traders-guide

TRAITS OF SUCCESSFUL TRADERS:a four part guideResearch & Analysis: DailyFXIn the fall of 2011, the DailyFX research team and the DailyFX trading instructors closely studiedthe trading trends of FXCM clients, utilizing a full year of trade data from FXCM client accounts.They went through an enormous number of statistics and anonymized trading records in order toanswer one question:What separates successful traders from unsuccessful traders?With this unique resource, they were able to distill some of the “best practices” that profitableFXCM traders follow, such as the time of day they trade, the amount of leverage they use, thecurrency pairs they trade, and more. Those best practices are outlined for you here in this guide.We hope that this series will help you become a profitable trader.-FXCM Inc.


Table of Contents5566889101213Part One: What is the Number One Mistake Forex Traders Make?SummaryIntroductionWhat does the average forex trader do wrong?Cut your losses early, let your profits runHow to Do It: Follow one simple ruleStick to Your Plan: Use stops and limitsDoes this rule really work?Game planResources14141516171920Part Two: When is the Best Time of Day to Trade Forex?SummaryIntroductionDoes the time of day that I trade matter?What about other currency pairs?Game planResources2121222324Part Three: How to Trade the Majors During Active HoursSummaryIntroductionWhat strategy should I use to trade the US daytime?What is a breakout?2


2425272829How do you trade breakouts?Sample Strategy: Channel breakoutWhen should I look to trade breakouts?Game planResources3030313133343637Part Four: How Much Capital Do I Need to Trade Forex?SummaryIntroductionA likely culpritHow much “effective” leverage should I use?Adjusting “effective” leverage to suit your risk toleranceGame planResources3838383839393939404040AppendixAppendix 1.1Appendix 1.2Appendix 1.3Appendix 1.4Appendix 2.1Appendix 2.2Appendix 2.3Appendix 2.4Appendix 2.5Appendix 3.13


4141414142424242Appendix 3.2Appendix 3.3Appendix 3.4Appendix 3.5Appendix 3.6Appendix 4.1Appendix 4.2Appendix 4.34343434343DisclaimersHigh risk investment warningDailyFX Release of liabilityHypothetical performance and backtesting risksLeverage risk warning4


TRAITS OF SUCCESSFUL TRADERS: PART ONEWhat is the Number OneMistake Forex Traders Make?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Summary: Traders are right more than 50% of thetime, but lose more money on losing trades thanthey win on winning trades. Traders should usestops and limits to enforce a risk/reward ratio of 1:1or lower.5


TRAITS OF SUCCESSFUL TRADERS: PART ONEWhat is the Number One Mistake Forex Traders Make?Profitable Trades by Currency Pair80%70%60%50%49%54% 57% 58% 59% 59% 60% 60% 61% 61% 62% 64% 64% 66%71%40%30%0%NZD/USD EUR/GBP AUD/USD EUR/JPY USD/CAD GBP/USD GBP/JPYAUD/JPY USD/JPY EUR/USD USD/CHF EUR/AUD EUR/CHF GBP/CHF AUD/NZDCHART 1.1Percentage of trades that closed with a profitSource: Appendix 1.1INTRODUCTIONBig US Dollar moves against the Euro andother currencies have made forex tradingmore popular than ever, but the influx of newtraders has been matched by an outflow ofexisting traders.Why do major currency moves bringincreased trader losses? To find out, theDailyFX research team has looked throughamalgamated trading data on thousands ofFXCM live accounts. In this article, we lookat the biggest mistake that forex tradersmake, and a way to trade appropriately.WHAT DOES THE AVERAGE FOREX TRADERDO WRONG?Many forex traders have significant experiencetrading in other markets, and their technical andfundamental analysis is often quite good. Infact, in almost all of the most popular currencypairs that FXCM clients trade, traders arecorrect more than 50% of the time.6


TRAITS OF SUCCESSFUL TRADERS: PART ONEWhat is the Number One Mistake Forex Traders Make?The Importance of Money Management10K8K6KWithout stops/limitsWith stops/limits4K2K0-2KCHART 1.3Hypothetical returns* from a basic RSI strategy trading USD/CHF (12/14/01 - 03/27/11)Past performance is not indicative of future resultsSource: Appendix 1.3Many of the most successful forex traders areright about the market’s direction less thanhalf the time. Since they practice good moneymanagement, they cut their losses quicklyand let their profits run, so they are stillprofitable in their overall trading.DOES THIS RULE REALLY WORK?Absolutely. There is a reason why so manytraders advocate it. You can readily see thedifference in Chart 1.3.The 2 lines in the chart show the hypotheticalreturns from a basic RSI trading strategy onUSD/CHF using a 60 minute chart. Thissystem was developed to mimic the strategyfollowed by a very large number of FXCMclients, who tend to be range traders. Theblue line shows the “raw” returns, if we runthe system without any stops or limits. Thered line shows the results if we use stops andlimits. The improved results are plain to see.10


TRAITS OF SUCCESSFUL TRADERS: PART ONEWhat is the Number One Mistake Forex Traders Make?Our “raw” system follows FXCM clients inanother way – it has a high win percentage,but still loses more money on losing tradesthan it gains on winning ones. The “raw”system’s trades are profitable an impressive66% of the time during the test period, but itlost an average $165 on losing trades, whileonly making an average $98 on winningtrades.For our stop and limit settings in this model,we set the stop to a constant 115 pips, andthe limit to 120 pips, giving us a risk/rewardratio of slightly lower than 1:1. Since this isan RSI range trading strategy, a lowerrisk/reward ratio gave us better results,because it is a high-probability strategy.Fifty six percent of trades in the system wereprofitable.In comparing these two results, you can seethat not only are the overall results better withthe stops and limits, but positive results aremore consistent. Drawdowns tend to besmaller, and the equity curve a bit smoother.Risk-to-Reward Ratios Matter3503002502001501005001-to-0.5 1-to-1 1-to-1.5 1-to-2 1-to-2.5CHART 1.4Hypothetical overall profit* from a basic RSI strategy using different risk-to-reward ratiosPast performance is not indicative of future resultsSource: Appendix 1.411


TRAITS OF SUCCESSFUL TRADERS: PART ONEWhat is the Number One Mistake Forex Traders Make?Also, in general, a risk/reward of 1-to-1 orlower was more profitable than one that washigher than 1-to-1. Of course it must be said,with all backtesting, past performance is notindicative of future results.Chart 1.4 shows a simulation for setting astop to 110 pips on every trade. The systemhad the best overall profit at around the 1-to-1and 1-to-1.5 risk/reward level. In Chart 1.4,the left axis shows you the overall returngenerated over time by the system. Thebottom axis shows the risk/reward ratios.You can see the steep rise right at the 1:1level. At lower risk/rewards levels, the resultsare broadly similar to the 1:1 level.Again, we note that our model strategy in thiscase is a high probability range tradingstrategy, so a high risk/reward ratio is likely towork well. With a trending strategy, we wouldexpect better results at a lower risk/reward,as trends can continue in your favor for farlonger than a range-bound price move.GAME PLAN:WHAT STRATEGY SHOULD I USE?Trade forex with stops and limits witha risk/reward ratio of 1:1 or higher.Whenever you place a trade, makesure that you use a stop-loss order.Always make sure that your profittarget is at least as far away fromyour entry price as your stop-loss is.You can certainly set your price targethigher, and probably should aim for aratio of 1:2 or lower. Then you canchoose the market direction correctlyonly half the time and still make moneyin your account.The actual distance you place yourstops and limits will depend on theconditions in the market at the time,such as volatility, currency pair, andwhere you see support and resistance.You can apply the same risk/rewardratio to any trade. If you have a stoplevel 40 pips away from entry, youshould have a profit target 40 pips ormore away. If you have a stop level500 pips away, your profit targetshould be at least 500 pips away.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12


TRAITS OF SUCCESSFUL TRADERS: PART ONEWhat is the Number One Mistake Forex Traders Make?DailyFX Resources for Successful Money ManagementDailyFX and the DailyFX Trading Instructors have years of experience trading the markets andhelping thousands of new traders learn forex. Here are a few of their many tips that can help youtrade better by improving your money management:VIDEO RESOURCESWatch Money Management BasicsWatch David Rodriguez’s presentation of this research at the FXCM ExpoLIVE ONLINE CLASSESFXCM clients can take free interactive classes via the DailyFX PLUS Trading Course.Learn More about the DailyFX PLUS Trading Course13


TRAITS OF SUCCESSFUL TRADERS: PART TWOWhen is the Best Time of Day to Trade Forex?Profitability by Hour of Day60%55%50%45%40%GBP/USD EUR/USD USD/JPY AUD/USD USD/CHF0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24CHART 2.1Percentage of trades in the given hour (Eastern Time) that closed with a profitSource: Appendix 2.1INTRODUCTIONIn looking at the trading records of tens ofthousands of FXCM clients, as well as talkingwith even more traders daily via webinars,email, and Twitter, we have come to believethat most individual forex traders are what arecalled “range traders”. It also becomesapparent that many of them have troublebeing successful in forex because they aretrading during the wrong time of day.They should avoid trading during the mostactive times of the trading day. Why?We’ve seen records for thousands of traders,and we’ve seen what works and what doesn’t.Chart 2.1 shows the percentage of FXCMclient trades in the five most popular pairsthat closed with a profit, displayed by thehour of day.Most forex traders should trade during thelate US, Asian or early European tradingsessions – essentially 2 PM to 6 AM EasternTime (New York), which is 7 PM to 11 AMUK time.15


TRAITS OF SUCCESSFUL TRADERS: PART TWOWhen is the Best Time of Day to Trade Forex?EUR/USD - Average Hourly Range in Pips25201510500 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23Late US, Asian, and Early European SessionCHART 2.2EUR/USD average hourly (Eastern Time) range in pipsSource: Appendix 2.2By reviewing Chart 2.2, you can see that thisgenerally correlates with the low-volatilitytrading hours. Traders tend to see the bestresults during the low volatility Asia Sessionhours.This is because most individual forex tradersuse “range trading” strategies – buyingoversold currencies near support and sellingoverbought currencies near resistance. Thesetend to work well during low volatility times,when support and resistance tends to hold.Range traders can incursignificant losses when support or resistanceis broken, which happens most often duringthe more volatile times of day.DOES THE TIME OF DAY THAT I TRADEMATTER?Yes, it matters a lot. We have constructeda strategy that closely models your “typicaltrader” (You can find a full description of themodel strategy at the end of this article). Wesimulated the strategy’s performance tradingthe EUR/USD16


TRAITS OF SUCCESSFUL TRADERS: PART TWOWhen is the Best Time of Day to Trade Forex?24 hours a day during the sampling period.The results, shown in Chart 2.3, are not good.However, once we factor in the time of day,things become interesting. Let’s say youmade a rule to only trade during low-volatilitytimes. Chart 2.4 shows the same strategyover the same time window, but the systemdoes not open any trades during the mostvolatile time of day, 6 AM to 2 PM EasternTime (11 AM to 7 PM London time). Thedifference is dramatic.By sticking to range trading only during thehours of 2pm to 6am, the typical trader wouldhave been far more successful during thesampling period than the trader who ignoredthe time of day.WHAT ABOUT OTHER CURRENCY PAIRS?Of course, not all currencies act the same.For example, the Japanese yen tends to seemore volatility during Asian hours than theEuro or British Pound, since that is theJapanese business day.Model Strategy: No Time Filter10K8K6K4K2KModel Strategy: Time Filtered18K16K14K12K10K0October, 20010May, 2011 October, 2001May, 2011CHART 2.3Hypothetical returns* w/ no time filterSource: Appendix 2.3CHART 2.4Hypothetical returns* using a time filterSource: Appendix 2.3Past performance is not indicative of future resultsPast performance is not indicative of future results17


TRAITS OF SUCCESSFUL TRADERS: PART TWOWhen is the Best Time of Day to Trade Forex?We simulated the same strategy, with severaldifferent possible time settings for the threemajor European pairs: EUR/USD, GBP/USD,and USD/CHF.Chart 2.5 shows combined results for thestrategy on the EUR/USD, GBP/USD, andUSD/CHF during different time frames (in theNew York Timezone). As you can see, usingthis strategy overnight during Asian and earlyEuro session has yielded much better resultsthan our baseline 24 hour RSI.We find that the same time filters work verywell for the EUR/USD and USD/CHF, as theyare closely correlated. The filters also workfairly well for the GBP/USD. You should rangetrade these currency pairs during the 2 PM to6AM time window.Unfortunately, as Chart 2.6 shows, ouroptimal time window does not work well forAsian currencies.Time-Filtered RSI Strategyon European CurrencyPairs15K10K5K0-5K-10K-15KTime-Filtered RSI Strategyon Asian Currency Pairs0-10K-20K-30K-40K-50K-60K-20K05’ 06’ 07’ 08’ 09’ 10’ 11’-70K05’ 06’ 07’ 08’ 09’ 10’ 11’RSI Base 16:00 - 06:00 14:00 - 06:00 20:00 - 03:00 17:00 - 03:00CHART 2.5Hypothetical returns* from an RSI strategySource: Appendix 2.4Past performance is not indicative of future resultsCHART 2.6Hypothetical returns* from an RSI strategySource: Appendix 2.5Past performance is not indicative of future results18


TRAITS OF SUCCESSFUL TRADERS: PART TWOWhen is the Best Time of Day to Trade Forex?Our tests of different time windows on theUSD/JPY, AUD/USD, and NZD/USD have notproduced a single positive equity curve overthe past 6 years. This is due to the fact thatthese currencies are more often subject tolarge moves during Asia Session than theEuropean currencies.It is worth noting that the time of day canhave a significant affect on returns in thesecurrencies as well. 24 hour trading shows fargreater losses than the other time windows.GAME PLAN:WHAT STRATEGY SHOULD I USE?Trade European currencies during the“Off Hours” using a range tradingstrategy.Our data show that during thesampling period, many individualcurrency traders have been successfulrange trading European currency pairsduring the “off hours” of 2 PM to 6 AMEastern Time (7 PM to 11 AM UKTime).Many traders have been veryunsuccessful trading these currenciesduring the volatile 6 AM to 2 PM timeperiod. Asia-Pacific currencies can bedifficult to range trade at any time ofday, due to the fact that they tend tohave less distinct periods of high andlow volatility.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19


TRAITS OF SUCCESSFUL TRADERS: PART TWOWhen is the Best Time of Day to Trade Forex?DailyFX Resources for Successful Range TradingDailyFX and the DailyFX Trading Instructors have years of experience trading the markets andhelping thousands of new traders learn forex. Here are a few of their many tips that can help youtrade better by improving your skill at range trading.VIDEOSWatch Support and Resistance BasicsWatch RSI BasicsWatch Range Trader BasicsWatch Focus Appropriate Strategies on Appropriate MarketsWatch Using Trend Lines to Optimize EntriesWatch David Rodriguez’s presentation of this research at the FXCM ExpoARTICLESRead Trading with Support and Resistance (part 1)Read Trading with Support and Resistance (part 2)Read JW Ranger StrategyLIVE ONLINE CLASSESFXCM clients can take free interactive classes via the DailyFX PLUS Trading Course.Learn More about the DailyFX PLUS Trading Course20


TRAITS OF SUCCESSFUL TRADERS: PART THREEHow to Trade the Majors DuringActive Hours. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Summary: North American trading hours tend to bethe most difficult to trade in due to the high level ofvolatility in the market. Breakout trading strategiestend to do relatively well in volatile environments, soif you plan to trade during these times, look to tradebreakouts.21


TRAITS OF SUCCESSFUL TRADERS: PART THREEHow to Trade the Majors During Active HoursProfitability by Hour of Day60%55%50%45%40%GBP/USD EUR/USD USD/JPY AUD/USD USD/CHF0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24CHART 3.1Percentage of trades in the given hour (Eastern Time) that closed with a profitSource: Appendix 2.1INTRODUCTIONOur past research shows that traders couldbe well-served restricting their trading toless-active trading hours, as general traderprofitability tends to improve when marketsare less volatile. But what if you can’t tradewhen it’s quiet? For traders who feel the needto be in the market during the more volatiletimes, here is some advice about how to do it.Chart 3.1 emphasizes that FXCM clients tendto do poorly in the 5 most popularly tradedpairs during the North American daytime.If we compare these results with measuresof volatility, we can see that this poorperformance seems directly correlated tosharp price swings, as this time of day tendsto be the most volatile. Chart 3.2 shows theaverage hourly moves in pips for theEUR/USD, the most popular currency pair totrade. You can see that traders’ best resultscoincide with the times of day that have lowervolatility, such as the Asia trading session.22


TRAITS OF SUCCESSFUL TRADERS: PART THREEHow to Trade the Majors During Active HoursEUR/USD - Average Hourly Range in Pips25201510500 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23Late US, Asian, and Early European SessionCHART 3.2EUR/USD average hourly (Eastern Time) range in pipsSource: Appendix 2.2In part two of this series, When is the BestTime of Day to Trade Forex, we showed thatthe highly popular Relative Strength Indextrading strategy produced significantly betterrisk-adjusted returns if we limited it to tradeexclusively during the least-volatile hours ofthe trading day, 2 PM to 6 AM Eastern Time(New York).WHAT STRATEGY SHOULD I USE TOTRADE THE US DAYTIME?As mentioned before, we advise traders totrade during the lower-volatility times of daydue to the risks that volatility present, and thebetter results we see in the range tradingstrategies that FXCM clients tend to use.Some traders may prefer to trade during thevolatile US daytime, however. So, if you’regoing to do that, make sure that you use theappropriate strategy at the appropriate time.Do not try to range trade. Instead, do theopposite: trade breakouts.23


TRAITS OF SUCCESSFUL TRADERS: PART THREEHow to Trade the Majors During Active HoursWHAT IS A BREAKOUT?A breakout is when a currency that has beentrapped in a range or channel on the chartbreaks through support or resistance,escaping the channel. When this happens,the movement in prices tends to be verypowerful, and can create a tradingopportunity.Here is an example where the EUR/USDDaily chart had a channel for two months.You can see that when this channel broke,the move was swift and powerful.HOW DO YOU TRADE BREAKOUTS?Trading breakouts is almost the exactopposite of trading ranges. When price movesupwards through resistance, look to buy.When it moves downard through support, lookto sell. In the above example, a range traderwould have tried to sell at the top of thechannel and would have likely lost money.A breakout trader would instead have lookedto buy.Identifying a Price ChannelChannel Breakout Example1.501.4501.451.4451.401.4401.351.350February 2011August 201107/25/11 07/27/11CHART 3.3EUR/USD daily chart showing price channelSource: Appendix 3.2CHART 3.4EUR/USD five minute chart showing breakoutSource: Appendix 3.324


TRAITS OF SUCCESSFUL TRADERS: PART THREEHow to Trade the Majors During Active HoursSAMPLE STRATEGY: CHANNEL BREAKOUTPast performance is not indicative of futureresults, but the Channel Breakout strategy isquite straightforward and has performed fairlywell historically. The system draws a channelsurrounding price action, with the top of thechannel set at the highest high and the bottomset at the lowest low of the past twenty bars.In Chart 3.5 below, you can see the top of thechannel in light blue and the bottom of thechannel in red. The green dotted line showsprofitable trades made by the system, whilethe red dotted line shows losing trades madeby the system.Model Channel Breakout StrategyBuy when price touchesthe top channelSell when pricetouches thebottom channelCHART 3.5Sample channel breakout strategy illustrating buy and sell signalsSource: Appendix 3.4Past performance is not indicative of future results25


TRAITS OF SUCCESSFUL TRADERS: PART THREEHow to Trade the Majors During Active HoursWe sell the currency pair if the price breaksbelow the channel bottom. If price quicklyreverses, we will be taken out of the trade ata loss. Yet if price continues lower, we standto see profits on the continued moves.Thus we can conceptualize this trade systemmight work especially well during times ofhigh volatility, when channels tend to bebroken. Let’s test by looking at how well it hasdone on the Euro/US Dollar in the pastseveral years.The channel breakout system did reasonablywell overall, and especially well during timesof strong market volatility in late 2009. Yet ithas also had long stretches ofunderperformance and noteworthy losingstreaks. Since we know that breakoutstrategies tend to work better during times ofhigher volatility, how can we instruct oursystem to trade only during those times?EUR/USD Channel Breakout Strategy (2005 - 2011)15K14K13K12K11K10K9K09/07/06 04/27/08 12/23/09CHART 3.6Hypothetical returns* from the model channel breakout strategy (2005-2011)Source: Appendix 3.526


TRAITS OF SUCCESSFUL TRADERS: PART THREEHow to Trade the Majors During Active HoursChannel Breakout Strategy Filtered10K8K6KBase Channel Breakout50th Percentile75th Percentile4K2K005’ 06’ 07’ 08’ 09’ 10’ 11’CHART 3.7Hypothetical returns* using a model channel breakout strategy and volatilty filterSource: Appendix 3.6Past performance is not indicative of future results.WHEN SHOULD I LOOK TO TRADEBREAKOUTS?Every day, we publish Volatility Percentilefigures on the DailyFX Technical Analysispage for reference. The Volatility Percentile isderived from FX options prices. The higherthe number, the more volatile options tradersexpect the currency pair to be. We can usethese volatility percentages to judge when it isbest to use particular strategies. Whenvolatility percentages are high, we look totrade breakout strategies. When they are low,we look to avoid them.When looking at the Channel Breakoutstrategy above, a quick optimization showsthat the strategy improves noticeably whenwe apply filters. We simulate two casesbelow. In one case, the strategy is onlyallowed to trade when our Volatility Percentileis above 50%. In the other, it is only allowedto trade when it is above 75%. As you cansee in the chart below, in both cases we seebetter overall results than the “base case” ofletting the system trade at any time.27


TRAITS OF SUCCESSFUL TRADERS: PART THREEHow to Trade the Majors During Active HoursWith the 50 percentile filter, the strategy isallowed to trade about half the time. With the75 percentile filter, the system can only tradeabout 25% of the time. Over time, the 50percentile filter has been shown to preventmany of the losing trades in the system, whilepreventing only a few of the winning trades.This has produced some of the best historicalreturns on an overall final net-profit basis buthas also shown significant losing streaks.Keep in mind that past performance is notindivative of future results.With the 75 percentile filter, prevents evenmore trades – both good ones and bad ones.While the overall result over the past sixyears has not been quite as good as the 50percentile one, there were few times ofsignificant losses. Indeed, when we fully takerisk into consideration, we prefer the 75thpercentile filter, as it makes rather fewerlosing trades and we are glad to forego somepotential profits in order to lower our risk ofpotential loss.GAME PLAN:WHAT STRATEGY SHOULD I USE?When volatility is above 75%, tradeusing a breakout strategy.Our data show that over the samplingperiod many individual currencytraders have generally beenunsuccessful trading in times of highvolatility. We generally recommendtrading European currencies duringthe “Off Hours” using a range tradingstrategy, as we found that thisapproach tends to perform well andbest matches how most FXCM clientstrade.Traders who feel the need to tradeduring times of high volatility shoulduse a different strategy and look totrade breakouts rather than ranges.Breakout trading tends to show thebest risk-adjusted returns if limited tothe most volatile trading days. Usethe DailyFX Volatility Percentage togauge what FX options traders expectfor volatility in the near future. Whenabove 75%, breakouts aresignificantly more likely than normal.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .28


TRAITS OF SUCCESSFUL TRADERS: PART THREEHow to Trade the Majors During Active HoursDailyFX Resources for Successful Breakout tradingDailyFX and the DailyFX Trading Instructors have years of experience trading the markets andhelping thousands of new traders learn forex. Here are a few of their many tips that can help youtrade better by improving your skill at trading breakouts.VIDEOSWatch David Rodriguez’s presentation of this research at the FXCM ExpoARTICLESRead How to Trade a Breakout Strategy on the EUR/USDRead Breakouts: How to Stay Away from Some Losing TradesLIVE ONLINE CLASSESFXCM clients can take free interactive classes via the DailyFX PLUS Trading Course.Learn More about the DailyFX PLUS Trading Course29


TRAITS OF SUCCESSFUL TRADERS: PART FOURHow Much Capital Do I Needto Trade Forex?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Summary: Our research shows that the amount ofcapital in your trading account can affect yourprofitability. Traders with at least $5,000 of capitaltend to utilize more conservative amounts ofleverage†. Traders should look to use effectiveleverage of 10-to1 or less.30


TRAITS OF SUCCESSFUL TRADERS: PART FOURHow Much Capital Do I Need to Trade Forex?Profitability by Account Equity40%30%33.12%37.37%20%20.91%15%$0 - $999 $1,000 - $4,999 $5,000 - $9,999CHART 4.1Percentage of accounts in the given equity range that were profitableSource: Appendix 4.1INTRODUCTIONIn looking at the trading records of tens ofthousands of FXCM clients, as well as talkingwith even more traders daily via live webinars,Twitter, and email, it appears that traders enterthe Forex market with a desire to cap theirpotential for losses on their risk based capital.Therefore, many newer traders choose to starttrading forex with a small capital base.A LIKELY CULPRITSince many smaller traders are inexperiencedin trading forex, they tend to expose theiraccount to significantly higher levels ofeffective leverage. As a result, this increase inleverage can magnify losses in their tradingaccount.What we have found out through the analysisof thousands of trading accounts is that traderswith larger account balances tend to beprofitable on a higher percentage of trades.We feel this is a result of the “effective” leverageused in the trading account.31


TRAITS OF SUCCESSFUL TRADERS: PART FOURHow Much Capital Do I Need to Trade Forex?Profitability & “Effective” Leverage40%30%20%15%26:120.91%$999 $4,999 $9,999CHART 4.2Average “effective” leverage given account equitySource: Appendix 4.133.12%6:137.37%5:130:125:120:115:110:15:10Emotionally spent, traders then either give upon forex or choose to compound the issue bycontinuing to trade in relatively high amountsof effective leverage. This becomes a viciouscycle that damages the enthusiasm whichattracted the trader to forex.No matter how good or bad your strategy is,your decision (or non-decision, as the casemay be) about effective leverage has directand powerful effects on the outcomes of yourtrading. Last year, we published some testsshowing the results over time of the samestrategy with different leverage.In Chart 4.2, we have modified 2 elements ofthe chart in figure 1. First, we renamed eachcolumn to represent the highest dollar valuethat qualified for the given column. Forexample, the $0-$999 equity range is nowbeing represented as the $999 group. The$1,000 - $4,999 equity range is now beingrepresented as the $4,999 group. Andlikewise, the $5,000 - $9,999 range is nowbeing represented as the $9,999 group.32


TRAITS OF SUCCESSFUL TRADERS: PART FOURHow Much Capital Do I Need to Trade Forex?The above illustration shows a trader’saccount size and the maximum trade sizebased on 10 to 1 leverage. That means if youhave $10,000 in your account, then neverhave more than 100,000 of open trades atany one time.Their effective leverage is at least 26 timeswhich is significantly higher than the 10 timesleverage discussed earlier. If these traderswant to trade at no more than a 10 to 1effective leverage, they would need to makeat least one of the adjustments noted below.The precise amount of leverage used isdecided entirely by each individual trader. Youmay decide that you are more comfortableusing an even lower effective leverage suchas 5 to 1 or 3 to 1.Most professional traders enter into tradingopportunities focused on how much capitalthey stand to lose rather than how muchcapital they are looking to gain. Nobodyknows the future movement of prices soprofessional traders are confident in theirtrading approach but conservative in their useof effective leverage.ADJUSTING EFFECTIVE LEVERAGE TOSUIT YOUR RISK TOLERANCEOur research indicates that accounts with thesmallest capital base (the group labeled$999) have an average trade size of 26k foreach trade.Increase their trading account equity bydepositing more funds to an amount thatreduces their effective leverage to less than10 to 1. So our average trader, who isaveraging 26k trade sizes, would need atleast $2,600 in their account to trade 26k on a10 to 1 effective leverage.Decrease their trade size to a level thatreduces their effective leverage to less than10 to 1. Use the figure 3 calculations andchart above.In Chart 4.3, notice how the trade sizeremains relatively stable as the accountequity increases from the $999 group to the$4,999 group. In essence, this indicates thattraders are looking for, on average, at least$2.60 per pip (if they average 26k34


TRAITS OF SUCCESSFUL TRADERS: PART FOURHow Much Capital Do I Need to Trade Forex?“Effective” Leverage & Account Exposure30:125:120:115:110:15:1026:126K30K$999 $4,999 $9,999CHART 4.3Average market exposure and “effective” leverage for the given equity levelSource: Appendix 4.36:154K5:160K50K40K30K20K10K0for each trade, or $2.60 per pip. Perhaps theywant a large enough trade size to make theirtime invested trading worthwhile. In otherwords, traders may be seeking a price per pipvalue and $2.60 is the minimum threshold onaverage. If these traders were to use no morethan 10 to 1 effective leverage, they wouldneed at least $2,600 in their account tosupport $2.60 per pip.Another possibility is that many newer traderssimply don’t understand the power ofleverage and how one large losing trade canwipe out several winning trades in a row.Using a conservative amount of leverage willhelp slow down the rate of capital losseswhen a trader goes through a losing streak.Regardless of the reasons, our goal is to useconservative amounts of leverage. If youknow how much risk capital you haveavailable, then use the chart and calculationsin Figure 3 to determine the right trade sizefor your account.35


TRAITS OF SUCCESSFUL TRADERS: PART FOURHow Much Capital Do I Need to Trade Forex?If you have a target “per pip” value, then usethe calculations in figure 5 to determine theminimum amount of account capital neededto support your trade size. Increasing yourcapital base does not mean you will becomemore profitable. It means that you can stay ina trade longer if it goes against you. Onaverage, traders that use a combination ofsufficient capital (at least $5,000) andconservative use of effective leverage(10 to 1 or less) tend to be more profitable.Leverage is a double-edged sword and candramatically amplify your profits. It can alsojust as dramatically amplify your losses.GAME PLAN:WHAT STRATEGY SHOULD I USE?Trade with “effective” leverage of 10:1or less.Leverage is a double-edged sword thatcan that dramatically can dramatically amplify amplify your your gainsand gains losses. and losses. If you choose If you choose to trade to withwith trade leverage, with leverage, we recommend we that youdo recommend not lever your that you account do not more lever than10 your times account (10:1). more Doing than so 10 can times greatlydecrease (10:1). Doing your so chance can greatly of being decreaseprofitable. your chance of being profitable.Most professional traders enter intotrading opportunities focused on howmuch capital they stand to lose ratherthan how much capital they are lookingto looking gain. to Nobody gain. Nobody knows the knows future themovement future movement of prices of prices so professional sotraders professional are confident traders are in their confident tradingapproach their trading but approach conservative but in their useof conservative effective leverage. in their use of effectiveleverage.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .36


TRAITS OF SUCCESSFUL TRADERS: PART FOURHow Much Capital Do I Need to Trade Forex?DailyFX Resources for Successful Money ManagementDailyFX and the DailyFX Trading Instructors have years of experience trading the markets andhelping thousands of new traders learn forex. Here are a few of their many tips that can help youtrade better by improving your skill at money management.VIDEOSWatch Introduction to Money ManagementWatch David Rodriguez’s presentation of this research at the FXCM ExpoARTICLESRead Arriving at a Risk/Reward RatioRead Increase Your Chances of Becoming a Successful TraderRead Forex: How to Determine Appropriate Effective LeverageLIVE ONLINE CLASSESFXCM clients can take free interactive classes via the DailyFX PLUS Trading Course.Learn More about the DailyFX PLUS Trading Course37


Appendix1.1 - Chart 1.1Chart 1.1 shows the percentage of trades in the given currency pair that closed with a profit.The data is derived from Forex Capital Markets LLC accounts—excluding managed and EligibleContract Participant accounts—from 10/01/2009 to 09/30/2010. All data is rounded to the nearestwhole number.1.2 - Chart 1.2Chart 1.2 shows the average profit and loss per trade in the given currency pair. Profits and lossesare shown in pips. The data is derived from Forex Capital Markets LLC accounts—excludingmanaged and Eligible Contract Participant accounts—from 10/01/2009 to 09/30/2010. All data isrounded to the nearest whole number.1.3 - Chart 1.3Chart 1.3 shows the hypothetical returns from a model RSI strategy trading USD/CHF on a60-minute.The blue line is the model strategy’s hypothetical returns when stops and limits were notused in this backtest.The red line is the model strategy’s hypothetical returns when stops and limits were used inthis backtest.The model RSI strategy was designed to mimic a “typical trader” using one of the most commonintraday range trading strategies—following RSI on a 15 minute chart.Entry Rule: When the 14-period RSI crosses above 30, buy at market on the open of the next bar.When RSI crosses below 70, sell at market on the open of the next bar.Exit Rule: Strategy will exit a trade and flip direction when the opposite signal is triggered.38


When adding in the stops and limits, the strategy can close out a trade before a stop or limit is hit,if the RSI indicates that a position should be closed or flipped. When a stop or limit order istriggered, the position is closed and the system waits to open its next position according to the“Entry Rule.” Backtests were generated using FXCM’s Strategy Trader platform.1.4 - Chart 1.4Chart 1.4 uses the same model RSI strategy as described above in appendix 1.3. It shows howthe overall profit changes when different risk-to-reward ratios are used.The stop distance was held constant at 110 pips of risk for every trade that opened. The limitdistance was adjusted accordingly for each backtest so that the following risk-to-reward ratioscould be achieved: 1-to-0.5; 1-to-1; 1-to-1.5; 1-to-2; 1-to-2.5.2.1 - Chart 2.1 and Chart 3.1Chart 2.1 and Chart 3.1 shows the percentage of trades in the given currency pair that closed witha profit. The data is derived from Forex Capital Markets LLC accounts—excluding managed andEligible Contract Participant accounts—from 10/01/2009 to 09/30/2010. All data is rounded to thenearest whole number.2.2 - Chart 2.2 and Chart 3.2Chart 2.2 and Chart 3.2 shows the average hourly range, in pips, for the EUR/USD. All times aredisplayed in Eastern Time.2.3 - Chart 2.3 and Chart 2.4Chart 2.3 shows the hypothetical returns from a model RSI strategy trading EUR/USD 24 hours aday during the sampling period. Chart 2.4 shows the hypothetical returns from the same modelstrategy. However, in Chart 2.4 no trades were placed from 6AM to 2PM Eastern Time.The model RSI strategy was designed to mimic a “typical trader” using one of the most commonintraday range trading strategies there is—following RSI on a 15 minute chart.39


Entry Rule: When the 14-period RSI crosses above 30, buy at market on the open of the next bar.When RSI crosses below 70, sell at market on the open of the next bar.Filter: Strategy cannot enter trades between the “end hour" and the next “start hour".Exit Rule: Strategy will exit a trade and flip direction when the opposite signal is triggered.This strategy has worked best over the past 10 years using European currency pairs and settingthe start hour to 2 PM and the end hour to 6 AM Eastern Time (New York). Please note, pastperformance is not indicative of future results. Backtests were generated using FXCM’s StrategyTrader platform.2.4 - Chart 2.5Chart 2.5 uses the same model RSI strategy as described above in appendix 2.3. However, thestrategy trades the EUR/USD, GBP/USD and USD/CHF. Five backtests were performed usingdifferent time filters: 1) no time filter; 2) 16:00 - 06:00 ET; 3) 14:00 - 06:00 ET; 4) 20:00 - 03:00 ET;4) 17:00 - 03:00 ET. The same sampling period was used.2.5 - Chart 2.6Chart 2.6 uses the same model RSI strategy as described above in appendix 2.3. However, thestrategy trades the USD/JPY, AUD/USD, and NZD/USD. Five backtests were performed usingdifferent time filters: 1) no time filter 2) 16:00 - 06:00 ET 3) 14:00 - 06:00 ET 4) 20:00 - 03:00 ET4) 17:00 - 03:00 ET. The same sampling period was used.3.1 - Chart 3.2Chart 2.6 uses the same model RSI strategy as described above in appendix 2.3. However, thestrategy trades the USD/JPY, AUD/USD, and NZD/USD. Five backtests were performed usingdifferent time filters: 1) no time filter 2) 16:00 - 06:00 ET 3) 14:00 - 06:00 ET 4) 20:00 - 03:00 ET4) 17:00 - 03:00 ET. The same sampling period was used.40


3.2 - Chart 3.3Chart 3.3 is a daily chart of the EUR/USD from February 2011 to August 2011. It is used to illustratea price channel.3.3 - Chart 3.4Chart 3.4 is a five minute chart of the EUR/USD from 07/25/11 to 07/27/11. It is used to illustratehow an instrument’s price can breakout significantly if/when its price moves through a price channelboundary.3.4 - Chart 3.5Chart 3.5 is a model channel breakout strategy. For our models, we used one of the most commonand simple breakout trading strategies there is, creating channels on a 60 minute chart.Entry Rule: When price crosses above the highest price of the last 20 bars, buy at market on theopen of the next bar. When price crosses below the lowest price of the last 20 bars, sell at market onthe open of the next bar.Filter: Strategy can only enter new trades when the Volatility Percentage is above the specified level(such as the 50% or 75% examples used in Part Three of this series).Exit Rule: Strategy will exit a trade and flip direction when the opposite signal is triggered.The EUR/USD this strategy has shown the best risk-adjusted returns in the EUR/USD over the past6 years when it was restricted to trade only when the Volatility Percentage was above 75%. Pastperformance is not indicative of future results.3.5 - Chart 3.6Chart 3.6 shows the hypothetical returns of the model channel breakout strategy described inappendix 3.4. The EUR/USD pair was traded from 2005 - 2011 using a 60 minute chart. No volatilityfilters were applied to this backtest.41


3.6 - Chart 3.7Chart 3.7 shows the hypothetical returns of the model channel breakout strategy described inappendix 3.4. The EUR/USD pair was traded from 2005 - 2011 using a 60 minute chart.Three separate backtests were performed using the following volatility filters: 1) No filter; 2) tradesare only entered when the Volatility Percentile is greater than 50%; 3) trades are only entered whenthe Volatility Percentile is greater than 75%.4.1 - Chart 4.1Chart 4.1 shows the percentage of accounts in the given equity range that were profitable at the endof the quarter. The data is derived from Forex Capital Markets LLC accounts—excluding managedand Eligible Contract Participant accounts—from 10/01/2009 to 09/30/2010. All data is rounded to thenearest whole number.4.2 - Chart 4.2Chart 4.2 shows the average “effective” leverage used assuming the given equity figure. Effectiveleverage is calculated by taking the average notional account exposure divided by the given equityfigure (i.e. $999, $4,999 or $9,999). The data is derived from Forex Capital Markets LLCaccounts—excluding managed and Eligible Contract Participant accounts—from 10/01/2009 to09/30/2010. All data is rounded to the nearest whole number.4.3 - Chart 4.3Chart 4.3 shows the average market exposure and “effective” leverage for the given equity level.The data is derived from Forex Capital Markets LLC accounts—excluding managed and EligibleContract Participant accounts—from 10/01/2009 to 09/30/2010.All data is rounded to the nearest whole number.42


DisclaimersHigh Risk Investment WarningTrading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors.The high degree of leverage can work against you as well as for you. Before deciding to trade foreignexchange you should carefully consider your investment objectives, level of experience, and risk appetite.The possibility exists that you could sustain a loss of some or all of your initial investment and thereforeyou should not invest money that you cannot afford to lose. You should be aware of all the risksassociated with foreign exchange trading, and seek advice from an independent financial advisor if youhave any doubts.DailyFX Release of LiabilityDailyFX does not warrant the accuracy or completeness of the information, text, graphics, links or otheritems contained within these materials. DailyFX shall not be liable for any special, indirect, incidental, orconsequential damages, including without limitation losses, lost revenues, or lost profits that may resultfrom these materials. Opinions and estimates constitute our judgment and are subject to change withoutnotice. The information in these articles does not constitute investment advice. Past performance is notindicative of future results.*Hypothetical Performance and Backtesting RisksHypothetical performance results have many inherent limitations. No representation is being made thatany account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequentlysharp differences between hypothetical performance results and the actual results subsequently achievedby any particularly trading program.One of the limitations of hypothetical performance results is that they are generally prepared with thebenefit of hindsight. In addition, hypothetical trading does not involve financial risk. Variables such asthe ability to adhere to a particular trading program in spite of trading losses as well as maintainingadequate liquidity are material points which can adversely affect actual real trading results.Past Performance is not indicative of future results.†Leverage Risk WarningLeverage is a double-edged sword and can dramatically amplify your profits. It can also just asdramatically amplify your losses. Trading foreign exchange with any level of leverage may not be suitablefor all investors.43

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