The MetaTrader 4 platform provides access to a wide range of chart analysis tools. These tools can be found in the Line Studies tab.
In the standard view we see 10 different icons.
The first is the arrow or a standard mouse cursor.
This is the cross, which allows you to check price and date / time on charts. The cross will allow you to measure the graph height of the movement in pips and see how many candles the price move lasted.
This tool is a vertical line. It is useful in marking date or time on the chart.
For the application of support and resistance levels you can use the horizontal line. It also allows you to select the psychological levels on your chosen market.
The next icon shows the trendline. It is the most commonly used tool by many traders. It allows us to highlight upward or downward trends by applying them to tops and price bottoms respectively. Taking this opportunity let’s see how to properly build the trendline.
Before we begin to draw a trendline we have to localise the outermost price movements. Then we put a trendline on the first peak price in a decrease trend. The second point will be applied in such a way that the line does not intersect candles that lie between the points. Let us remember that a properly applied trendline is drawn at maximum prices, so-called candle wicks, instead of closing prices. When the price bounces up from the mapped trendline, it will be a confirmation of the strength of the trendline.
The next tool is the Equidistant Channel, which is a trendline with a built-in second parallel line.
One of the most popular technical tools is the Fibonacci Retracement. It is used to determine significant levels of support and resistance, from which the market may reverse its movement.
In the above example, we see a clear rebound in price on the 50% retracement level.
Next is a text level. This allows you to write on the chart either in a fixed position on the chart or free-standing.
The last icon allows the use of different kinds of symbols which can be applied for informative reasons.
Each tool in the graph can be edited by double-clicking on the object and then selecting the ‘Object Customise’ tab. Now we can change the color of a particular tool or set personalised parameters.
There’s also a possibility of extending the palette of instruments. To do this, right-click on the Line Studies panel, and choose Customise.
Selecting this will show all available tools. After moving tools to the right side they will appear on the primary display.
Now we’ve covered the basic tools available on the MT4 platform, we can begin to use it in our daily market analysis.
Metatrader 4 is a platform for trading currencies, commodities and indices. The wide range of instruments it offers and an extremely intuitive interface makes it one of the most popular trading platforms, which is used by traders from all around the world.
Once you launch the trading platform, you will see several windows:
In the Market Watch section, you’ll find a large base of instruments available on the platform. If you’d like to see more, simply right-click on any instrument and select ‘show all instruments’. To open a position, double-click on your selected instrument and a separate window will open.
The symbol shows what instrument we have currently open.
Volume gives us the option to choose the size of our trade (in lots):
In the Navigator window you can see all of your accounts, available indicators, strategies, and scripts. If you want to log into another account just double click the login of that account and enter your login, password and choose your server.
In the terminal you can monitor your positions, both open and pending.
In the first “Trade” tab you can see:
100% margin call level means if your account margin level reaches 100%, you can still close your open positions, but you cannot open any new positions.
At GFX, your margin close level is set to 30%, which means if your margin level falls below this level, the platform starts to close your losing positions automatically. This is an automatic safety mechanism to help protect your account funds and prevent losses from deepening. It starts by closing the biggest losing position and stops when your margin level returns to at least 30%. Learn more about margin here.
The terminal window has also a number of helpful bookmarks. You can view your past trading activity and generate a report of a specified period.
The main part of the platform is the Chart Window, which has a black background by default. However, the MT4 platform easily allows you to customise the appearance of the charts for your needs. Simply:
Right-click on the chart and select ‘properties’. Here, we can use the default templates (colour, design) or create your own.
If you’d like to save your template for when you open new charts, simply right-click on the chart, select Template, then Save Template, and give your new template a name. Then you’re ready.
On the MT4 platform you can also easily keep track of the price of the instrument at different intervals:
You can easily change the chart type:
Zoom in or out of graphs:
Apply any element:
Add an indicator using the button below:
If you’d like to view multiple charts in one window, just click the button displayed below:
As you can see, the Meta Trader platform provides you with plenty of ways to customise and adjust the platform to suit your needs. Remember that all trading carries a level of risk and losses can exceed deposits.
Let’s take a quick look at how to trade using MT4, one of the most universally popular trading platforms in the industry.
The MT4 platform offers different options when opening or closing positions.
To open orders in the market window, you must right-click on the specified instrument and then select “new order”, or double-click the left mouse button on the selected instrument.
When the order window opens you will see the parameters that you can set:
Symbol shows what instrument you have currently open.
Volume gives you the opportunity to choose the size of your trade (in lots):
1 lot is equivalent to 100 000 units of the base currency, which in this example, is euro. Proportionally 0.1 lot is 10 000 and 0.01 lot is 1000 units of the base currency.
Stop Loss – This is an order which is designed to limit losses if the market moves against your position, hence the name; stop losses. The order is executed automatically.
Take Profit – This is an order which automatically closes your position when the price reaches your specified profit target.
Comment gives you the possibility to write a comment on your trade and keep trading notes.
Type – select the type of order: Instant Execution or Pending Order.
There are 4 types of pending orders (except Stop Loss and Take Profit):
Sell – we sell EUR and buy USD
Buy – we buy EUR and sell USD
Enable maximum deviation from quoted price – Here we can determine the maximum deviation from the price we want to open the trade.
Open and pending orders are visible in the “Trade” tab in the terminal window.
The fastest way of opening a position is to use the one-click trading option. To activate one-click trading, Press alt + t.
Once one-click trading has been activated, we can open a position at the market price, buy or sell, and set the position size. Please note that the order will open right away.
To close an open position click the “x” in the Trade window in the Terminal.
Another way to open a position is to right-click on the chart window and select ‘Trading’ and then ‘New order’. Here, you can set pending orders, as well as putting limits and stops order in place.
To make it quicker, you could also open a limit order by right-clicking on the chart and choosing a sell or buy limit order according where you clicked.
Another way is to right-click the line order and select ‘close’.
If you would like to close only a part of position, click the right-click on the open order and select “Modify”. Then, in the Type field select instant execution and choose what part of the position you want to close.
The term CFD stands for contract for difference. CFD trading allows you to take a position on the value of an instrument and predict whether it will rise or fall. It’s important to remember that as a derivatives product, you don’t actually own the underlying asset directly. This saves you from traditional physical dealing costs such as UK Stamp Duty, and all you are doing is simply trading on the movement of underlying prices.
The contract itself is an agreement between two parties to exchange the difference between the opening and closing price of the instrument, hence the term ‘contract for difference’.
CFD trading explained
Unlike conventional forms of trading, CFDs enable you to profit from falling markets as well as rising ones.
If you believe the price of an asset is going to rise, you go long or ‘buy’ and you’ll profit from every increase in price.
If you believe the price of an asset is going to fall, you go short or ‘sell’ and you’ll profit from every fall in price.Of course, if the markets don’t move in the direction you expect, you’ll suffer a loss.
So, if you believe for example that Apple’s share price will fall in value, you simply go short on Apple share CFDs and your profits will rise in line with any fall in price below your opening level. However, should Apple’s share price actually rise, you would suffer a loss for every rise in price. How much you profit or lose will depend on your position size (lot size) and the market price movement, which is explained in more detail here.
The ability to go long or short along with the fact that CFDs are a leveraged product makes it one of the most flexible and popular ways of trading short term movement in financial markets today.
Ready to try trading with a demo?
Ready to try trading with a demo?
CFDs are a leveraged product. This means that you gain a much larger market exposure for a relatively small initial deposit, meaning your return on your investment is significantly larger than in other forms of trading. In conventional dealing, you would have to pay your broker the total value of the asset you wish to purchase – but with CFDs, you’re only required to provide a fraction for the same trade, so you can make your investment amount go much further.
Let’s say you want to purchase 10,000 shares of Barclays and its share price is 280p, which means that the total investment would cost you £28,000 – not including the commission or other fees your broker would charge for the transaction.
With CFD trading however, you only need a small percentage of the total trade value to open the position and maintain the same level of exposure. For example, we give you 10:1 (or 10%) leverage on Barclays shares, so you would only need to deposit an initial £2,800 to trade the same amount.
If Barclays shares rise 10% to 308p, the value of the position is now £30,800. So with an initial deposit of just £2,800, this CFD trade has made a profit of £2,800 which is a 100% return on investment, compared to just a 10% return if the shares were bought physically.
The important thing to remember about leverage, however, is that while it can magnify your profits, your losses are also magnified in the same way. So if prices move against you, your losses could exceed your initial deposit – so it’s important to understand how to manage your risk.
What markets can you trade CFDs on?
We offer contracts for difference on over 200 global markets and multiple asset classes, all with the ability to utilise leverage and go both long or short including:
Now that we’ve covered the basics, let’s look a closer look at how CFD trading works. Here, we explain the aspects of both a winning and losing trade.
Let’s say you believe that the value of the FTSE 100 will increase against stronger than expected earnings from the UK’s major companies. At GFX, our FTSE 100 market is called the UK 100.
You go long on the UK 100 at 6700, which has a margin from 0.5% (200:1).
As you can see, in this example opening a contract on the UK 100 with 1 lot equates to £10 profit every point the UK 100 moves in your favour. GFX’s advanced calculator instantly determines how much profit or loss you could make depending on your stop loss, lot size, and limit order, allowing you to make instant and informed trading decisions.
A lot is your trade size and the nominal value of one lot varies across all of our markets. For example, one lot in a forex trade is the equivalent to 100,000 of the base currency, whilst one lot of the US 30 index (Dow Jones) is $20 per point. So make sure you understand what one lot equates to before trading.
When trading CFDs, you’ll notice that there are two available prices. One is the sell or ‘bid’ price, and one is the buy or ‘ask’ price. The spread is essentially the difference in price between these two figures. The tighter the difference the lower is transaction cost and faster you could get profit on your trades.
Trading the markets can seem extremely daunting and complicated when you first start out. With a large amount of information easily accessible online, as well as ever-increasing ways to interpret charts, data and fast-moving markets, it’s easy to be overwhelmed or succumb to the fear of the unknown. One of the best things to keep in mind then is simplicity. Don’t overcomplicate your trading strategy when you first start. Keep it simple. Bear in mind a few basic rules, and build your experience from there.
Three rules for getting started :
Focus on a handful of markets :
You should concentrate on trading just a small number of markets and importantly, only trade a market that you know. Each day you research it, or open a position, is another day you grow more familiar with its patterns, behaviours, and movements. This in turn means you’ll gradually get to know what affects prices and how they move.
Become familiar with announcements that may trigger volatility in your chosen instrument. For example, if you’re trading oil but don’t know that every Wednesday there is a weekly Petroleum Report published by the EIA which typically triggers oil price volatility, then you could be fighting a losing battle. So take the time to understand what affects prices in your selected markets.
Our Forex calendar within the platform keeps you up to date with all the macroeconomic releases, displays the previous figures and current forecasts, and rates each print by potential impact. For example, the release of US non-farm payrolls on the first Friday of each new calendar month are rated as high because they typically create volatile price movement in USD currency pairs and global indices like the US 30 and UK 100, as well as the price of Gold.
Select a timeframe that suits you
The style of your trading is dependent on what timeframes you’re comfortable with. For example, a long-term trader will hold almost all of his or her trades for a matter of weeks, months, or even up to a year. Since trades are held for long durations, the number of trades is generally lower – maybe only five to ten a month. Therefore, a long-term trader makes most of his or her decisions based on monthly or weekly charts and uses daily or four-hour charts to choose precise entry points.
Meanwhile, a swing trader is typically a more medium-term trader who holds positions for a few days, or perhaps a week or two. A typical day trader is usually in and out of a position within a day, although some trades may last up to three days.
Consider all the different timeframes that could suit your trading style and personality. These timeframes should suit the amount of time you can dedicate to trading – whether that’s hourly, daily, weekly, or monthly.
If you can react to changing situations quickly and clearly, shorter timeframes may well suit you whilst those prone to a ‘rush of blood to the head’ may prefer longer timeframes where they can analyse the market situation more carefully.
At the same time, many people who are in full-time employment cannot check positions during the day so do most of their analysis in the evenings or over the weekend. You have to find the right timeframe that suits you.
These are all factors to be carefully considered.
Create a trading plan
And of course, have a trading plan. You should know the direction you want to trade a market (up or down), the rationale for getting into a position, specific entry and exit points and how much of your capital is being risked, all before entering a trade. By creating a trading plan, you can help avoid some of the typical mistakes new traders make when starting out, like poor risk management. Your trading plan also serves as a reminder to the rational for getting into a position when you may consider changing tactics in the middle of a trade.
Risk management: always consider using stop losses
Rather like the name suggests, a stop loss ‘stops your losses’ if a market price moves against you. Essentially a stop loss is a type of closing order whereby you specify how much risk you are willing to accept on a trade. If the market moves in the opposite way to your prediction and you start to suffer a loss, our systems will automatically close your trade at your maximum risk level. You can set the level you want your position to close when opening a trade or you can edit an existing position through our platform to add a stop loss later on.
Stop losses are free to use and they protect your account against adverse market moves, but please be aware that they cannot guarantee your position every time. If the market becomes suddenly volatile and gaps beyond your stop level (jumps from one price to the next without trading at the levels in between), it’s possible your position could be closed at a worse level than requested. This is known as price slippage.
Guaranteed stop losses, which have no risk of slippage and ensure if a market does move against you, the position is closed out at the stop loss level you requested, are available for free with a basic account. Ask our account managers for more details, or discover how to manage your risk.
To become a successful trader, you must learn how to understand macroeconomic data releases and indicators.
Let’s start with introducing key macroeconomic indicators which drive the market.
GDP – Gross Domestic Product:
GDP is the widest indicator of a country’s economy and shows total market value for all goods and services produced in a given year. GDP itself is often regarded as an indicator follower, so most investors focus on two reports which are published in the months before the final GDP and preliminary report.
Those reports can cause considerable market volatility.
CPI – Consumer Price Index is probably the most important indicator of inflation. It is a statistical estimate constructed by using the prices of a sample of representative items whose prices are collected periodically. CPI simply measures a rise of prices of goods and services and it is computed for different categories and sub-categories.
If the publication of CPI is higher than expectation, this means that inflation pressure is high and the central bank can raise interest rates, which could lead to an increase in the value of the currency.
Retail sales is an indicator published every month and is crucial information for FX traders, because it shows the spending power of consumers.
The higher the number, the higher the expectation for the economy, so a positive release means that there is greater expectation of future GDP growth.
Because fundamental analysis is based on observation and analysing macroeconomic situations, we’ll look at data releases in more detail.
Labour market data can also be an important factor in the financial markets. Two of the most high-impact data prints are unemployment rates and the US non-farm payrolls.
Unemployment rates show the percentage of the total labour force that is unemployed but actively seeking employment and willing to work.
Before we study the reaction of the market to labour market data, let’s analyse the internal dependence on the labour market.
The steady increase in the level of unemployment is a manifestation of a deteriorating economic situation of the country, negatively perceived by the financial markets as a signal to retreat from the currency.
The market concludes that the higher the unemployment level, the weaker the currency.
The most important cyclical data published in the US takes place every first Friday of the month at 2.30pm, known as the non-farm payrolls or NFP.
Newly created jobs in the non-agricultural sector reflect the economic conditions of the country.
High index values are a positive signal and can contribute to a country’s currency appreciation.
Take a glance at market publication on GBP/USD :
The NFPs in this case was much higher than expected, leading to the dollar to strengthen in value.
The impact of interest rates on exchange rates
Let’s move to the most important factor which determines the behaviour of exchange rates – interest rates.
The decision on interest rates
Each trader should know that an increase in interest rates means for most investors the higher profitability of safe investments in that country. Free capital “circulating” on international markets can be very quickly transferred to the strengthening currency, causing its appreciation. At the opposite end of the spectrum, reduction of interest rates causes the currency to lose its value.
Let’s say for instance that the Council of the European Central Bank unexpectedly lowers key interest rates by 25 basis points to 1.25%.
Let’s see the reaction of the EUR/USD market:
As you can see, fundamental data releases drive the market and increase volatility. Please note however that the market reaction often various according to existing sentiment or expectations, and often can already be priced in.
What is fundamental analysis?
Fundamental analysis is considered the cornerstone of investing and stock-picking. Typically broad in nature, the fundamentals ultimately boil down to the review of financial statements of companies. The main financial reporting statements used in fundamental analysis is the balance sheet, the income statement and finally the cash flow statement. These statements can give traders and investors an idea of the company’s financial performance over a long or short period.
Companies are legally obligated to report these figures on a quarterly basis. By reviewing these statements, traders can evaluate whether a stock is undervalued or overvalued. By using key fundamental ratios, traders can compare the performance of a stock relative to another stock, which can be instrumental in identifying potential trading opportunities.
Key fundamental ratios to be aware of
Here are some of the key ratios that fundamental analysts often use to compare stocks:
Earnings per share (EPS)
The most commonly used fundamental is earnings per share (EPS). EPS is a direct indicator of a company’s profitably and is calculated by taking net income less the dividends from preferred stocks and dividing it by the weighted number of shares outstanding. In general, EPS is considered the most single most important ratio as it not only determines the monetary value of earnings per share, but it also feeds into the calculations of the price-earnings ratio (P/E). Generally speaking, the higher the EPS, the more profitable the company will be in the future.
Price to Earnings ratio (P/E)
The price to earnings ratio or P/E ratio is defined as the market value per share divided by the earnings per share. What this ratio tells us is how expensive this stock is relative to its earnings. Essentially P/E ratio indicates the dollar amount an investor can expect to invest in a company in order to receive one dollar (or base currency) of that company’s earnings. Generally speaking, a high P/E ratio means the company is a ‘growth’ stock where one can expect stable dividends in the future; whereas a low P/E ratio means the stock is a ‘value’ stock which is currently undervalued.
Finally, the dividend yield ratio is defined as the how much a company pays out in dividends each year relative to its share price. This is calculated by dividing annual dividend per share by the price per share. Essentially, the dividend yield ratio tells you how much cash flow you are getting for each dollar investing in the stock. This can be viewed as interest earned on the investment, and generally the higher the dividend yield the better. However, the only downside to higher dividend yield is limited upside growth potential of the company itself.
What is fundamental analysis?
During this lesson we will look at fundamental analysis in more detail.
Unlike technical analysis, which looks at price action and trends to help pinpoint where prices may head to next, fundamental analysts consider all available data to help them to determine the relative value of a market. They then look for discrepancies between the current market price and their own valuation to spot trading opportunities. For example, they may want to go long or buy Apple shares if their own valuation of Apple is higher than its current share price.
While technical traders believe all the information they need can be found in the charts of a market, fundamental traders analyse a multitude of information including political, economic and social, as well as significant macroeconomic data releases and corporate earnings.
Some of the most important macroeconomic data releases include:
Interest rates can have a direct impact on currency rates; often, the demand for a currency with a higher yielding interest rate is greater than the currency with a lower interest rate.
Labour market data
Data from labour markets, such as the US non-farm payrolls, are highly influential in the financial markets and can spark volatility in indices and forex. The employment report is released on the first Friday of every month, and represents the total number of paid US workers of any business. This market is very sensitive to this type of data, because of its importance in identifying the rate of economic growth and inflation.
If the non-farm payroll is increasing, this is a good indication that the economy is growing. If increases in the non-farm payroll occur quickly, this indicates that inflation could be increased. If the payrolls come in below expectations, FX traders will usually sell USD in anticipation of a weakening currency. If it beats expectations, the value of the US dollar usually increases.
Inflation is the rate at which the general level of prices for goods and services is rising. Central banks attempt to limit inflation, and avoid deflation, in order to keep their respective country’s economy running smoothly.
Aside from non-farm payrolls, there are other economic indicators that can have impacts on the market – such as retail sales figures. Retail sales are an important economic indicator because consumer spending drives much of the economy.
Company earning reports
Fundamental analysts look at a company’s financial statement to evaluate whether to take a position on that particular stock. This involves looking at revenue, expenses, assets, liabilities and all the other financial aspects of a company, which are often made available through quarterly earnings reports.
Here, we take an in-depth look at all the factors you need to consider when opening a forex position.
All forex pairs are quoted in terms of one currency versus another. Each currency pair has a ‘base’, which is the first denoted currency, and a ‘counter’, which is the second denoted currency.
Each currency could strengthen (appreciate) or weaken (depreciate). As there are two currencies in each pair, there are essentially four variables you are speculating on when it comes to forex trading.
If you believe the value of a currency will rise against another, you go long or ‘buy’ that currency. If you believe the value of a currency will fall against another, you go short or ‘sell’ that currency.
So for example, if you felt the USD would strengthen (appreciate) against the JPY, you’d go long or buy the USD/JPY forex pair. You’d also buy if you felt the JPY would weaken (depreciate) against the USD. Alternatively, if you felt the JPY would strengthen against the USD or the USD would weaken against the JPY, you’d sell or go short USD/JPY.
An example of a forex trade
Here, we explain the aspects of both a winning and losing trade.
Let’s say you believe that GBP will strengthen against the USD due to weaker than expected data coming from the US’s non-farm payrolls. By buying GBP, you’re simultaneously selling USD.
You buy GBP at 1.5662 in the hope that the market will react the way you predicted.
Spreads and pips
When trading on forex, you’ll notice that there are two available prices. One is the sell or ‘bid’ price, and one is the buy or ‘ask’ price. The spread is essentially the difference in price between these two figures. We offer tight spreads on our forex pairs, which means you’re closer to the market value of the underlying instrument. If the market moves in your favour, your trades can become profitable earlier.
Pips, or percentage in points, are where traders make profits or losses. Most of the currencies we offer are quoted to four decimal places. One pip is the smallest movement a currency pair can make. Let’s take a look at GBP/USD which trades at 1.5560. If the price moves to 1.5565, this is a change of 5 pips.
For even more precise quotations, we offer some prices that are quoted in fractional pips – this means there is an extra decimal place in the quote. So, a change in price from 1.55652 to 1.55664 means a movement of 1.2 pips. Learn more about pip value here.
Put simply, forex – also known as FX or foreign exchange – is the exchange of one currency for another at an agreed price.
Let’s say you’re planning a holiday to the United States and you need to change your spending money from pounds sterling (GBP) into US dollars (USD).
On Monday, you find a local currency exchange and see that the exchange rate for GBP/USD is $1.45. This means that for every pound you exchange, you’ll get $1.45 in return. You spend £100 to get $145.
However, you pass the same currency exchange a few weeks later and notice that the latest exchange rate for GBP/USD is now $1.60. Your £100 would now get $160 – an extra $15 – had you known to wait for the pound’s rise in value against the dollar.
Currency exchange rates are fluctuating all the time for a variety of factors such as the strength of a country’s economy. What forex traders seek to do is profit on these fluctuations by speculating whether prices will rise or fall.
Ready to try forex trading with a demo?
Forex is a 24-hour market.
Essentially, forex trading is the act of speculating on the movement of exchange prices by buying one currency while simultaneously selling another. Currency values rise (appreciate) and fall (depreciate) against each other due to a number of economic, geopolitical and technical factors.
Forex is a globally traded market, open 24 hours a day, five days a week (Monday to Friday). It follows the sun around the earth, opening on Monday morning in Wellington, New Zealand, before progressing to the Asian markets in Tokyo and Singapore. Next, it moves to London before closing on Friday evening in New York.
Unlike most markets, forex is an over-the-counter market (OTC) which means that there is no physical location or central exchange and trades take place 24 hours a day through a global network of businesses, banks and individuals.
Liquidity and leverage
Forex is the world’s most traded market with an average turnover in excess of $5 trillion a day.
This means that currency prices are constantly fluctuating in value against each other, creating multiple trading opportunities for investors to take advantage of. Moreover foreign exchange is a leveraged product, which means that you can gain a much greater exposure to currency moves than you would normally be able to when physically buying currencies.
What makes forex trading so volatile?
Forex rates are one of the most important means to determine a country’s level of economic health, so they are constantly watched and analysed against a multitude of different factors.
This is what makes trading forex so fast-paced and exciting – high market liquidity means that prices can change rapidly in response to news and short-term events, political conditions, international trade, central bank policy and more.
Some of the key factors that influence forex prices are:
What is leverage?
Leverage allows you to gain a large exposure to a market for a relatively small initial deposit. This means that if a market moves in your favour, your net returns could be much greater than in traditional trading and your profit is magnified.
However, if a market moves against you, your losses can also exceed your initial deposit, so it’s important to understand how to manage your level of risk when trading.
Let’s use a few examples to understand the way leverage works.
Our first trader wants to open a trade on EUR/USD worth 0.1 lots.
The contract value is therefore €10,000 and leverage is 200:1 or 0.5%.
This means that the investor needs 0.5% of €10,000, which is €50, as a deposit to open their position.
Our second trader wants to buy a contract for S&P500 with a multiplier of 50.
For the sake of this example, let’s say the price of the S&P500 is 2,000.
To open a position without leverage, the investor would need 2,000 x 50 = $100,000 (USD) in their account.
If the leverage is 100:1, the trader only needs 1% of that to open a position. So with just $1,000 as an initial deposit, they can gain an exposure equivalent to $100,000 in the S&P500.
The benefits of leverage:
The risks of leverage:
If you have a basic account you can reduce your overall risk by using a guaranteed stop loss, where available, which can limit potential losses to a specific amount, or you can simply reduce the size of your position.
Margin levels and initial deposit requirements
Your margin level is the deposit required to maintain each open trade on your account. To open and maintain your trade, you must have sufficient trading resources to cover the margin requirement at all times. Free margin represents the amount of capital you have remaining to place new trades or cover any negative price moves in your open trades.
At GFX, we operate a margin limit level of 30%. The limit level is calculated by dividing your equity by the required margin and multiplying by 100%.
Within our trading platforms, you’ll find an indicator called the margin level. When this indicator falls below the level of 30%, your open position with the biggest loss will be automatically closed as an in-built safety mechanism by us to help you from incurring even greater losses. To avoid being closed out of your position by a margin call, you’ll need to ensure your margin level is always greater than 30% by depositing more funds.
Trading with the trend
All financial markets move in two distinct trends; up or down. When markets are not in a trend, they are then moving sideways, where there is an ongoing battle between sellers and buyers. By spotting which of these two types of trends a market is in can help to present strong trading opportunities that come with transparent guidelines.
This strategy is dictated by one simple rule: trading the path of least resistance by always trading in the direction of the prevailing trend. Imagine a wave moving towards the shore; the easiest thing a trader can do is ride atop the crest of that wave, not swim against it.
Of course, a trend can change at any given time but you can use technical indicators to try to pinpoint at which point a trend is likely to have changed direction.
A rising market
If a market is rising, you may consider buying that market and trade with the prevailing trend i.e. the path of least resistance. The key will be picking the right moment to get into a buy position. Ideally you want to get into the buy position as low as possible, to maximise your potential upside. Some traders may wait for a pullback (a small dip in the market) but this carries the risk of waiting too long to get into the market and you could miss out on further upside.
A rising market, also known as an uptrend, shows a series of higher highs and higher lows. In other words, each bottom (support) is higher than the previous one.
A market trending lower
Conversely, if a market is falling you may consider selling that market. To maximise your potential returns you would need to enter that market as high as possible, thereby enabling you to maximise any downward move in price.
A falling market, also known as a bearish trend, is where the market creates lower lows and lower highs.
What to do in a sideways market
A market moves sideways when it’s at a point of indecision and buyers or sellers are at an impasse. Buyers and sellers test each other, but no pure consensus emerges. Here, most traders face two potential strategies; range trading or waiting for a breakout.
Typically when a market moves sideways it does so within a specific range. The upper part of this range becomes a resistance point, where prices struggle to go higher, whilst the lower part of the range becomes a point of support, where buyers typically emerge. Range traders look to take advantage of prices staying in the range by buying when prices are near the bottom of the range or selling when they are close to the top. Traders can manage their risks by placing stop losses just outside of the range in case of a breakout, meaning any potential losses are minimised.
Those traders waiting for a breakout typically place buy orders above the top of the range or sell orders below the range to capitalise on a breakout. Remember however that this strategy carries the risk of a false breakout.
When identifying a trend
One of the most important things when identifying a trend is determining your time frame. Usually, when you are analysing a long-term trend you’ll use a long-term time frame over a short-time frame. However, for intraday purposes, shorter time-frames are of greater value. Large commercial traders might be interested in the fate of a currency or company over a period of months or years. For retail traders however, a weekly chart can be used as a ‘long-term’ reference.
By setting up a short-term exponential moving average and a longer term simple moving average on a weekly and daily chart, it is possible to gauge the direction of the trend (learn more about moving averages and trend identification here). Knowing the trend does help in taking positions but bear in mind that the markets move in waves. These waves are called impulse waves when in the direction of the trend and corrective waves when contrary to the trend.
By counting the waves or pivots in each wave, you can attempt to anticipate whether a trading opportunity will be against the trend or with the trend. This is where the Elliott Wave theory comes in – an impulse wave usually consists of five swings and corrective wave usually consists of three swings.
In the early 20th century, Ralph Nelson Elliott discovered that stock markets do not behave randomly, but that they actually tend to follow the laws of nature based on Fibonacci ratios. The conclusion was that market movements can be predicted and actually measured.
The Wave Principle was based around the idea that rising and falling price moves have repetitive sequences which he called waves. In his typical wave structure, a market movement was made up of five waves in the direction of the trend (known as 1, 2, 3, 4 and 5) and three waves forming a corrective movement (known as A, B and C).
The Elliott Wave Theory was later developed by the likes of AJ Frost, Robert Prechter and Robert Miner, who created many rules on how the theory could be put to practice. Below you can find some of the most important rules:
Below you can find an example of the Elliott Wave Structure on a Daily time interval on the EUR/USD market:
Now let’s see if the above example adhered to the four aforementioned rules:
Below you can find another example of the Elliot Wave Structure, this time on a 4 hourly time interval on the EUR/GBP market:
Using this example, let’s see if the four rules were adhered to:
As you can see, in all examples provided, the Elliott Wave Theory was fairly consistent in identifying the trend of a market. However, it should also be said that one should consider multiple technical indicators when identifying a trading opportunity to have the highest probability of success.
The Elliott Wave Theory as a whole is not a simple concept and does require time to understand and even more time to apply, but what many traders do is apply Elliott Wave Theory derived rules and blend them with other technical analysis tools, thus creating high probability technical analysis set-ups.
Price patterns are very important tools used in technical analysis. Price patterns can help us to identify turning points on the market as well as to define the strength of a given price movement.
Price patterns are divided into two groups:
You can look for price patterns on chosen time intervals depending on your trading strategy. However, you should remember that patterns forming over a longer period of time are more reliable than those observed on shorter intervals.
Trend reversal patterns
Trend reversal patterns indicate the weakness of the current trend and initiation of a movement in the opposite direction.
Using price patterns you can also calculate the minimum price objective for the fall or rise which should occur after the pattern is completed.
The ones that appear on the local tops indicate the possible reversal of an uptrend.
Head and Shoulders Pattern
This is the most popular reversal pattern. It’s built from three price peaks with the highest peak in the middle. The head and shoulders pattern requires a neckline, which is the line that connects local lows reached by the price between the head and two shoulders. When the market price cuts the neckline, this is a signal that the downtrend is starting. To find a minimum price objective for the fall, you need to mark the distance between the head and neckline and then put this section in the place where the neckline was broken.
Each pattern observed on the local tops has its equivalent on local bottoms, indicating the end of a downtrend and the beginning of a growth trend. They constitute the mirror image of formations occurring on tops. The head and shoulders pattern at the bottom is called an inverse head and shoulders pattern:
Let’s have a look at real market example:
The head and shoulders pattern is a strong signal, especially when prices break the previous structure’s high. This is first indication of weakness, after which prices retrace to support level and continue moving higher.
Double top and double bottom formation
Other examples of the pattern and its mirror image are the Double Top and Double Bottom.
The double bottom looks like the letter “W”. When this pattern is spotted, it signals a possible reversal. Prices have reached their lows and the bulls are starting to take control.
Meanwhile, the double top is shaped like an “M”. The formation occurs in an uptrend when prices have reached a high, and bounce from the top before making their way lower. The minimum price objective for M and W formations is measured by taking the high or low of formation to the last point of resistance or support.
Our example shows a double bottom formation created in strong downtrend. The second attempt to break the first bottom was done with higher volatility (wick and huge spread on candle) and this eventually leads to a reversal.
The second group of price patterns are continuation patterns which confirm further market movement in the direction of the current price movement
The first group of continuation patterns are triangles which are created by two converging trendlines. There are three types of triangles: symmetrical, ascending and descending. A triangle is completed when one of its trendlines is broken by the market price. To define the minimum price objective for the price move which should occur after a triangle is created, you should mark the distance between two trendlines taken at the beginning of triangle formation and then put this distance in the place where trendline was broken. The best environment for trading triangles is in a strong developed trend.
Let’s see how the symmetrical triangle on a
4-hour chart leads to move continuation. After breakout from the descending trendline, we see huge moves up within the direction of the trend.
Other effective continuation patterns are rectangles.
Rectangles can be very profitable as a formation that forms during a trading range when there’s a pause in the trend. The pattern is easy to identify just by comparing highs and lows.
The longer the price remains within the formation, the more dynamic the move after the breakout.
As you can see on our real market example prices often pause, and trade in the range and then break in the direction of the trend.
Flag and Pennant
The flag pattern forms what looks like a rectangle, but the flag is not perfectly flat and will have its trendlines sloping.
The pennant is a formation that looks similar to symmetrical triangles, but is smaller in size (volatility) and duration.
On our market example we see the perfect flag. The price is dropping slowly stopping on lower trendlines and continuing higher with direction of the main trend.
You should keep in mind that opening positions should take place after the whole pattern is created, and an important level for each pattern is broken.
Indicators and oscillators are tools that help identify the prevailing trend and sentiment, and are also used to determine turning points as well as entry and exit points.
Some of the most popular indicators are:
Some of the most popular oscillators are:
Moving averages are basic indicators for determining trends. When the price of an instrument is above the moving average the trend is up, and when it’s below it’s down. This is a very simple, but very effective tool.
Simple, Exponential, Weighted – all period 50
Moving averages are used to gauge the direction of the current trend. Every type of moving average is calculated by averaging a number of past data points. Moving averages can be calculated based on closing price, opening price, and high or low prices.
For identifying significant, long-term support and resistance levels and overall trends, the 50-day, 100-day and 200-day moving averages are the most common.
A basic trading signal on moving average appears when prices cross the moving average. A sell signal is indicated when the asset’s price crosses under the moving average. This suggests that the market price is losing momentum and is under-performing when compared to the moving average.
A buy signal is when the asset’s price crosses over the moving average. This is an indication that the price is trending upwards as it is increasing at a faster rate than the moving average. For this reason, this is typically seen as a potential opportunity to buy.
Trade signals on multiple moving averages
Investors often place several moving averages on the same price chart. One of the moving averages will be designated the faster moving average consisting of fewer data points, and one will be a slower moving average. The faster moving average will be more volatile than the slower moving average.
Bollinger bands are volatility bands placed above and below the moving average. The volatility is based on the standard deviation, so the wider the bands are, the higher the volatility.
Let’s take a look at when we should be looking to buy, as well as what selling signals to look out for using Bollinger bands.
Oscillators take their name from the fact that they oscillate (in a manner similar to a sine wave) around a horizontal line called the line of balance. This refers to your price points and zero momentum, which is the point at which the momentum does not rise or fall.
The MACD indicator was developed by Gerald Appel. It shows the difference of the two exponential averages moving with nine-period exponential average of the difference as a signal line.
Currently, a typical MACD indicator is defined as 12-26-9, where the average 12 and 26 day-old calculates the difference, and 9-day average is a signal line.
The result is a smooth oscillator that can give signals to the transaction: the intersection of the zero line, divergences, and the intersection of the input signal in overbought or oversold zone.
Let’s move to trading signals which are generated by MACD.
The MACD buy signal is generated when the MACD (blue line) crosses above the MACD Signal Line (red line). Similarly, when the MACD crosses below the MACD signal line a sell signal is generated.
We could also place trades based on MACD when the blue line crosses the zero line. Then the buy signal is generated when blue line crosses above the zero line and sell signal when it crosses below.
The MACD moving average crossover is one of many ways to interpret the MACD technical indicator. Using the MACD histogram and MACD divergence warnings are two other important methods of using the MACD.
RSI (relative strength index)
The RSI is a technical momentum indicator that compares the magnitude of recent gains to recent losses for determining when the underlying asset is overbought or oversold.
The RSI is probably the most common oscillator and is typically used for 14-day periods. RSI value falling within the 0 to 30 region is considered oversold. Traders assume that an oversold currency pair is an indication that the falling market trend is likely to reverse (i.e. a bullish signal) and is treated as a buy opportunity.
On the other hand, an RSI value falling into the 70 – 100 region of the scale is regarded as being overbought.
This signal suggests that the resistance level for the given asset is near or has been reached and the rate is likely to fall; traders would interpret this as a sell (i.e. a bearish signal) opportunity.
Remember that you enhance your chances of success by using trading signals that are in the direction of the main trend.
Broadly speaking, there are two approaches that traders use to access the market. These are known as fundamental analysis and technical analysis.
While fundamental analysis looks at the economic information of a company, commodity or currency, technical analysis only uses the chart to predict future price movements.
As one of the most popular methods used today by traders to help identify trading opportunities, there are three principles of technical analysis:
The market discounts everything
Technical analysis only considers price movement, ignoring fundamental factors, since all these factors affecting the market price are assumed to be contained within these movements. Therefore, all that needs to be examined is the price itself.
Prices move in trends
In technical analysis, price movements are believed to follow trends. This means that after a trend has been established, the future price movement is more likely to be in the same direction as the trend than to be against it. Most technical trading strategies are based on this concept – learn how to trade with the trend.
History repeats itself
The cornerstone of technical analysis is the belief that history tends to repeat itself. As such, technical analysts utilise historic price data to help them to forecast where prices are likely to head to next. This is where support and resistance levels come in.
Charts are the most important resource in a technical analyst’s armoury. Charts help you to track how prices have traded over a particular time period, enabling you to spot trends and use tools to forecast where prices could turn to next.
A OHLC chart plots four important bits of information for a specific timeframe to give you a visual reference for how prices have behaved. They trace the Opening price (left-hand side of the bar), Highest price (the high), Lowest price (the low) and the Closing price (right-hand side of the bar).
Candlesticks are one of the most popular charting tools as they give you an excellent visual reference to the movements of prices within a time frame such as minute, hourly, daily, monthly and more. They operate like OHLC charts except with a coloured body to trace the difference between the opening and closing price of a bar.
The author of the Fibonacci sequence of numbers was an Italian mathematician, Leonardo Pisano. This sequence has been known for centuries as the sequence of numbers: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89 and so on and so on, until infinity. The number is calculated by the sum of the two numbers before it.
Example: 1+1=2 or 3+5=8
This numerical relationship has also been used in financial markets for over a century. Particularly important is the golden number Phi. Phi was created by the golden ratio. The Golden Ratio is the ratio of any two consecutive numbers, where the higher number is the numerator and the smaller number equals the denominator. The result is always approximately 1.618, as seen below:
a = 0.618
b = 0.382
0.618/0.382 = 1.618
Golden Ratio: 0.618 + 0.382 = 1.000
There are many Fibonacci ratios and methods to their calculation, but we’ll focus on its practical use so that you can apply it to your trading.
The Fibonacci retracement is a method of determining the potential resistance and support levels of an asset’s price. It is based on the idea that a price will retrace a predictable portion of an original movement, after which it will continue to move in its original direction. Often a correction retraces a Fibonacci percentage of a preceding wave. Historically, the most common retracement areas have been 38.2%, 50% and 61.8%. These levels are where the majority of analysts focus on, as they act as a potential turning point in the market.
For example, on this chart of gold we see the price rally towards $1,190. Then prices fall precisely to the 38.2% of this swing, before prices stabilise and continue higher once again.
The next chart shown is GBP/USD on a 15-minute timeframe. As we can see, markets began to retrace to the 38.2% area, but could not stabilise and continued to fall to the next retracement level of 50%. Prices then recovered to reach a new high, continuing its previous upward trend.
Fibonacci analysis enables traders to forecast the levels of support and resistance from a price correction and could help identify price targets and potential turning points in the market.
The measurement should be in the same direction as the measured movement of price. After the measurement, horizontal lines will be imposed on the chart. These lines are potential support and resistance levels.
How to draw Fibonacci retracements on your charts:
Preferably, you use the shadows of the candles, so that the study includes the extremes of the market sentiment. Most of the time, the difference is insignificant but sometimes it can be crucial. In the examples below, you can see that the Fibonacci retracement has been drawn to the shadows of the candles, at the bottom and top of the trend.
Fibonacci retracements can be very efficient for timing entries in the direction of the trend. This method is often used as part of a trend trading strategy by investors. In this strategy, traders observe important price levels taking place within a trend. Next, traders try to open a position in the same direction of the initial trend (considered lower risk). When using this scenario, you anticipate that the price has a probability of bouncing from the Fibonacci levels back in the direction of the main trend. On our example, the price fell to the level of 61.8% of the retracement before recovering. The odds of a turning point in the market increase highly when a Fibonacci retracement level coincides with pre-determined support or resistance levels in the market.
We see the same situation in the next chart when the price stopped for a longer time on 61.8% retracement. This corresponds with last resistance level and the market goes back into the direction of the main trend.
This is only a brief introduction of the Fibonacci Retracement and this tool can be used effectively in various methods.
Candlestick patterns are divided into two groups: trend reversal patterns and trend continuation patterns.
Let’s start by looking at popular trend reversal patterns.
Trend reversal patterns indicate the weakness of the current trend and initiation of a movement in the opposite direction.
One common reversal pattern is called a shooting star which can indicate the potential end to a bullish trend.
A shooting star is a pattern that consists of just one candle. It has a small body and a very long upper shadow. The colour of the body can be either black or white, but a stronger sell signal is generated when the body is black.
In order for the candlestick to be considered a shooting star, the formation must be on an upward or bullish trend, and the distance between the highest price for the day and the opening price must be at least twice as large as the shooting star’s body.
The long upper shadow of a shooting star implies that the market tested a resistance level, only for sellers to push prices lower. After an uptrend, the shooting star can signal to traders that the uptrend could be over, at least in the short term. However, other technical analysis tools should be used in conjunction with the shooting star, and you should keep in mind that traders typically wait for the whole pattern to be created before placing a new trade. Because the shape of the shooting star may change before the interval has been completed.
The bullish version of the shooting star pattern is known as the hammer.
Trend reversal patterns can also appear to signal the end of a potential downward trend i.e. markets could soon head higher. They constitute the mirror image of patterns occurring on tops:
Now let’s look at continuation patterns.
Trend continuation patterns are used by candlestick traders to confirm further market movement in the direction of the current price trend. They often appear after a long period of stabilisation or correction on the market.
Here’s how continuation patterns look when prices are in an upward trend:
Three White Soldiers
The three white soldiers is a pattern that consists of three bullish candles which have a similar construction. Each candle closes higher than the previous one. Candlesticks with no shadows increase the strength of this continuation pattern.
Here’s how a continuation patterns look in a bearish trend:
Three Black Crows
The three black crows is a pattern that consists of three bearish candles which have a similar construction. Each candle closes lower than the previous one. Candlesticks with no shadows increase the strength of this continuation pattern.
Candlestick patterns are important tools that help in technical analysis and in the understanding of market emotions. Thanks to them you can define potential turning points in the market, which is why they often constitute one of the most important elements of a strategy for technical traders.
Let’s explore how to spot trading opportunities using simple moving averages.
Any trading strategy needs to include specific information for not only when a trade may be opened, but also a risk management system to cut your losses. This increases your overall probability of trading success over the long-term.
Simple Moving Averages
One of the most popular technical analysis tools is the Simple Moving Average, which is calculated by adding the closing prices of a given market for a chosen number of periods and then dividing this number by the number of periods.
The general rule is that when the market breaks below a moving average (i.e. from above), with the body of a candlestick and not with only a shadow, then that is a signal that the bears are gaining power and that there is a bigger probability the market would start to fall.
On the other hand if the market breaks above a moving average (i.e. from below), with the body of a candlestick, then this is a signal that the bulls are gaining power and that there is a bigger probability the market would start to rise.
Of course, you can use multiple different moving average periods and many traders use more than one period (such as 50 and 100 or 100 and 200) to give them a greater sense of the current market direction and when a trend may soon reverse.
Below you can find an example of a 89 period moving average on the hourly
chart and how this strategy would have performed:
It’s very important to clearly define the moment when a trade should be entered but it’s also crucial to know when to exit a trade, whether on a profit or loss. There is a belief that trading is not so much about the number of times that a trader anticipates what the market will do, but rather about making as much when the market does what is expected and losing as little when the market does the opposite of what is expected.
Of course, it’s up to you to find out what kind of strategy works for you when trading.
To begin analysing charts, it’s crucial to understand what type of charts can be used to predict market movements and how different charts are built. The three most popular types of charts are:
A line chart is formed by connecting points representing the closing price of different time intervals with a line. Line charts are one of the oldest types of charts, used in the past by stock traders. One of the advantages of using a line chart is the amount of visibility they provide. However, line charts only provide you with information about the closing price at a given time interval. The information that line charts miss out on are the opening price, the maximum price and the minimum.
Below you can find an example of a line chart on the 15-minute interval on the EUR/USD.
Unlike line charts, bar charts provide traders with all the relevant information about a given time interval; the close price, the open price, the maximum and the minimum. This can be best understood by having a look at an example of a bar below:
The bar is formed initially by a horizontal line appearing on the left side of the vertical line and this represents the opening price of the chosen time interval. After the opening, the vertical line starts forming where the top of the vertical line represents the maximum of the time interval and the bottom of the vertical line represents the minimum of the time interval. When this interval reaches its end a horizontal line appears on the right side of the vertical line representing the closing price of the interval.
What should be kept in mind is that is the left horizontal line is below the right horizontal line, and this bar represents an ‘increase’ bar where the market gained in power. On the other hand, if the left horizontal line is above the right horizontal line, then this bar represents a ‘decrease’ bar where the market lost momentum.
In conclusion, bar charts can provide you with all the necessary information about a time interval but on the other hand, their flaw is the lack of visibility, especially when you zoom out of the market. With a zoomed out chart it is very difficult to determine whether a given bar was an increase or decrease bar.
Below you can find an example of a bar chart on the 15-minute interval on the EUR/USD.
Candlestick charts date back to 18th century Japan where rice traders plotted candlestick charts to analyse possible movements in prices that may affect their business. Similar to bar charts, candlestick charts provide you with all the necessary information about a time interval and also solve the problem of visibility, which is the flaw of bar charts.
A candlestick is formed like a bar with one exception; the horizontal lines are expanded to both sides and connected forming a body for the candlestick. If the given candlestick noted an increase the body will be either white or green, while if the candlestick noted a decrease the body will be either black or red. Of course, the colour of the body of the candlestick may differ and that will depend on the trading platform or your own preferences.
As explained above, the body will represent the opening and closing prices and the vertical lines coming out of the body will represent the maximum and the minimum of the time interval. These are called shadows.
What is interesting about candlesticks is that they tend to create shapes and sequences of shapes which allow traders to understand the market’s current sentiment and also aid in identifying possible reversal zones.
Below you can find an example of a candlestick chart on the 15-minute interval on the EUR/USD.
A risk:reward ratio is utilised by many traders to compare the expected returns of a trade to the amount of risk undertaken to realise the profit. To calculate the risk:reward ratio, you divide the amount you stand to lose if the price moves in an unexpected direction (the risk) by the amount of profit you expect to have made when you close your position (the reward.)
Some of the most popular reward:risk ratios are 2:1, 3:1 and 4:1 and these will change depending on the strategy of the trade. Of course there are other aspects which may affect the risk of a trade, such as money management and price volatility but having a solid reward:risk ratio can play a strong role in helping you to manage your trades successfully.
An example of a risk:reward ratio
Let’s say that you decide to go long on ABC shares. You ‘buy’ 100 lots, equivalent to 100 shares, which are priced at £20 for a total position value of £2,000 – on the basis that you believe the share price will reach £30. You set your stop loss at £15 to ensure that your losses do not exceed £500.
In this case then, you’re willing to risk £5 per share to make an expected return of £10 per share after closing your position. Since you’ve risked half the amount of your profit target, your reward:risk ratio is 2:1. If your profit target is £15 per share, your reward:risk ratio would be 3:1, and so on.
It’s important to remember however, that while risk:reward ratios helps to manage your profitability, it doesn’t give you any indication of probability.
The importance of a risk:reward ratio
Most traders aim to not have a reward:risk ratio of less than 1:1 as otherwise their potential losses would be disproportionately higher than any likely profit i.e. a high-risk trade. A positive reward:risk ratio such as 2:1 would dictate that your potential profit is larger than any potential loss, meaning that even if you suffer a losing trade, you only need one winning trade to make you a net profit.
Below we have included a table below to highlight different reward:risk ratios and their impact on your total profits and losses. The table below assumes 1 is equal to £100 and you have a win rate of 50% across 10 trades.
You can see clearly from the table below the potential benefits of having a positive reward:risk ratio and how this can impact your net profitability.
First, let’s look at the basics of what constitutes a good strategy.
A Trading system is the consistent application of the rules which govern a particular strategy, such as specific entry and exit points or always trading in the direction of the prevailing trend.
Psychology is the work on your own emotions that arise during trading and investing. Learn more about the psychology of trading.
Money management is the part of the strategy which specifies the size of the position, the amount of leverage used and the Stop Loss and Take Profit levels. Good money management is a vital part of trading successfully over the long term.
Proper consideration of these elements will play a strong role in your ability to maximise profits and minimise losses.
Let’s look at a situation where these elements are being largely ignored. In this example, let’s say your account funds are $5,000 and you sell EUR/USD with a trade size of 4.59 lots and leverage of 100:1. In this example, you are utilising most of your account funds in this one position ($4,998.51), giving yourself little leeway for any negative price movement. Every pip move would result in a profit or loss of $45.90. Let’s see what happens next.
Some data is released and markets react by strengthening the euro, which rallies over 100 pips against the USD. This move puts the trade in a loss of $4,590 in a matter of minutes, which is most of the account funds and leaves hardly any left to rebuild the account.
This trade is a clear example of a position that is too large for the funds in the account.
Even the best traders suffer a loss at some point. Its part and parcel of trading. The key is to limit your losses to a more manageable level. This way, you’ll find that you’re able to stay in the market for longer, increasing your chances of having more successful trades. One way to ensure you strike the right balance between reward and risk is to stick to a reward:risk ratio such as 2:1, where your targeted profits are always double that of your maximum losses. So even if you suffer three losing trades, you’ll only need two profitable ones to ensure your total profits outnumber your losses if you stick to this reward:risk ratio.
Let’s look at two traders that are both starting with $10,000 and utilising a 2:1 reward risk ratio, but apply very different levels of money management in their trading. The first trader uses a very aggressive approach, risking 60% of his capital on each trade, and seeking to take profit at 120%. The second trader is much more conservative, and only risks 5% of his account funds. For simplicity, let’s say that each trader has the same set of ten trades, and that every second trade is profitable.
These tables show the trading results of two traders using different levels of risk management.
Despite the fact that both strategies had equal rates of success, the same initial capital and the same 2:1 reward risk approach, because of a very different money management style, the final results differ significantly. The first trader’s aggressive approach resulted in a total loss of 47% whilst the second trader enjoys almost 25% total profit at $12,462. So you can see how a little adjustment to your approach to risk management and can give you healthier profits.
Trading can be hard on your emotions, especially when prices are moving fast and you witness your profits or losses fluctuating rapidly. The impact on your emotions can lead you to make impulse trades, where your emotions override logic or rationality. This is why creating a trading plan can be extremely helpful in keeping you focused on your strategy for each trade.
Here are the typical pitfalls of emotions when trading and how to conquer them:
Every trader hopes that their trades will be successful and that they’ve called the market correctly. But hope can be misleading, especially if prices start to turn against you. Be mindful of this and stick to your strategy. When prices move in a way that proves the rationale for getting into a trade is wrong, you should look to close the trade at the best price possible.
Being scared to enter a trade is fairly commonplace, especially for beginners. Most of the fear of trading is down to the prospect of suffering a loss. But you need to accept that losses are common when trading and you shouldn’t let fear prevent you from taking a solid opportunity. If you continue to be fearful of trading, then perhaps look at longer timeframes.
This is perhaps the worst emotion in some traders. Greed can make you chase the market, run losses, over-trade or worst of all, convince you to leave all tactics aside. Create a trading plan and stick to it. Some traders find that they don’t follow their own rules unless they have written them down – that way, you have a visual reminder each time you open a new position.
Leave emotion out of it
The best way to protect yourself against the emotions of trading negatively impacting your decisions is to treat trading like a business. You need to create a detailed trading plan and strategy behind each position you take and stick to the rules of your plan. Even the best traders suffer losing trades. It’s part of the life of a trader. The most important thing to do when you do suffer a loss is learn from it, don’t repeat any mistakes and move on to the next potential opportunity.
Trading markets is an activity highly reliant on the concept of probability. Therefore, you should not only be looking at having as many profitable transactions as possible, but more importantly to realise as much profit as possible when the market moves in your favour – and lose as little as possible when the market does not.
This is why the concept of the ratio between risk to reward is so important. This concept is connected with how traders may manage their open transactions and how they can run their profits.
In this lesson, we will assume that the minimum accepted risk:reward ratio is 1:3, and this means that when the trader makes money, then he should make at least three times as much as he is accepting to lose. The main reason for this is to be able to generate profits with a smaller number of profitable transactions. Taking this scenario under consideration, let’s use the following example:
With this ratio, the trader can make a profit if he has a success rate of only 30% as you can see below:
30 profitable transactions x £300 profit = £9,000
70 losing transactions x £100 loss = £7,000
Net profit = £2,000
It may seem that having a success rate of just 30% isn’t positive, but the example above shows that it may actually help with achieving success on financial markets.
This ratio will help develop a scheme which will assess how traders can manage open positions.
When you open a transaction you should decide what your maximum accepted loss will be, and set a stop loss. If you use the 1:3 ratio between risk and reward, once your profit reaches an amount three times higher than your stop loss, you have two options:
Example of a Stop Loss shift
Here, the trader opens a position on EUR/GBP, setting a stop loss and minimum target three times higher than the value of the stop loss.
After the market reaches the trader’s target, he shifts his stop loss to a new level and reassigns his target level, providing a chance to increase profits under the same transaction.
The market reaches the trader’s new target, after which the trader repeats the previous action of modifying both the stop loss and also the target level. Unfortunately on this occasion, the market does not allow the trader to keep his transaction open and closes the transaction on the new stop loss.
These are two of the most popular ways of managing your open trades and running your profits, but there are more options that may suit your level of emotional comfort.
An example of the Stop Loss shift based on prior tops and bottoms can be found below.
Here, the trader opened the transaction on the level of the blue line and assigned an initial stop loss on the green line, after which with each breakout of the last bottom the trader assigned a new stop loss on the maximum of the previous top. After three stop loss changes, the market closes the transaction.
In conclusion, there are various methods of managing open trades to increase the probability of achieving higher gains, thus also increasing the risk to reward ratio as much as possible. Try to evaluate what percentage of profitable trades you would require if you increase the 1:3 ratio that was discussed earlier in this lesson to 1:5 or possibly 1:8.
Pip Value & Margin
One of the first decisions you’ll need to make as a trader when initiating your investment process is choosing a trading volume you can apply to your positions.
The choice of trading volume will depend on many psychological factors such as emotional comfort and risk aversion, but the choice of trading volume will also be highly connected with the risk management that you plan to apply. In other words, this means that understanding how the trading volume may affect you is crucial, because the volume you choose will determine both the margin per trade and the value of the pip.
When opening a transaction, you will need a certain amount of outlay. This is known as margin. The margin is not a cost but is an amount of money that is frozen under a given transaction and is returned to you once the transaction has been closed. It is important to know what amount the margin will be so you can evaluate not only the risk itself but also whether the remaining funds will allow you to open additional positions.
What is important is that with CFDs, you only need a fraction of the nominal value to be able to open a position. For example with a leverage of 1:200 you’d only need 0.5% of the nominal value for the margin of the transaction.
The second factor that the volume size will influence is the pip value. In the investment process it is very important to know the pip value, especially for risk management purposes. You should know how your portfolio will be affected if the market goes 100 pips in your favour, or 100 pips against you.
This calculation will help you evaluate on which market level your maximum accepted loss could be and where you can possibly assign a Stop Loss order.
The general idea is that you should not lose more than 5% of your total capital in a position. The reason for this is that trading is based on probability and you should give your strategy a statistical chance of assessment, to identify whether you have a bigger probability of achieving success rather than defeat.
You open a 1 lot transaction on the GBP/USD where the pip value is 10 USD. You will also the follow the rule of not accepting a loss higher than 5% of your total capital. Therefore, your total capital is £5,000 so your maximum accepted loss is £250, which is approximately $380.
If you know that 1 pip is worth $10 and your maximum accepted loss adds up to $380, then by dividing $380 by 10, your maximum Stop Loss level is 38 pips.