Understanding risk and reward
Maintaining discipline
One of the great things about trading the markets is that every day has the potential to bring something new.
It's what makes trading exciting. But it also means that a good trader needs to maintain discipline and focus.
It's all too easy to get engrossed in a situation, or a trade, while losing sight of the bigger picture. Always keep the risks in the forefront of your mind, no matter how confident you feel in your idea.
Did you know?
On 15 January 2015, an event occurred that caught even the most experienced traders by surprise. Without warning, the Swiss National Bank announced that it would no longer hold the Swiss franc at a fixed exchange rate with the euro.
Example
Because of this 'peg,' the currency pair had been popular with forex traders and was generally considered predictable. Removing the peg caused the euro to plummet dramatically against the franc, and the speed and magnitude of this movement resulted in high levels of loss and slippage on some trades.
Nevertheless, those traders who were following our five rules and had guaranteed stops in place were protected against the worst of this storm. With their losses restricted to manageable levels, it's likely these traders quickly put the incident behind them and moved on to take more profitable positions.
So if you want to become a successful trader, look at the markets as a business. By all means hope for the best, but always prepare for the worst. Be pragmatic, manage your own expectations and plan your strategy - always following our rules.
And that brings us to rule 5:
Rule 5: obey all of the rules - always
Our final rule might not sound very thrilling in itself, but it will let you focus on what really is more exciting: staying on top of the markets and making healthy, sustainable profits.
To recap, our five rules are:
- Plan how you'll exit a trade before you enter it
- Set a stop when you open a position, so you have protection right from the outset
- Look for positive risk vs reward ratios, because nobody has a crystal ball and you can't win every trade
- Never risk more than 5% of your equity on any single trade idea
- Obey all of the rules - always
Lesson summary
- Expect the unexpected in the markets
- Keep risk in the forefront of your mind
- Plan and prepare
- Be disciplined and focused
- Follow the five rules at all times
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