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An extremely successful way to determine exit points is to look at the risk/reward ratio on a trade. Applying the risk/reward ratio provides a pre-set and well calibrated exit points. If the trade doesn’t offer a favorable risk/reward, then the trade should be avoided, which helps to eliminate any low-quality trades from being taken.
If the target is reached on a trade, then the position will be closed, and the target priced according to the strategy in place. If the stop loss is reached, then the manageable loss will be accepted, and the trade will be closed before it has the opportunity to become a larger loss. With this, there isn’t any confusion regarding what to do, an exit has been planned for the predetermined exit points, regardless of if it is unprofitable or profitable.
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If the trend is up during a trade, then buying during a pullback is recommended. In some cases, waiting for the price to consolidate for several bars or candlesticks, and then buying when the price exceeds the high of consolidation is best. The difference between entry and stop loss is significant enough to see, making it possible to know what to do, and when.
In theory, the risk/reward model is both effective and simple. The real challenge occurs when a person tries to make it work altogether. It doesn’t really matter how good the reward:risk is if the price doesn’t ever make it to the profit target. A quality target, that has a favorable risk/reward will also require a quality entry technique. The stop loss and entry will determine the risk portion of the equation, so the lower the risk is, then the easier it will be to have a more favorable risk/reward scenario. Note that the loss shouldn’t be so small that the stop loss is triggered unnecessarily.
While this may sound confusing, it is easier to understand with a real-world scenario. Assume that you are making a swing trade and purchase a currency pair with a profit target of 60 pips. Then, a reasonable the stop loss is set at 25-30 pips. In this case, only 25-30 pips just above or below your support or resistance levels, will give you a 2 to 1 reward to risk as a realistic expectation.
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The actual calculation of the risk/reward ratio is contingent on the currency pair that is being traded and, due to the many pre-existing variables in the calculation of the pip value for a trade, it is easier explained with stocks to use a fixed value. If you enter a trade for a stock that is priced at $50 USD , your target is $55, and your stop loss is set at $1, the stock will only have to move by 10 percent to reach the $55 mark, or two percent to reach the stop loss, which creates a 5:1 reward:risk.
Depending on market conditions and the economic calendar, there are quite a few currency pairs that will move by 10 percent. I would never set a trade with a 1:1 risk/reward ration and would always go for a 2:1 or a 3:1 reward/risk. This means a bigger move is needed to achieve the target, but makes the risk worth entering the trade.
To be successful, a trader have to find a setup that helps to produce a high risk/reward ratio. However, it is necessary to have a relatively conservative price to produce the desired ratios.
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If you want to trade the Elliott Wave theory, then you should learn the concept of corrective and impulsive waves which, because of its simplicity, can be very beneficial in your trading efforts. These two wave types create the market structure and, if you are able to tell the difference between the two, it allows you to see high probability and low probability trades.
The impulsive wave is what allows the trends to exist. It exists as a sustained move in a single direction with the majority of the price bars also moving in the same direction.
The correction is the smaller move. This takes place in the opposite direction of the aforementioned impulse.
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An impulse highlights the direction of existing momentum. The impulses are responsible for creating trends, which means you want to enter on a corrective wave and the ride an impulsive wave. Every trend is made up of several impulse waves and just a few corrections.
The prices move in a structured manner. In some cases, when the structure is unclear, it helps to make the switch to a longer period of time. This allows you to see if the currency pair is within a larger, more complex correction pattern, which is the reason the structure isn’t very clear in the time frame you were looking at. You should trade in the same direction as the impulses until there is an obvious reason not to.
Some of the reasons you should avoid trading in the direction of the seen impulses include:
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This doesn’t always mean you are trading at all times. You don’t want to trade every time a price swing occurs. If the price structure isn’t clear, then don’t make a move until it is. The wave structure takes place on each time frame, which means impulse waves that are higher on a chart over a minute may be a corrective wave against a downtrend on a 10 or 15 minute chart.
Don’t let this scare you away from making a trade on your time frame, but try to keep some perspective on where you plant to take trades, related to the trends and the corrections that are seen in other periods of time.
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Although Bollinger bands is one of the most used and reliable indicators to determine trends and breakouts. You should always use it in combination with other indicators such as the Parabolic SAR which indicates price reversal and the Stochastic oscillator which indicates momentum. These other indicators will help you determine whether the signals provided by the Bollinger Bands are in fact good and whether you should enter a trade.
Bollinger Bands (BB)
As we discussed in previous articles, the BB is made out of 3 bands: the lower, the middle, and the upper BBs. The middle band is comprised of your commonly used 20-day Simple Moving Average. The “juice”, however, is in the upper and lower bands since they will indicate your trading signals. Depending on your setup, the BBs will show the price moving within a range, what is the range of the price 85-90% of the time.
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By knowing the range within which the price is moving during a consolidation, you can buy or go long when the price hits the lower band and, conversely sell or go short when the price hits the upper band. Another signal for the BB is when the price breaks through the bands which usually indicate the beginning of a trend in the direction of the breakout.
The Bollinger Bands also help determine the volatility of the market. In a nutshell, a squeeze or narrow band width show a period of low volatility and usually indicates that a surge is impending and, therefore, a strong move in price is about to occur.
You should never use Bollinger bands alone to make your trading decisions. Use the BBs in conjunction with your trend or Fibonacci indicators to make a killer combination to successful trades.
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Stochastic measures the momentum of the currency pair. The plot range for Stochastic goes from 0 to 100. When the Stochastic goes over 80 that usually indicated that the market is overbought and that a downtrend is about to develop. Conversely, when the Stochastic goes under 20 that may indicate that the market is oversold and an uptrend may be starting to develop. Obviously, at 50 the Stochastic would indicate that the price is flat and there’s no movement. Keep in mind that, unlike other indicators, the Stochastic indicator does not signal the highest or lowest price level, but rather a possible reversal of price direction. Like any other indicator, the Stochastic oscillator should be used with other indicator to assist you with your trades.
Parabolic Stop And Reverse (SAR)
The Parabolic SAR one of the most used indicators to help determine a reversal in price. As a general rule of thumb, traders go long or buy when the Parabolic SAR dots go below the price line and the opposite is true when the Parabolic SAR dots go above the price line indicating a sell signal. Always keep in mind that this indicator only works when the currency pair is trending and will not produce reliable signals if the currency is consolidating or, in other words, a flat market.
Use your chart setup to determine a trend whether you use Fibonacci, MACD, candlesticks, line charts, or any other trend indicator of your liking. Corroborate your entry and exit points with indicators like the ones outlined above and your chances of a successful trade increase dramatically.
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Choosing the right Forex broker can be a difficult task. Many brokers are registered in unregulated countries. Other brokers charge too much for the spread. Worse of all is that some brokers are just plain scammers and you may never see your hard earned money again. What this means is that, regardless of how good your trading strategy is, a broker can greatly affect your profits and even your livelihood as a Forex trader.
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What follow are just a few guidelines to help you select the right broker.
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These are just a few guidelines and you should make your due diligence. Although online reviews are great, you should also use caution when reading them because some of them are posted by the brokers themselves. I stayed away from a broker because of the wildly mixed reviews and the tone/wording of the good reviews which were obviously written by the same person. With all the bad said, I must say that there are many great brokers in the market, you should make sure you do business with one of them.
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Trends rule in the Forex market. Every trader loves a good, strong trend. As traders, many of us like to make quick profits. Who doesn’t? The problem is that by just focusing on making quick profits, we often overlook a much more profitable strategy which is the long-term trend.
First let’s discuss the anatomy of a short-term trade. A short term trade can last anywhere from less than a minute to about 20 minutes, if you get really lucky. A 20 minute trade should return huge profits. Those are the uncommon trades and the 1 to 5 minute trades are more common when day trading. As a trader, you must make a split second decision of whether to enter a short term trade.
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A savvy trader will set both exit points, profit and stop-loss, when entering a short term trade. Most traders, however, set a stop loss, but don’t set a goal for their profit leaving the exit at their discretion and, often, to luck. If you do short term trading, set your exit points before entering the trade. You can always adjust them as the trade progresses, but you will be protecting yourself against sudden reversals and changes of market sentiment.
Long-term trading in Forex is often overlooked and even frowned upon by many traders. For one reason or another the belief among most Forex traders is that most money is made scalping the market and that holding positions overnight is not a good strategy. Well… That assumption is wrong. The Forex market is very much like the stock market in that aspect and those that trade the long term charts, whether you use a day or weekly chart, have a better chance of making unbelievable gains.
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The reason for it is that, except for exceptional events, currencies make their big gains and losses over longer periods of time and not in a 30 minute time span. If you take a look at the long chart of any currency pair, you will see that, had you traded the long term chart, you would maximize your profits. That is because instead of just making small one day gains on a currency that is trending, you would ride the trend for several days, weeks, and, sometimes, even months. I ask, where do you see the opportunity for bigger profits?
I agree, the long term chart offers a better chance to maximize your profits, but it takes discipline and reconditioning your mindset to stay in a trade for a much longer period of time.
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A lot of traders underestimate the effectiveness and simplicity of swing trading using the stochastic oscillator. Stochastic is one of the best indicators to determine when a currency is either overbought or oversold. By using this indicator, you can determine when a trend is about to reverse and take advantage of that swing to the opposite direction.
This is how this strategy work:
As discussed before, we are simply taking advantage of reversals of a trend so, when the currencies are overbought, we sell or go short and, the opposite is true when a currency is oversold where we would buy or go long.
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The stochastic oscillator is the perfect indicator for this type of strategy, but, before we get into the strategy itself, let’s get the technical explanation out of the way. No worries, this is a visual indicator and you don’t really need to fully understand the formula. The formula is provided so that you know how the “engine” that drives this oscillator works.
The assumption for this technical indicator is that as a currency nears the 100 percent moving average a reversal to drive the price downwards is about to occur. The same is true as the price gets closer to the 0 percent moving average where a reversal will drive the price up.
The indicator is plotted as follow:
This oscillator is made out of 2 lines, the slow line which is the %D and the fast line which is the %K.
Since it is slower, the %D line is less sensitive than the %K line.
The %D line is a moving average of %K.
The trade signal is given by the %D line.
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These lines are drawn on your chart ranging from 0 at the bottom of your chart to 100 at the top of your chart indicating the absolute highest and absolute lowest points a currency can get. Within those two lines, you will find a line at 80% and a line at the 20% marks. When the price goes above the 80%, it is assumed to be overbought, and, when it goes below the 20%, it is assumed to be oversold.
Now, let’s trade the signals:
1. Determine where your support and resistance levels are as they are important to know.
2. Check how extreme the overbought or oversold move is.
3. Wait for the actual crossover of %K and %D in both your fast stochastic and your slow stochastic for confirmation and enter the trade.
4. Make sure to enter your stops using the resistance and support lines to determine them.
5. Take profits early before the next reversal occur. You could use the next crossover as your “take profit” signal.
6. This is actually a lesson I learned years ago, don’t get frustrated if you exit too early and made less profits than you could have. Keep in mind that you are never going to lose money by taking profits no matter how small the profit may be.
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As you can see, this strategy is very simple, yet extremely effective.
Make sure to combine the stochastic oscillator with other indicators. The Relative Strength Index and the Bollinger bands work extremely well with stochastic.
When you have an easy swing trading strategy like the one we discussed implemented, trading becomes fun because, while you are not stressing out with the implementation of your strategy, you are still making great profits!
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One of the most useful indicators is the Bollinger Bands. The Bollinger Bands are composed of a moving average and an upper and lower standard deviations. The Bollinger Bands are computed as follow:
First is the moving average. Many systems are set to a 20-period simple moving average by default.
Second is the standard deviation which measures the volatility of the currency prices.
Third and Fourth are the upper and the lower bands. These bands are usually set at 2 standard deviations over the moving average. This 2 standard deviation setup is based on 20-periods of closing data.
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The Bollinger Bands will contain the measurement of approximately 85% of the movement of the currency pair. If you set the standard deviations with a higher value, the resulting percentage will be higher and more of the price data will be included inside of the bands. Obviously, the smaller the number will include a lesser value within the bands.
Although there are several ways in which the bands can be used, the two most commonly used strategies are mean reversion and the breakout.
For the mean reversion strategy you already know that the price of the currency will stay within the bands 85% of the time when you use a 2 standard deviation. This strategy calls for you to sell when the price hits the upper band and to buy when the price hits the lower band.
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As the name suggests, for the Breakout strategy you wait until the price of the currency pair breaks through the bands. This would indicate that there may be a significant break in the direction of the trend. This is especially true when the volume and the price of the currency pair has been and there’s a sudden break. A simpler way to trade the breakout strategy is to buy or sell when the currency pair break above or below the band respectively and exit the trade when it closes below or above the 20 simple moving average.
There are many ways of using the Bollinger Bands and several variations of the two strategies discussed above. For example you can set a spread strategy using the mean reversion and make small profits as the currency moves within the bands. Whatever strategy you decide to use, whether it is the mean reversion or the breakout strategy, make sure that you know well how to execute it and start making successful trades with it.
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