Risk Tolerance

The Secret:

The secret to successful investing is learning your own style, or in other words trading method(s) that work for you. There is no correct approach that everyone should learn. However, every trader needs to assess how much risk they can comfortably handle. It is the single most important investment issue for long-term success in the Forex market.

Are you able to stomach the risk when the markets are moving up or down as fast as your nervous heartbeat? Do you carefully consider the various risks that are associated with each trade you make? The fact is, many people either don't have a clue how or don't feel they need to protect themselves from unnecessary risk. In most cases they don't even understand all the types of risk their investing is exposed to. We will be reviewing the various types of risk and proper risk management to maximize your personal performance, including:

- What is risk?
- The different types of risk
- The risk/Return Balance
- Diversifying your trading

What is Risk?

Whether it is investing, driving, flying, swimming, or just walking down the street, everyone exposes themselves to risk. Your personality and lifestyle play a big role on how much risk you are comfortable with. For most investors, risk simply means "losing money." But if your investment choices leave you unable to sleep at night you are probably taking on too much risk.

The dictionary's definition of risk is "The variability of returns from an investment or the chance that an investment's actual return will be different than expected. This includes the possibility of losing some or all of the original investment. It is usually measured using the historical returns or average returns for a specific investment. The greater the variability of an investment (i.e. fluctuation in price or interest), the greater the risk."

The enhanced daily price movements and the leverage available in the Forex market compared to other financial instruments like stocks is the reason the Forex market is categorized as a "high risk investment vehicle". As investors are generally averse to risk, investments with greater inherent risk must promise higher expected yields to warrant taking on additional risk. Others add that higher risk means a greater opportunity for high returns or a higher potential for loss. However a higher potential for return doesn't always mean that it must have a higher degree of risk. This is why identifying and adhering to a strict trading strategy is so important to the overall performance. Learn more about use of proper money management to minimize your risk exposure. Do you have a hard time giving money back to the market when you feel that you have worked so hard for every penny of profit? If so, you would find yourself amongst the "risk adverse" category of investors. On the other hand, super active day traders feel most comfortable making dozens of trades per day and are considered "risk loving". When investing in currencies, stocks, bonds, commodities, futures or any investment instrument there is a lot more risk than most investors think. Learn more about the different types of risk that effect your Forex trading.

The Different Types of Risk

There are two basic classifications of risk: Systematic Risk - A risk that influences a large number of currency pairs. Examples of systematic risk are global political events, natural disasters, or war. Unsystematic Risk - Sometimes referred to as "specific risk". Its risk affects a very small number of currencies and currency pairs. An example is economic news that affects a specific country or region, such as a sudden strike by employees or a change in the Canadian interest rate. Diversification across multiple non-related currency pairs is the only way to truly protect yourself from unsystematic risk.

Now that we've determined the two main classifications of risk lets take a closer look at more specific types of risk.

Default Risk - This is the risk that the company with whom you have your Forex trading account will be unable to pay out an investor's account balance when a withdrawal request is submitted. Many Forex traders remember the incident of Refco in the fall of 2005. Unfortunately Refco, one of the world's largest investment firms with brokerage arms within commodities, futures and foreign exchange filed for bankruptcy protection and each of the brokerages were auctioned off to competitors or former subsidiaries. Their clients were unable to withdraw profits and initial capital until the brokerages were sold off. As of yet the dust has not settled and it is still too early to tell if all former customers received complete compensation. Choosing a suitable, stable broker is more than choosing the biggest.

Country Risk –This refers to the risk that a country won't be able to honor its financial commitments. When a country defaults it can harm the performance of all other financial instruments in that country as well as other countries it has relations with. Country risk applies to stocks, bonds, mutual funds, options, futures and most importantly the currency that is issued within a particular country. This type of risk is most often seen in emerging markets or countries that have a severe deficit.

Foreign Exchange Risk – When investing in foreign currencies you must consider that the currency exchange rate fluctuations of closely linked countries can drastically move the price of the primary currency as well. For example, economic and political events directly tied to the British Pound (GBP) have an effect on the Euro's trading (i.e. the EUR/USD might have similar reaction as GBP/USD even though they are both separate currencies and are not in the same currency pair). Knowing what countries effect the currency pairs you trade is vital to your long-term success.

Interest Rate Risk - A rise or decline in interest rates during the term a trade is open will affect the amount of interest you might pay per day until the trade is closed. Open trades at rollover are assessed either an interest charge or interest gain depending upon the direction of the open trade and the interest rate levels of the corresponding countries. If you sell the currency with the higher interest rate you will be charged daily interest at the time of rollover based on your broker's rollover/interest policy. For more specifics on understanding your interest risk, please consult your broker for complete details of their policy including time of rollover, interest price (also called swap) and account requirements to receive interest paid to your account.

Political/Economic RiskPolitical/Economic Risk - This represents the risk that a country's economic or political events will cause immediate and drastic changes in the currency prices associated with that country. Another example of this risk is government intervention that we typically see with Japan and the need to maintain low currency prices to bolster their exports.

Market Risk - This is the most familiar of the risks we have discussed, and according to some, really the main risk to consider. Market risk is the day to day fluctuations in a currency pair's price; also referred to as volatility. Volatility is not so much a cause but an effect of certain market forces. Volatility is a measure of risk because it refers to the behavior, or "temperament," of your investment rather than the reason for this behavior. Because market movement is the reason why people can make money, volatility is essential for returns, and the more unstable the currency pair the higher the chance it can go dramatically either way.

Technology Risk – This is a particular risk that many traders don't think much about. However, with the majority of individual Forex traders executing trades online, we are all technology reliant. Are you protected against technology failure? Do you have an alternative internet service? Do you have back-up computers that you could use if your primary trading computer crashes?

As you can see, there are several types of risk that a smart investor should consider and pay careful attention to in their trading. Deciding your potential return (target profit) while respecting risk is the age old decision that each investors must make

The Risk Reward Balance

The risk/return balance could easily be called the iron stomach test. Deciding what amount of risk you can take on while allowing yourself to walk away from your computer without worrying and to get sound rest at night while you have long-term trades open is a trader's foremost important decision. The risk/return balance is the balance a trader must decide on between the lowest possible risk for the highest possible return. Remember to keep in mind that low levels of uncertainty (low risk) are associated with low potential returns and high levels of uncertainty (high risk) are associated with high potential returns. Trading is all about risk and probabilities. Understanding the inner functions of your trading strategy(s) and proper placement of entry and exit orders will assist in limiting your risk exposure while maximizing your profit potential.

What about how much of your account to place on each trade, or in other words the number of lots per trade? How much of your account have you lost in a single trade? Was it to much to swallow? If so you might not have utilized proper risk management and over leveraged your trade. Establishing the right level of leverage and corresponding margin requirements are a big part of managing risk. How are you doing?

There is Not One Correct Risk Level

Just as there is no single favorite food for everyone, there is no right risk level for everyone. Only you can determine what level of risk is right for you. You need to find the right balance between the amount of risk you are willing to take, and the amount of risk you can actually take. All too often investors think they are willing to take risk, but when it happens, they find out they aren't. Surviving in the market long-term is the most important way to make the market work for you. To do that, you need to learn your own risk tolerance ability. This could mean that you loose money during this learning process, but if this loss helps you achieve this level of understanding then you can financially afford the loss. This financial and emotional tuition is a valuable trading resource and something most experienced investors have paid through the process of trial and error.

In Conclusion

Different individuals will have different tolerances for risk. Tolerance is not static, it will change along with your skills and knowledge. As you become more experienced tolerance to risk may increase as your strategies or systems of trading become more and more proven in your mind and wallet. But don't let this fool you into still adhering to and thinking about proper money management practices. Achieving the right median between risk and return will ensure that you achieve your financial goals while allowing you to get a good nights rest.

Source: https://www.interbankfx.com/Ibfxu/Catalog/TradingStrategies/STR1001.aspx

Technical Indicators in Forex Trading - Understanding Their Limitations

Forex traders often look at indicators such as Bollinger Bands, Pivot Points, MACD, Moving Averages and the such to help them determine where to enter or exit trades. Using technical indicators is fine, however many traders overemphasize their importance or just plain misunderstand them.

Many forex traders think that they can simply download an indicator and then mechanically apply it into their trading and do so profitably. This is just a plain illusion. Successful traders realize that there is a lot more to using indicators than just asking them to generate buy/sell signals or pin-point exact entry points. Technical indicators for them represent just one part of their trading strategy.

Let’s take a look at some of the reasons why you should not put all your faith into those sometimes confusing little indicators.

Take Moving Averages (MA’s) for example. They are "supposed" to show the direction of the trend. The most common and often used are the simple 200day MA, 100day MA, 50day MA, 35day MA and the 21day MA but they are only valid on daily graphs. Some forex day traders say that a good signal is when the 50day MA is crossed by the 13day MA and that when this occurs you should trade in the direction of the cross.

The problem with this (apart from the fact that it only works on daily graphs) is that these types of “crosses” do not occur often enough for traders to exploit them. This can often lead to a situation where traders are seeing what they thought was a cross now reverse and uncross. Even worse, it can lead to a situation where day traders are "chasing" and trying to anticipate a cross. If you are doing this, you are distancing yourself from the market which you are trying to trade. Not only are you trying to guess what the price is going to do next but you are guessing what the indicator, based on the prices, is going to do next.

Other problems with technical indicators involve issues with the quotes and prices given to you by your broker. Forex brokers are market makers and as such different brokers will give you different quotes and prices at a specific point in time. Naturally, a different price could lead to a situation where different traders, trading the same market have the same indicators giving them different responses. That’s how arbitrary technical indicators can be.

Finally, a lot of these technical indicators were developed by people trading the stock market. With the growth of computers and software packages that incorporate these indicators, technical analysis has become very popular and spread to other markets such as the forex market. What currency traders should be aware of however, is that as these indicators were developed in a time where real time information did not exist. As such, the limitations of technical analysis becomes even more exaggerated in forex trading – not only is technical analysis an interpretation of historical events but it becomes even more so in the forex market, a market moved by real time events.

Conclusion:

Successful forex traders understand the limitations of technical indicators and realize that technical analysis should incorporate just one part of their trading strategy. In a recent international Forex market event visited by the major banks and institutions - the main players that influence the foreign currency market – a survey was done to better understand what analysis they use. The results might be surprising to some tarders. The survey showed that a mere 26% use technical analysis and indicators compared to 41% who said they use fundamental analysis.

Jovan Vucetic is the Editor of Margin Strategies, an educational forex website, which reviews forex trading systems. Learn about different types of forex trading strategies including a purely mechanical trading system which does not require interpretation of the usual Technical Indicators.

Article Source: http://EzineArticles.com/?expert=Jovan_Vucetic

Default Improving Your Trading Performance: The Single Most Important Step You Can Take

A chess player analyzing the board for the next move; fighter pilots maneuvering their planes to get a lock on enemy aircraft; a baseball player tracking the release of the ball from the pitcher’s arm; ballet dancers executing their leaps; an oncologist diagnosing a rare form of cancer; a bodybuilder sculpting a small muscle group to achieve symmetry: all of these are examples of performance activities. They are also examples of fields that have been widely researched in the past two decades, uncovering important clues as to the factors that create successful performance.

This research raises fascinating questions: What makes expert performers different from less successful ones? Is expert performance a function of inherited personality traits and skills, or can it be cultivated in the proper environments? Which techniques has research found to dramatically improve performance? Will the performance-enhancing techniques that benefit chess grandmasters and Olympic athletes also assist traders? The book I am currently writing will tackle all these questions and more. This article has a more modest aim: It will draw upon research studies with chess experts to identify the one most important thing traders can do to accelerate their development.


Trading as a Performance Activity

Not all trading is a performance activity, of course. A computer can be programmed to enter, manage, and exit positions, but the computer does not perform in the same way as the athlete, dancer, or fighter pilot. Performance, in the psychological sense, begins with the human element in competition. Humans choose when to take action and when to refrain; they can select various courses of action on different occasions and can invent new strategies when needed. The trading computer does not have good days and bad days—only profitable ones and unprofitable ones. Human traders can perform poorly even if they make money, and they can have good days even when they’re in the red. That is because performance is a function of the chosen actions of performers, the correctness of those choices, and the skill with which the actions are carried out. Once an element of discretion enters into trading, it becomes a performance activity: one in which outcomes are dependent upon the choices of the performer.

There are several common features of performance activities:

* They can be executed well or poorly. Activities that are performed well on a consistent basis require a high degree of skill. A lucky outcome, such as winning a lottery, is not a skilled performance.
* There are individuals who can be identified as expert performers. With very rare exception, expert performers are ones who have developed their talents over time. Most expert performers undergo specialized training to cultivate their talents.
* They require a specialized knowledge base. The knowledge may be the “how-to” knowledge of a gymnast or the research knowledge of a scientific researcher. To perform well in a field, a person must master the information and skills specific to that field.

Trading, as a performance activity, has much in common with chess. It is competitive, requiring a high degree of concentration and strategy. It also features a limited number of actions that, in combination, create a large array of possible strategies and actions. This makes both activities easy to learn, but difficult to master. Chess can be played in lightning fashion, with very little time between moves, or it can allow players many minutes to plan moves—or even days (postal chess). Trading can also be conducted on a very short-term basis or can be planned and executed over hours or days. These similarities make chess an excellent starting point for examining the performance dynamics of trading, especially since chess is one of the performance fields most studied by researchers.


The Performance Ingredients of Chess

A well-replicated finding in chess research is that the memory processes of experts are different from those of non-experts. One intriguing set of studies took chessboard arrangements from a past tournament games and briefly showed them to expert players and novices. Afterward, the expert chess players were able to recall the positions of many more pieces than the novices. When the two groups were shown chessboards with randomly arranged pieces, however, their recall of the positions of the pieces was quite limited. The researchers’ conclusion was that experts do not have better memories than non-experts; rather, they have better memories for meaningful relationships among chess pieces. Instead of remembering where each individual piece was on the board, the experts viewed the board as clusters of pieces and remembered these. When the board was randomly arranged, there were no meaningful clusters of pieces and the experts had no effective means for encoding their information.

How do expert chess players gain this ability to perceive meaningful patterns among pieces? Because chess players are given ratings based upon their tournament play, it is relatively easy to compare experts (masters and grandmasters) with less accomplished players. When a variety of factors are incorporated into multiple regression equations to predict chess ratings, two stand out as highly significant:

1. The number of books owned – Research conducted by Neil Charness and colleagues finds that the correlation between books owned by chess players and their current performance ratings was .53.
2. The cumulative number of hours spent in practice – Those same researchers found that the correlation between the amount of time spent in practice and current performance ratings was .60.

To appreciate these findings, it is necessary to understand what chess books are and how they are used. These texts typically break the game down into components (opening, endgame, defenses, etc.) and present historical games from tournaments, along with annotation from an expert author. Readers do not merely skim over these games; they learn specific opening or defensive sequences and then see how these were utilized in actual games. They recreate those games on their own boards and carefully play through the positions, so that they can see what the expert players saw. They also play through alternate sequences to observe where these might lead.

Interestingly, chess experts do not have significantly more chess-playing experience than non-experts. Rather, a higher percentage of the experience of experts is spent in the systematic practice of various facets of the game. Non-experts tend to spend a higher proportion of their time in games against similarly-skilled opponents. This experience neither exposes the learner to the moves of experts, nor does it provide time for a careful review of moves, exploration of alternate lines, etc. In the Charness work, the correlation between solitary practice and chess ratings is almost twice as high as the correlation between practice with others and ratings. This is because solitary practice with chess books allows learners to obtain chess knowledge in context. Instead of focusing on the moves of an opponent, learners encounter—again and again—those meaningful configurations of pieces that appear in the games of experts.


Enhancing Trading Performance

Students of trading are at a huge disadvantage relative to students of chess. Chess books document the performance of centuries of experts in actual tournament situations. Because of this, chess students can create and play through almost any challenging situation imaginable, drawing upon the accumulated wisdom of experts. Trading possesses no such database. Trading books, unlike chess texts, are not annotated compilations of the trading decisions of objectively rated experts. One cannot use trading books to recreate trading sessions or to systematically explore trading decisions and their alternatives. Chess books lend themselves to independent deliberative practice; trading books present ideas outside the context of actual trading.

As a result, traders tend to spend little time in the systematic practice that is the single greatest predictor of chess expertise—not to mention expertise in music, athletics, and dance. This violates a principle from the performance research that is so striking that it might even be called a law:

In every performance field, the development and maintenance of expertise requires a high ratio of time spent in practice relative to time spent in actual performance.

Athletes spend far more time working out, practicing, and scrimmaging than actually playing in competitive events. The same is true for chess masters, professional dancers, fighter pilots, and racecar drivers. Our analysis of chess expertise helps to explain this law. Only significant time spent in absorbing winning and losing chess enables players to internalize the patterns of play that distinguish experts from non-experts. The trader who spends more time trading than practicing trading is like the golfer who spends more time playing rounds with buddies than on the driving range, putting green, and in lessons. We all know golfers like that, and they are not the ones who make their living on the PGA tour.

This then leads us to the single most important step you can take to become an expert trader:

The expert trader needs to be able to review and re-experience markets and systematically rehearse facets of trading performance: entering, managing, and exiting positions.

Note that what I am suggesting is NOT paper trading. Paper trading is usually a following of the market in real time, accompanied by simulated trading decisions. Such paper trading does not allow traders to replay market action, review their decisions, test out alternatives, etc. It is this re-experiencing that cements learning, and it requires a database of market days similar to the database of tournament games utilized by chess books.

Think of each trading session as a chess game, and each game as a contest between two expert players named “Bull” and “Bear”. Every short-term swing in the market is a move by Bull or Bear that ultimately leads either to a victory for one of them or a draw. In tracking the moves of Bull and Bear, we can pause the match at any point and observe how each player exploits the weak moves of the other. With the aid of an electronic database that collates similar trading sessions, we can even explore how alternate moves by each side produce different outcomes. Moreover, we can play and replay the “games” (and their similar variants), seeing if our simulated trading decisions accurately reflect our reading of the strengths and weaknesses of the players’ positions.

How could we create such a database? Two methods stand out at present, and my hope is that software vendors will create even more:

1. Replay. Some programs, such as Ensign and e-Signal, allow users to replay market data at varying rates of speed. This permits repetition of a market day, so that paper trading can be accompanied by review and fresh practice. Programs that allow users to save and replay tick data are especially valuable, as this creates a library of trading sessions akin to the collections of chess games found in books.
2. Taping. Videotaping of one’s trading screens allows for unlimited review of market action and one’s trading decisions. It is not too far-fetched to imagine video-taping of simulated trading from video-taped data, creating feedback loops for learning. Over time, collections of these tapes form a library for study that would allow traders to practice trading almost any kind of market imaginable.

If this analysis has merit, then most of the services offered to traders in the popular media have limited value. Self-help techniques, exhortations regarding discipline, didactic presentations of patterns, and general rules and advice do not turn chess novices into experts, and there is no reason to believe they will advance the performance curve for traders. Knowledge and practice—and especially the direct experience of knowledge-in-practice—are the keys to the acquisition of expertise.

We commonly hear the statistic that 90% of all traders ultimately fail. If this is so, it is not because they lack the right personality traits, indicator patterns, or software programs. Rather, they have failed to structure their learning to facilitate expertise. This is one of the most important lessons we can learn from the decades of research and hundreds of studies on the topic of performance. The path to our greatness lies not only in performing, but in the systematic work we put into performance. The next great advance in trading technology, I believe, will be the creation of dynamic learning environments that serve as the electronic equivalent of chess books. The learning platforms we rig for ourselves today will pale in comparison to tomorrow’s technology, but that matters little to those pursuing self-development. The single most important step you can take, Ayn Rand realized, is to fight for tomorrow, so that you might live in it today.


Brett N. Steenbarger, Ph.D. is Director of Trader Development for Kingstree Trading, LLC in Chicago and Clinical Associate Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical University in Syracuse, NY. A clinical psychologist and active trader for the past 20 years, Brett is the author of The Psychology of Trading (Wiley; 2003) and numerous articles on trading psychology for financial publications. His book chapters on brief psychotherapy can be found in such reference works as The Psychologist's Desk Reference (Oxford University Press, 1998) and the Encyclopedia of Psychotherapy (Academic Press, 2002). His newest, coedited book, The Art and Science of the Brief Psychotherapies (American Psychiatric Press, 2005), has been selected as a core training text for psychiatry residency programs.

(Article Source: Forexfactory http://www.forexfactory.com/showthread.php?t=31242)