Why Forex Traders Plan To Fail Before They Even Place Their First Trade & How You Can Know It & ...

Have you heard the wise saying that a trader who fails to plan, plans to fail? I have, and I was once that trader! However, did you know that even though traders who have constructed a plan, which incorporates their trading stategy (their "edge"), they have a plan that is likely to fail?

If we look at all traders who participate in the market: we have one group that fails to plan and therefore plans to fail; another group whose plan is failed; and a third group who properly plans and therefore does not fail.

Is it any wonder that the success rate for forex traders is so slim?

Well it doesn't have to be.

Here's a list of reasons why those whose plan is destined for failure fail:

1. They become emotionally attached to their ideas about how the market should be with minimal or inadequate testing;

2. They fall in love with their back-tested net profit results without fully understanding other key statistical data;

3. They don't admit they're plan is wrong.

Let's explore each point in a little more detail.

1. Becoming emotionally attached to your ideas without adequate results

Most new traders when they realize the importance of obtaining a trading plan and sticking to that plan immediately begin to use the knowledge they have been taught and haphazardly throw it all together into what they deem their "trading plan".

When they are questioned on whether they have a trading plan most of these traders answer with an unequivocal "Yes!".

Most of these traders are destined for failure because their strategy is untested. They rely on blind faith to guide them through the trading jungle to make their untold millions. Would you walk from one length of the Amazon jungle to the other blind-folded? Of course not! You'll have to watch out for all the snakes, tarantulas, and other creepy things that go bump in the night, so why would you approach trading in the same fashion? I mean all you're really doing is placing the blind-fold on your capital!

Why do traders do this?

Because it's easy. That's right... it's easy. They don't need to learn a computer language to type their system into some piece of software that will take them the better part of 6 months to a year to learn, and they don't have to spend any money on buying historical data. Therefore it's easy and it's cheap and it also conserves time!

So does success meet lazy people like this?

Not many! However I will admit that it does meet a fortunate few - only those lucky enough to start their trading during roaring markets where even a monkey can make money! To repeat again: don't wear the blind-fold. Your success may be great at the start, but given time and trades, you'll be the one out of the game - having depleted all your capital.

So what do you do if you KNOW that your method is untested?

If you have the time, the money and the learning capacity I would strongly encourage you to purchase some back-testing software (such as ), acquire some , ask heaps of questions on the Wealth-Lab forum on how to code your ideas and within 3-6 months you'll be safely coding your own forex system and testing adequately.

If you do not have the time, the money nor the learning capacity I would strongly suggest that you manually write down your system into clearly defined steps that you MUST follow. Then, after opening a DEMO forex account you would trade your system according to the rules you have set out. Trading your rules until about 20 trades have been completed.

After traders obtain their results from their testing period they unfortunately look at only one figure and make a rash conclusion about the system based on that one performance figure, namely, the net profit. This then leads us into the next problem of why traders plans are failed prior to placing their first live trade...

2. They fall in love with the net profit result and no longer question it any further!

The net profit is only one statistic among thousands, however, to keep things simple we will look at the top 3 results that you need to make sure you fully understand.

Here are the other statistical pieces of data that you should look at when your system has completed its testing period:

I. How many trades did it have? If you have made a nice profit, but have only had 3 trades during the testing period you do not have a sufficient sample space to arrive at any safe conclusions. Can you imagine what would happen to Neil Armstrong if NASA had only done 3 computations on how they would arrive on the moon??!! If it's not good for NASA then it's probably not good for you either, however, as NASA do zillions of computations you would only need to conduct about 20 trades as the bare minimum before you can arrive at any safe conclusions;

II. What was your money management procedure during the testing phase? This is by far the most important point, however, you need to make sure your system is properly working prior to even embarking on this difficult area (hence the reason why it is a CLOSE second to the above point). Be sure you fully understand what I am about to explain (read it several times to absorb it if need be)... If you test a method whereby you rely on a percentage amount of capital on a trade you can be biasing your results!

How?

Let us look at the following comparison sheet where we plot 21 trades with their pip return (we'll assume that each pip = US$1), and compare the returns against using 10 contracts per trade, 10% capital per trade, or 2% risk per trade...

Now as you can see from the results they can easily be doctored according to the different type of money management technique you use and what variable you decide to use it on (i.e. who is to say that we not use 20 contracts per trade, or 20% capital, or 5% risk per trade - all of these would inflate the net return figures).

It is best when you trade to stay at a fixed quantity. If you use any results that require a percentage calculation of the equity balance prior to the trade quantity being calculated you will BIAS the last trades more than the trades at the start. Hence, using a fixed quantity throughout the entire sample is one of the true indications of whether your system is profitable or not.

III. What was the drawdown? This is the largest peak to trough distance on your equity curve. In other words, if you were to enter in on the day the equity curve made a peak, how much would you have lost if you bailed out at the lowest point? To test this manually you would obtain an equity curve peak trace how far the equity curve goes down until it moves higher that the peak you started from - the lowest point made between these two points will be your trough figure which you will then subtract from your starting peak figure. The figure with the largest % loss would be your drawdown.

You would then need to look at this drawdown figure and determine whether or not it fits your risk profile. Would you be okay mentally if your account was down the drawdown % figure? If not, then you're going to have to re-create another system. As a rule I don't like systems that generate more than 30% drawdown.

One other statistic that incorporates drawdown that I like to check to determine whether the system is profitable or not is the recovery factor. The recovery factor divides the net profit by the drawdown (without the negative sign). As an example, if the net profit were $5,659 and the drawdown were -$3,542 dividing the net profit by the drawdown would result in a recovery factor of 1.597 (get rid of the minus sign). I generally prefer systems to have this statistic above 3.

So even though we have created our system that fits our personality and risk tolerance level well trades can still fail by not heeding the third and final statement...

3. Don't fall in love with the system

Most traders once they have designed a system cannot believe that their system is making a loss, or worse yet, a loss greater than the system's historical drawdown.

So, to combat this they dig their head in the sand hoping that the problem will go away. Just as trades fall in love with their position, at their own peril, falling in love with their system is also to their detriment.

Treat this as a business with your system as one of your salesmen. If the salesman is costing more than he is bringing in then you need to fire him and find another one.

How do you know if your system is no good?

As a rule I look at the historical drawdown of my system and add 10%. As an example, if my system had historical drawdown of 20% once the system reached 20% x 1.1 = 22% I would stop trading this system and move onto another. And sometimes you can still trade the same system, just with different variables, or a minor tweak.

Be sure that you fully understand the implications presented to you in this article. Trading is a business, therefore conduct it like one, as it is one of the most difficult endeavors you could ever undertake.

Ryan Sheehy is the author of and

---

Why Demo Account Performance Is Often Better Than Real Account Performance

Over the past several years, the popularity of online currency... Read More

Forex Scams: How to Spot Them A Mile Away

In recent years, investors have witnessed increased number of investment... Read More

Forex Signal, Forex Signals Advice

There are lot's of Forex signals providers out there. New... Read More

The Nature of the Trading Business

Consider the following: As a trader you are in a... Read More

Forex Trading

Foreign exchange market, or better known as FOREX, is the... Read More

Financial Crises, Global Capital Flows and the International Financial Architecture

The recent upheavals in the world financial markets were quelled... Read More

Options Trading - Advantages and Disadvantages

What is Options Trading?An option is simply granting someone the... Read More

The Yin and the Yang of Markets

I am reading a fantastic book on trading, first published... Read More

Two Timeless Rules in FOREX Investing

RULE #1) ~ Cut your losers; let your winners ride.One... Read More

Hedging Foreign Exchange Risks

The exchange rate of the Macedonian Denar against the major... Read More

Forex Made Easy for Everyone

Forex made easy is as simple as you would want... Read More

Risk and Stock Trading Fees: The Two Barriers To Overcome If You Want A Successful Trading Career.

You know the old joke:"How do you make a million... Read More

Welcome to the World of Currency Trading

Indeed large multinational and individual banks and other major financial... Read More

Types of Foreign Currency Hedging Vehicles

The following are some of the most common types of... Read More

How To Handle A String Of Losses

Everybody hates to lose and unfortunately no one is blessed... Read More

Day Trading the Index Futures - How to Judge Good Entries

QUESTION: If the SP futures fall through support and go... Read More

Creativity in Trading

"Is it important to be creative in your trading?"I'm not... Read More

How To Control Fear And Greed In Trading

There is an old saying that the market is driven... Read More

Trade Exit - How To Cut Losses And Let Profits Run

Cut your losses short and let your profits run. This... Read More

Exploring the World of Day Trading

Are you looking into a career in day trading? In... Read More

How Do Other Countries Devalue Their Currencies?

Countries devalue their currencies only when they have no other... Read More

Day Trading Training ... You need more than just going to a free stock market workshop to learn

Day trading is all about making buy and sell decisions.... Read More

Forex Broker

A broker is any person or firm that charges a... Read More

Business and the Forex

The business world is a complex web of supply and... Read More

Be a Smarter FOREX Currency Trader: Three Basic Principles

Below I will describe three basic principles that may come... Read More