All You Need to Know to Really Grasp the Dynamics of the Forex Market

For many new traders, the forex market is a wild beast that can’t be tamed. You work hard to come up with a strategy that looks good after months of trying. Yet you find it difficult to maintain consistent success. One week you are happy with an increase of 10% on your equity and the next week, you have lost it all and staring at double digit drawdowns. Does this sound like you?  This piece takes a look at all you need to know to understand the dynamics of the forex market.

Don’t Chase Price Movements- See the Big Picture

New traders make the mistake of getting into a trade because they saw price move in a specific direction for the last few minutes or hours. In some cases, they get into the trade blindly because a trading indicator is pointing to a specific direction. However, this is the wrong approach to trading.  If you don’t understand the reason behind a move, you will most likely not know whether you are getting in at the start of the move, in the middle or at the tail end of the trend.  If you have jumped into a trade right after economic data on a pair was released, you may be stuck in a bad trade as the market corrects impulse moves.

Professional traders take a holistic view of the market and try to find reasonable meaning to market movements. Instead of chasing price movements, they make sure they take positions after seeing the big picture. Is price in a minor retrace from a major move? Has the pair hit a supply or demand level on the higher timeframe and in a reversal? Is there major economic data pushing the pair and for how long can it continue in its direction? These are questions that professional traders answer before entering a trade. A buy trade entered after the market hit support on the daily chart (with good wiggle room before the next resistance) for example, will likely yield better results than one entered based on a short period of sustained upwards movement on the five minutes chart.

You Don’t Always Have to Be in the Market

When talking about the forex market, there is often emphasis on being able to make money round the clock. However, this is not true in practice. The market moves the most during busy times like the London session (especially during the time when it overlaps the New York session). Even at this time, there are days when there isn’t enough liquidity or market direction for even day traders to make profits.

Savvy traders understand the need for patience and will not panic when the day is about to end and they haven’t entered into a trade. They always wait until the elements of their trading strategy line up before they execute positions and they are disciplined enough to close positions when their system dictates. Traders that obsess over the market rarely do well in the long run. Accept the fact that the markets will normally move strongly for one to two days in a week. Be patient enough to catch these big moves while avoiding losing your money trying to force trades where none exists.

Profits are Best When They Are in Line With Money Management Rules

You cannot last long in the forex market without proper money management rules. If you still enjoy profits based on luck, instead of on careful and sensible risk  taking, your account will crash over time.  The nature of the market means that even the most experienced of traders encounter losses. Even when the trading system is 70% accurate, meaning 7 winning trades out of 10, the 3 losing trades could come in quick succession. Professional traders are able to stay in the market until the winning trades return, by ensuring properly calculated risk on all trades.  If you risk 30-50% of your account on one trade, you basically can’t afford to be wrong two times in a row. A trader that risks 2% of their account on a trade will only be down 6% if they lost 3 trades in a row. This leaves them 94% of the original balance to ride the 70% positive trades.

Therefore, the key to lasting success in the forex market is acting like a trader and not a lottery player or a gambler. See the big picture with your trading choices and make sure you will be in the market for the long haul.

Treat Each Trade in Isolation

Many struggling traders are guilty of allowing sentiments to cloud reality in the execution and management of trades. When in a losing trade, they keep moving the logical profit or loss boundaries. When in profits, this action could result in leaving money on the table if the market shows a forceful reversal. When losing, it leads to deeper losses as the market continues to pull away in the opposite direction. In other cases, traders that have closed a profitable trade get over confident on their next trade and sometimes, risk higher amounts. When they close out a trade in loss, they become more scared about taking the next trade.

These are signs of a trader that is not psychologically prepared for the forex markets. Expert traders know that you cannot show loyalty to a position or allow the results of the last trade to affect subsequent ones.

When you spot a trade based on your trading strategy, take the position with all the right parameters. Allow the market to play out and take any outcome. When the trade has played out, proceed to the next one. Don’t chop and change your strategy due to one good or bad trade and do not fiddle with the position once in play.

Important Price Levels Should Be Respected

In fact, many expert traders base their strategies completely around these price levels. What are they? They may be referred to as Pivots, Support, Resistance, Supply, Demand, Fibonacci Levels, etc. They are price levels on a given chart where most traders are expecting a reaction. In many cases, the expected reaction plays out, a sort of self-fulfilling prophecy, because millions of traders were expecting the same outcome, forcing it to happen.

The higher the time frame being analysed, the higher the chances of the important price level holding. Below is an example.

In the image above, there are two peaks on the daily chart of the USDJPY denoted by two arrows: yellow and green. The first arrow was the high which acted as a resistance when the market climbed to the green arrow area. Take note of how the high, which was formed over 8 weeks before the green arrow price action, was respected.  The area acted as resistance and sent the price back down.

Why? Many traders were watching reaction around that area and expected the market to go back down. They backed their predictions and of course, the market obeyed. Self-fulfilling prophecy. Traders who do not open their daily charts on the pair may have been stuck on the preceding upward move, taken unawares and losing all or some of the profits they might have. Traders that jumped into a “buy” trade near that high in anticipation of continuation of the trend without taking note of the important price level would have been left with deep losses.

Price levels especially on charts like the daily timeframe are important because it often takes a strong economic event to break them. During economic events that are powerful enough to break through such levels, traders forget about their natural instincts. So for this USDJPY example, the resistance area would have been invalidated if the price action that occurred around the green area was on the day of very strong job numbers from the US. Once the area is invalidated, traders look to the next interesting area to watch.

So, any trader that must last long in the forex market must first of all, learn how to scour the charts for these areas and take them into consideration with their trading strategies.

Don’t Be Fixated on Profit Targets

Many traders make the mistake of setting a profit target for themselves, daily, weekly, monthly and yearly. This puts them under unnecessary pressure, clouding their judgment when it comes to trade decisions and forcing errors. When you have a target of making 200 pips (points) in a week and it is not forthcoming, you could be tempted to look at pairs you don’t ordinarily trade to meet up. This could pay off but more often than not, it doesn’t. Instead of making the 200 pips, you could close the week in a loss.

Expert traders know that the market is random and are only concerned about making the best of what the market presents as profits. So, you could make 1000 pips one week and make 200 pips the next. You can also close the week at break even or even at a loss.  This is why you should remove all limits that prevent you from milking the market when it is there to be milked. The excess profits made will be your fall back in lean weeks or in losing weeks, preserving the capital. You will also be more relaxed about the lack of market movement at any given time.

Forex Trading Success Doesn’t Lie in Fanciful Indicators

You’ve definitely seen them; the different software that can be applied to the charts and then trading signals are generated. Some of them come as arrows showing where to buy or sell. While it is indeed possible to enjoy success using such tools, there are no guarantees that you will succeed with them. The marketers will publish excellent results that will nudge you towards whipping out your credit card but before you click buy, pause a bit. A search for “forex trading indicators” will pull up millions of possible options. Have you wondered why only very few forex traders can show proof of consistent success in live market conditions even with all the indicators churned out yearly? The answer is simple. The key to forex trading success lies in the traders psychology and discipline more than anything. A trader with the right psychology can succeed in the market with simple moving averages while another trader with sophisticated indicators, without the right trading psychology will continue to struggle.

At the end of the day, all traders are trying to catch the few major moves that happen every week. Your focus should be on getting in on the action early enough, while cutting your losses on false breaks or staying out of the market completely which brings us to the next reason why fancy indicators aren’t always the best: they lag heavily.  In our USDJPY chart, a trader that simply watches for price movement around important levels would have gotten into a “sell” trade around the green arrow.

Another trader  using a fancy indicator like the DDFX indicator for example, would  have taken the “sell” trade 8 whole days after as shown by the red arrow, missing out on  over 200 pips.

This trade still turned out to be a profit overall even with such a late entry but in many cases, the late entry leads to taking a position when the market is exhausted or near exhaustion.

So, should you ignore technical indicators? No. However, you need to ensure that they do not make up the crux of your trading strategy. Most importantly, whatever strategy and tools you use, there is a higher chance of failure if your trading psychology isn’t in top shape.

Final Thoughts

Understanding the dynamics of the forex market boils down to sniffing out trade opportunities as early as possible, always looking at the big picture (higher timeframes), accepting the randomness of the market, sticking to a robust and properly designed strategy and practice of astute money management.