Price Action & Your Trading Edge
MODULE 1
LESSON: What is Price Action in Forex?
What is price action?
Price Action trading is the skill of being able to read the price and make trades on any chart, in any market, in any time frame, and without the use of any indicators at all.
Price Action is everything that price is doing on any trading instrument, being represented on a chart for a trader to see.
In very basic terms, Price Action illustrates in a way that a trader can see exactly on a chart what a certain pair did for a particular time frame.
This basic explanation of Price Action is not subjective. What I see on my chart is exactly what another trader will see on their chart, providing they are using the same charting equipment.
The next question is the important question; how can a trader use Price Action to profit? Humans are very habitual. Traders tend to do the same things and react the same way over and over again when presented with similar circumstances.
If you have watched the charts previously you may have noticed that the same patterns, most of the time, repeat themselves. This is once again because humans are habitual and react the same way given the similar circumstances.
So if we can notice these patterns and human trading habits in the markets, we can start to find a trading strategy and implement it to make money off of the other traders, while they carry out their normal trading patterns.
These patterns will continue repeating themselves as long as human’s trade. Like I said, humans are very habitual and most of the time they repeat themselves, over and over again given similar circumstances.
Whilst traders continue to trade the market there will forever be opportunities to make money in the markets. Humans are ruled by what are call universal emotions. These are emotions that every single trader has and cannot escape, such as greed, fear of missing out and the tendency to compare with other traders.
These universal emotions that all traders have create mistakes and that is when the trading opportunity presents for the savvy trader to make trades and take advantageLESSON: What is an Edge and Why is it so Important?
Here at Forex School Online I am trying to change your entire way of thinking around trading.
FXCM not long ago put out a study looking at over 1 million trades and how traders are making well over 50% winning trades and in some pairs over 60% winning trades - BUT still lose money.
The way you think about the markets is CRUCIAL and will define you whole trading outlook.
Having a trading edge is not just the trades you make, the rules you put in place which you will come to learn and create through a plan, but it is the way you think about the markets and your trades.
This is why I could just teach your the lesson, videos, and a couple of other bits and bobs, but would would be leaving you without the key ingredients.
Through this whole students area I teach you price action, but also how to create and think within an edge and this is the introduction.
What is a Trading Edge and Mindset?
Often traders will have a profitable trading edge or strategy, but it is the way they think about their edge and trade within that edge that lets them down (Read that again).
This means that you may be placing all the right trades and managing your trades the right way, but if you are not giving your edge the chance it needs to work out then you will still run a high risk of failing.
An edge in the Forex market is something critical to success.
An edge very simply is something that gives you a mathematical % increase of coming out profitably over a large sample size of trades.
It is important that you take note that the edge is worked out over a large sample size of trades.
It doesn’t matter if you profited on your last trade or you just lost three trades in a row - that does not form the base for an edge or a losing system.
It doesn’t matter if you lost your last 5 trades. It matters if you were profitable over the last 50 trades. If you were profitable, it was because your method of trading Forex gave you an edge in the market.
Your Edge and Your Spread
The reason you have a solid edge is so important is because of the way Forex is set up, the chances of you becoming a winner are against you before you even start.
When you enter into a trade you pay a spread which already puts your trade at a loss even though the market has not moved.
If on top of the spread your edge is at best 50%, you are going to need to have high risk reward trades to make up for your losses.
Trades Don't Play Out in Order...
A major problem traders often run into is not allowing their edge enough room to work out. An example of this is with flipping coins. If I flip a coin, one side has a head and one side has a tails.
In theory if I was to flip ten coins, 50% should come out with tails and the other 50% should be heads and this is how your trading edge works, but just as your edge works we don’t know for sure if on those ten flips we will get a perfect five heads and five tails.
These coin flips may come out as nine heads and one tails or any other combination.
We never know which trades will be our winners and which will be our losers. Having a profitable trading edge over the market is all about having an edge that brings you out on top and makes you money, but what every trader has to get their head around is nothing in the market is certain.
Getting back to the coin example; just like our trading edge, we may have a winning rate of 60% wins. This does not mean for every 10 trades we make 6 winners and 4 losers.
We may have 4 losers in a row, followed by 2 winners etc., how the winners and losers are divided among the win rate for your trading edge is completely random.
The trick for traders is to treat their trading exactly like a casino and never bet the farm on any one trade and to never concentrate on one trade too much, but always focus on the bigger overall edge.
As soon as you fall into concentrating on the individual trade you will begin to risk too much on the one trade and you will throw the edge out of wack.
Casinos make huge profits because they have an edge and they play on it and that’s what traders do. Casinos know they will lose games and they may lose millions at a time, but in the end the edge is ALWAYS in their favor.
It’s all about staying in the game so your profitable trading edge can play out and make profits!
Give your edge a chance to work out.
The Risk and Reward Target Myth Trap
A common myth that you will hear around everywhere, that unless you average at least 2:1 Risk Reward on all your trades, you will be an unprofitable Trader. This is simply not true and is a trap. It is something would be far easier for me to teach because I could just say to you; hey guys just enter your trades and set targets for 2:1 or even better 5:1 if you can!
(Obviously the bigger the profits we can get the better and this is what we are aiming for in our trading, but as we discuss in a lot more detail later we need to do this with a whole logical business approach).
When I refer to risk reward or 1/1 RR I am meaning for every $100 your risk 1/ (R) you are making $100 profit reward 1 (R). So 2/1 RR would mean you have made twice the reward as what you initially risked.
It's Half the Equation
Risk reward is only half the equation. The truth is a trader can be profitable with a risk reward of 0.001/1RR and a trader can lose money with a risk reward of 10/1 RR. And they can both be profitable.
What determines whether a trader will be profitable and how much risk reward they will have to average is the average win rate they achieve.
The lower the win rate then obviously the higher the risk reward a trader is going to need to be aiming for to cover all the losers they are taking to their account.
Often traders find they have a low win rate because they are aiming for high risk reward rates and if they lowered their risk reward they could increase their win rate and profitability. We discuss this in much more detail in a further chapter below.
Keep in mind this: at the end of the month or year when you tally up your profit and loss totals you are not going to get any sort or records or medals for biggest risk reward winner or longest running trade.
The only thing you want to aim for is making bigger and more consistent profits.
There are trade-offs to each method. With the high reward method you have to be prepared to take a lot more losses and hold out for the big wins. This can be harder as you begin to risk more and more money and as you watch more and more losses.
As long as you’re profitable at the end of the week or month this is okay, you just have to be prepared for it. With the high win rate and low reward you will be banking more regular profits and have a much steadier profit curve.
The trade-off to this is whilst you will protect your capital you will have to at times miss out on catching the big winners. As I said each method has is a trade-off and you can make a choice whether you want the steady account curve or big winners and potentially more losses.
When working out the required risk reward that is needed for your method to be profitable, you must work out the winning percentage of your edge.
Let me explain:
You have 10 trades. Your edge averages 50% strike of getting a winning trade rate however you average 2:1 Risk Reward on most trades. You risk $100 on each trade.
Example #1:
10 trades: 5 winners at 2:1 RR i.e. 5 x $200 = $1000 Profit and 5 losses 5 x -$100 = -$500 = Total Profit $1000 profit - $500 loss = $500 total profit.
This shows that you can be profitable with only 50% winning trade average however you must average 2:1 Risk Reward or better.
You also can be profitable only averaging 1:1 Risk Reward, however you strike rate of winning trades needs to be higher.
In most cases it will higher because what you give up in large risk reward trades you make up in consistency of profits. Below is the equivalent example of example 1 however this time we are using a strike rate of 80% winning trades and only 1/1 risk reward on the winning trades.
Example #2:
10 Trades: 8 winners at 1:1 RR = $800 profit and 2 losses = -$200 then $800 – $200 = total profit $600
RECAP
It doesn’t matter which type of trader you are. You may be conservative and like to bank consistent profits and are not worried about the big winners, as long as you get those consistent profits.
Or you may be the Trader who only wins 1 in 4 trades but has huge risk reward scenarios, that makes you profitable over a large sample of trades.
Neither way is right or wrong. As long as you realize which Trader you are, do the maths to ensure you are trading according to what your needs are.
At the end of the day it doesn’t matter as long as you make regular profit and it suits your trading personality.