Monday, October 14, 2013

Increase Trading Profits, Decrease Risk

As the US government shutdown as well as debt ceiling debate continues to play out without a resolution in sight, I am attending a small investor conference for one of our projects. I am being approached by a young associate who asked me a question which answer I think may benefit all new traders, regardless if you trade forex or any other asset class.

The young associate, an intelligent young woman in her mid-20’s, has started to trade in the forex market in her own and told me that is has worked out a strategy which she is comfortable with. She asked me the following question:

How can I increase my trading profits while I also decrease my risk exposure at the same time?

The answer to the question is rather simple, but she asked me if I could take an hour over lunch to explain to her how she could implement it. She offered to take me out. I usually don’t give lessons like that, but there is always an exception.

I will not go into detail how lunch went, but I will give a short overview of what we discussed as we lunched away. The food was fantastic, the ambient amazing and the company great. Overall it was an experience I would not mind to repeat at a different setting.

The answer to her question: Stagger your entries in a support or resistance zone.

What does this mean?

Most new traders place one single order as they enter a trade and as you may know out of experience you usually witness a move against your first entry. This strategy is for real traders who do not scalp; those who scalp will find this useless.

Let’s say you want to trade 0.50 lots and EURGBP is your currency pair you would like to take a short position in. Newbie traders who do not understand how to trade will place one single order of 0.50 lots and set their stop loss as well as take profit; often they are so terrified that they keep the stop loss so tight which means a normal price move will stop them out.

Here is how you should do it, which does not only increase your profits but at the same time reduces your risk exposure:
  • Identify the resistance zone; there is always a zone and not just one single number which mark support or resistance.
  • Let’s assume you identified a resistance zone which spreads 30 pips
  • Split up your orders in as many as you feel comfortable with, in this example we will use 3 orders
  • Enter your first order for 0.15 lots
  • Enter your second order for 0.15 lots
  • Enter your third order for 0.20 lots

As you see your total lot size remains at 0.50 and this should not be confused with a martingale strategy. Uninformed traders will tell you that the spread you will pay will eat away your profit which is not only moronic, but false.

For starters a spread of one or two pips should never eat your profits and you should not have a bigger spread. In case you do you may want to consider switching to a good forex broker who offers you very tight spread. As I am writing this short post the spread for EURGBP over at PaxForex is 1.2 pips.

Let’s assume you plan to exit this trade for a profit of 75 pips, the spread on staggered entries will not eat away your profits as you actually earn higher profits with this approach in comparison to one single order of 0.50 lots.

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