What is winning in Forex?
What is winning in Forex? What realistic profits can a beginner expect? A Lamborghini in 5 years?
This lesson 3 of crash course Forex is about how to win in Forex and it is about insights and tips about winning. Most beginners expect to get rich quickly with Forex trading, but sooner or later they will have to come back to that. But what are realistic Forex profits you can expect?
What profit to expect?
From all the forums, courses trading rooms, etc that I have visited/attended the following most likely scenario appears.
In the first 1-3 years the beginning trader will win nothing, but will lose instead, maybe even a lot of money. Most beginners drop out as a result of that.
After another 1-3 years the trader knows what Forex trading is about, becomes finally profitable and may get a 2-4% monthly.
In the next 1-3 years the trader does better and better. The results improve and a 3-8% monthly may be possible.
These percentages are all monthly averaged. Losing is still possible. Even the best traders have losing months now and then. But on average all months will be winning months.
A 5% per month does not sound much. It’s only $150 monthly on a $3,000 account.
But wait.. there is another effect at work and it works in the background: the power of compounding.
Real profit in Forex trading does not come from the monthly 5% returns. It comes through the force that Einstein called the 8th wonder of the world: compound interest, or compound gains.
The power of compounding is at work if you reinvest your profit over and over again. Or in other words, if you just leave your profits on your trading account and don’t take them away.
Compounded gains is simply put NOT 12 x 5% = 60% per year. It is about 80% per year.
Let’s illustrate what this effect does with a small $3,000 account and a 5% monthly return. We use an online compound gains calculator for it.
As you can see in below image, in 10 years of time (120 months) the $3,000 has grown to over a million!
So a Lamborghini in 5 years? Is that possible? Well, the cheapest Lamborghini is $199,805 (the Lamborghini Huracan LP580-2). So check the compounding calculator!
Protect your account
But how to win in Forex? How to get that 5% monthly?
As explained in the previous lesson, the main thing is to trade a strategy and to trade it consistently.
The second thing is knowing that winning is not only winning, but also not losing.
The legendary investor Warren Buffett’s famous saying…
…..does not only apply to investing, but also to Forex Trading.
Therefore the following tips:
Tip1: Keep the risk per trade small: 1%
When you are trading a strategy, then you are going to have your winners and your losers.
Losers, especially a couple of losers in a row, lead to account drawdowns.
Drawdowns are normal, but sometimes they can be that huge that it becomes almost impossible to handle that psychologically. And as a result of that you may start to trade emotionally, off-strategy, resulting in even more losers, deepening the drawdown.
A good way to avoid big drawdowns is by never risking more than a small part of your account per trade, so that if you lose, you will only lose a little. Smaller drawdowns are better to handle, and you will be better able to stay on track.
Most pro’s never risk more than as little as 1% of their account for a single trade, and sometimes even less than that.
Of course, with a small risk the profits will be small to, making it hard to recover from even small drawdowns as well. But there’s a fix for that too: keeping a positive reward to risk ratio.
Tip2: Go for a reward/ risk larger than 1
The reward to risk ratio of a trade is the profit you will get if you win the trade divided by the loss if you lose it. So if you can win $2 and lose $1, then the reward to risk ratio is $2/$1 = 2.
A reward to risk greater than 1 is called a positive reward to risk: your potential profit is greater than your potential loss. A negative reward to risk means that the ratio is less than 1: your potential loss is greater than the potential profit.
If you have experienced a couple of losers in a row (a losing streak), then it will be harder to recover from that loss if you trade negative reward/risk trades.
Example: If you trade with a reward to risk of 0.5 and you lose 2 trades, then you will need 4 winners to recover. But if you trade with a reward/risk of 2 then you will only need 1 winner to fully recover.
So if you want to recover from drawdowns easier, it is strongly recommended to trade a strategy with a positive reward to risk.
Wrong: Trade when you shouldn’t, Don’t trade when you should
Trading is an emotional business, and emotions that play up are so common, that there are even names for them.
Trading emotions make traders take trades, when they should not. And conversely, they don’t let them take trades when they should take them.
Let’s explain these emotional trading styles:
Revenge-trading is placing a new trade immediately after the previous one ended at a loss. The trader is pissed because the trade ended at a loss, and the reason for placing the trade is to win the money back just lost. This kind of off-strategy trading is called revenge-trading.
Over-trading. This trading style is closely related to revenge-trading. Over-trading is placing way too many trades just for the desire to recover from loss quickly.
Fear of losing comes into play after a couple of losers in a row. The trader expects that the next trade will also end at a loss, like all the others, and he doesn’t dare to trade anymore. This way the edge of the strategy won’t play out anymore. Closing a running trade early, is another example of fear of losing. Again, the edge won’t play out.
Fear of missing out (FOMO) is the opposite of fear of losing, and it is related to over-trading and revenge-trading. The market is trending and the trader hasn’t jumped in. Driven by greed, the trader doesn’t want to miss out the rally, and so the trader jumps in recklessly, forgetting that markets often retrace after a run….
Fear of leaving money on the table is another example of FOMO. It is the fear that the market will continue to move in the direction of the trade after hitting the original profit target. The idea that the trader could have made more money later on is intolerable. So driven by greed, the trader does not close the trade as per the rule set of the strategy, but let it run instead.
Boredom-trading (also called random-trading or gamble-trading). Trading can be too boring sometimes and placing a trade just to fix that is called boredom-trading. Gambling is fun, but you will not make money with it in the longer term.
Trading the right way: taking ALL trades, and ONLY when you should
Know your strategy! If you have a clearly defined ruleset you are much better able to deal with trading emotions that tempt you to trade off-strategy.
Remember from the previous lesson that a strategy needs to be traded a 100% correctly otherwise its edge will never play out.
A highly recommended book to read about this topic is the best-seller book Trading in the Zone by Mark Douglas.
In ‘Trading in the Zone’ Douglas analyses why most traders are consistently losing. And he gives a fix for it also. It is not the strategy that will make or break you as a trader, but your own mindset, and you are in control of that yourself. Great traders are made, not born, is the underlying message of the book.
To me this is the best book about trading ever, and it very much improved my own trading. Worth to read it a couple of times!