Stopping Losses with Stop Losses and Trailing Stops (Basic Mechanics)

Whereas market orders and entry orders are trade entries, stop losses, trailing stops, and profi t limits (described in the next section) are trade exits. While many beginning traders concentrate almost exclusively on entries, most intermediate and advanced traders eventually come to realize that exits are at least as important, and some say even more important, than getting the entries right.

In this section, only the basic mechanics of stop losses and trailing stops will be touched upon. Later, in Chapter 6 , in a section that covers risk management, the full meaning and nuances of using stop losses will be discussed.

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Entry Orders (Basic Mechanics)

In contrast to the immediate nature of market orders, entry orders are pending positions whose purpose is to trigger when a certain price level is reached. These types of orders can be set to execute well ahead of time, and will only be executed if the specified price is reached. There are two primary types of entry orders stop entries and limit entries. In the retail foreign exchange market, the functional discrepancy between these two entry order types is largely semantic, and many brokers simply blur the differences by calling them both limit orders. But for those forex brokers that keep the delineation intact, traders simply need to learn and remember the defi nitions, which are as follows:

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Market Orders (Basic Mechanics)

Depending on the specific strategy or type of trading preferred, foreign exchange traders often rely heavily upon market orders. A market order simply means that a trader wishes to enter a currency position at the present moment, whether it is an order to buy (long) or sell (short) a specific currency pair.

The main functionality that differentiates this type of order from others is the fact that a market order is executed at the current market price, as opposed to a future price level.

Market orders are primarily used by traders who are physically at their trading stations watching the market, waiting for either a specific technical chart setup or a fundamental news announcement. Once one of these trading opportunities presents itself, the trader is then able to establish a virtually instant market position through the use of a well - placed market order.

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Going Long and Selling Short (Basic Mechanics)

The fact that currencies are traded in pairs differentiates the foreign exchange market from other fi nancial markets in important ways, one of which is the concept of long and short.

In trading equities, for example, a “ long ” entry is simply the process of buying shares in a specific security in the hope that it will go up in value. Conversely, a “ short ” entry is to sell shares before actually owning them. This is with the understanding that the shares must be bought back or “ covered ” at a later date, hopefully for a profit if the stock goes down. Consequently, if traders believe that a stock will go up, they will enter the trade “ long. ” If, on the other hand, they think it will go down in price, they will sell “ short. ” The foreign exchange market, in contrast, treats long and short in a significantly different manner. To be long EUR/USD, for example, is to simultaneously buy euro and sell dollar. To be short EUR/USD, on the other hand, is to simultaneously sell euro and buy dollar. So whether one is long or short any given currency pair, one is always long one of the currencies in the pair, and short the other.

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Anatomy of a Currency Pair (Basic Mechanics)

Major currency pairs

The foreign exchange market is traded in a very unique way when compared with other major financial markets like stocks or futures. Unlike these more traditional markets, foreign exchange trading is accomplished using the relative value of the underlying instrument, rather than the absolute value.

More specifically currencies are traded in pairs. When forex traders talk about trading the U.S. dollar, for example, they are really talking about trading the U.S. dollar ’ s relative value against another currency. This other currency could be the euro, the British pound, the Japanese yen, or even the Thai baht, among many others. The fi rst currency in a currency pair is called the “ base ” currency, while the second currency is called the “ quote ” (or “ counter ” ) currency. It cannot be emphasized enough how important it is to keep in mind that there are two integral, opposing components of a traded currency pair, instead of the single component prevalent in trading stocks or futures. When forex traders initiate market positions, it is imperative that they take into consideration the relative value of both currencies. This means that a trader should not just consider whether a currency will go up or down in value. Rather, the trader must always take into account whether the currency's value will go up or down in comparison with another currency.

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Simple trading rules to become success

Don't Panic!

Price moves the same way also when you don't look every minute. Don't make yourself crazy!

Plan Trades carefully. Better pending orders at a good price than just “jumping in”. Wait for the price to come back, don't enter at peaks just because you're impatient! If the price runs away without you, don't care so much about it!

R/R at least 1:5 (better 1:10)!!

Risk no more than 5% of trading balance if applicable!

When trade goes in the right direction, set stop-loss at least to 0. Don't place it too narrow!

Raise Stop-Loss if appropriate, but check volatility, don't place it too close.

Use Trailing Stop when not actively monitoring the trade. Also, make it wide enough to not get stopped out too early.

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Introduction to Foreign Exchange Trading

Trading Money to Make Money

Foreign exchange trading is essentially about trading money. There are several reasons why people and institutions would want to trade money. The two primary reasons are currency conversion and speculation.

Currency conversion is simply the changing of money from one currency to another for the primary purpose of purchasing goods, services, or assets from a foreign country. For an American company to buy British goods, for example, would necessitate the conversion of U.S. dollars to British pounds. This book will focus exclusively on foreign exchange trading for speculative purposes, or trading money with the explicit goal of making money. This speculation process is very similar to trading in stocks or futures. The goal, whether on a long - term or short - term basis, is to earn profits from price changes. Just as a stock like Microsoft will move up and down in price, currencies will also move up and down in price. The real trick is to be on the right side of the move, and to reap profits in return for assuming the risk of taking the trade. Of course, there are many important ways in which trading foreign exchange is completely different from trading stocks or futures, but the primary objective is the same. If a trader buys shares in Microsoft, for instance, the hope is that the value of the shares will go up and the trader will earn profits.

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