Having a great strategy is important, but it isn’t everything. The biggest danger to the trader is spending all their energy on the strategy, and never really getting started (or starting over repeatedly with new strategies).
Developing a strategy is the first step in a long game. The real work begins once you have been live trading for two or three years and have started to get a good sense of what works and what doesn’t in the markets. Perseverance is the trait that separates successful traders from those who don’t reach their goals.
The good thing with long-term trading is that perseverance is not onerous. It only takes a few hours of committed work per week. The key is doing it consistently, so that over time you can get good at what you do.
To kick things off for you, here is a brief approach you can use to get started as a long-term trader.
What to Trade
I recommend you stick to around twenty major currency pairs and crosses. The pairs I trade are the permutations of USD, GBP, EUR, JPY, AUD, NZD, CAD, CHF. So, all the combos of the above such as USDJPY, CADCHF and GBPAUD etc.
When you are long-term trading, you will primarily be looking at daily charts, though you will also use weekly, monthly, 4 hour and 1 hour charts (more on this below).
Now Some Money Management Rules
What kills long-term traders is taking too many correlated position at once, and then a major news event ends up going against them – taking out all their positions in one fell swoop.
Rule #1: Have a max of 3 correlated positions at once.
Another killer is having too many positions on, some of which contradict each other. For example, a trader might be short GBPAUD and short AUDUSD at the same time. This causes confusion, and confusion is the enemy of your success.
Rule #2: Have a max of 5 trades at any one time.
The next thing that causes problems is abnormal position sizing. Keep your standard position size equivalent across pairs. If you are trading GBPUSD, you need to trade a different number of lots compared to if you are trading NZDUSD. Otherwise, one trade will turn out to be a whole lot bigger than the other. To do this, you work out a position size in your base currency (say 100,000 AUD), then use a currency converter to make sure all your positions are equivalent to 100,000 AUD.
Rule #3: Have the same position size on each trade (not the same number of lots).
You also want to keep the overall risk limited. Each trade should risk no more than 2-3% of your account. This may mean that sometimes you need to reduce your position size further, or not take trades.
Rule #4: Risk no more than 2-3% of your account on any one trade.
Play Defence First
Good traders protect themselves first, then simply wait for their long-term edge to play out. To do this, you need to be placing a stop-loss on each trade. When long-term trading, you don’t want that to be too close. I prefer a market-based stop-loss (i.e. based on a support or resistance level) generally about a 2-3 percentage move away. On some trades this can be much closer, but let’s save that for another day.
Rule #5: Place your stop-loss 2-3% away, well behind a key support or resistance level.
It’s important to remember that you are not trying to catch every move, so if the market does not do what it is supposed to, then cut your losses before they get to your stop. For example, if the pair forms a reversal pattern right after entry, or if a key level is violated. Remember… one of the tenets of successful trading is to cut your losses short.
Rule #6: Close out positions that reverse right after entry, or otherwise are not working out.
Good Trading Is About Disciplined Processes
Now you have your protection in place, you can begin to focus on what to trade. Set up a time each week (I do it on Sunday mornings) where you can spend 2-3 hours reviewing the market and writing up your analysis. There are six things to consider then you do this analysis:
1. What is the market type? Is it bullish, bearish, sideways, volatile, normal or quiet?
2. Is there any technical analysis of interest, such as candlesticks, key levels or classical patterns? (Head and shoulders, etc.)
3. What do the higher timeframes tell us? What is the market type on weekly and monthly charts, and are there any technical patterns of interest?
4. What are the fundamental drivers of the 8 currencies you follow, including the key upcoming events? (You get this simply by reading trusted reports.)
5. What is market sentiment, i.e. what are the key things the market is focussing on right now? For example, is it a Fed rate hike, Oil, or Greek debt issues, risk-off?
6. Correlation studies. What are stocks, bonds and commodities telling us about currencies?
You need to do this process every week. It’s only by doing it consistently and seeing if your analysis is right or not each week that you get good at what you do. Practice makes perfect.
If you want to see this in action, I publish my weekly report on the blog each week.
Selecting what to trade
After you have followed the review process, you then select any pairs you want to place trades on. While there will be several trades you may like, before you jump in you need to assess the potential for a long-term move. Do you have a reason why you think the pair is going to move 6-10% or more?
You may be wondering how you can tell this. It’s about the process. After a year or two of disciplined application of the above analysis process, you will intuitively get a feel for this. It’s not something that can be taught easily without you doing the hard work.
You also want to make sure you select the correct strategy for the current market type.
Note that you are only looking for about 2-3 trades a month, and often all these trades will come at once. So, if you find yourself with 5 trades each week then something is out of whack.
Rule #7: Select your favourite long-term trade from your analysis.
Once you have selected what to trade, you want to work out your target. Move to the weekly charts and look for the destination for your trade. I recommend putting in a limit order on this level to close the position, but that is up to you.
Rule #8: Identify your final profit target.
Implementation of your position
Once you have decided what to trade, you need to decide on an entry point. This could be:
- At market on Monday morning/London Open, or
- At a certain price using a stop entry or limit entry order.
To select where to enter, you can zoom in on the 4 hour or 1 hour charts. Look for periods of consolidation or key levels where you want to leave your order.
Rule #9: Move to a lower timeframe to time the entry.
You also want to look for additional scale-in points. This could be if the price moves against you (as long as the integrity of your stop-loss is maintained it’s ok to leg into a position). Or it could be as the price moves in your favour. You may also decide that you don’t want to scale-in.
Rule #10: Identify scale in points.
Exit your position in three parts
“Longevity is the key to success” – Ed Seykota
To maintain longevity in the markets, it is helpful if your trading strategy is more consistent. If you go through big drawdowns and long losing periods it can be tough, and this is when many well-intentioned traders give up.
To reduce this stress, it is helpful to exit your trades in three parts. This allows you to consistently capture profits when the markets make them available, and to keep skin in the game for the really big wins.
Rule #11: Take 1/3 profit when the daily charts form a reversal candle or there is a strong move in your favour.
Rule #12: Take 1/3 profit when the market bottoms or tops out and forms a multiple day reversal pattern (such as a double top or bottom).
Rule #13: Take 1/3 profit at your final target, or on a wide trailing stop (such as the super-trend indicator or a close over the Bollinger bands), or a major weekly or monthly reversal pattern.
It is important that you don’t get knocked out of the market by intra-day noise. For this reason, only exit on the New York close.
Rule #14: Only manually exit from a position on the New York close (this goes for scaling in, too).
The Long-Term Trader’s Mindset
Long-term trading requires a different mindset to short-term trading.
Here are a few pointers.
- You are not going to win every month, or even every year, and that is OK.
- You truly and deeply need to grasp the fact that you need to cut your losses short and let your profits run.
- You need to be very patient, otherwise you won’t be able to do the above.
- Sometimes you need to lose carry (be charged interest each day) to win on your position.
- Trends can last a lot longer than you think.
- You don’t need to follow the markets every day – your weekend review will do.
- Relax and let your positions unfold… no need to stress over each little reversal.
- The markets rarely go in a straight line to your profit target.
- Sometimes, to capture a big move, you will need to suffer through a large pull-back in your profits.
- Be wary of recency bias. Just because the last trade did not work does not mean your strategy is defunct.
- A small amount of dedicated “deep work” on your trading each week is all it takes. Don’t waste your precious time on frivolous chart watching or news sites.
Lastly, you need to persevere. You have to learn to take the hits and keep on bouncing back. It is your persistence that will ensure you win in the long-term.
This article is a primer. There are several other techniques that can enhance your returns, which you will want to learn eventually:
- Managing positions around news events
- Building a position
- Trading around a position
- Using market’s money for position sizing
- Conviction-based position sizing
- Creating synthetic positions
- Trading exotic pairs
- Carry trades
Learn more about these for free in the Advanced Forex Course for Smart Traders.
Best of Luck
Long-term trading requires patience, discipline and perseverance.
There is no instant gratification, and the learning process can take years. But take heart. If you can learn to produce consistent long-term profits using a leveraged product like Forex, it will take you a long way towards your financial goals.
If you have any questions about the strategies above, please let me know in the comments below.
About the Author
Sam Eder is a currency trader and author of the Definitive Guide to Developing a Winning Forex Trading System and the Advanced Forex Course for Smart Traders (get free access). He is the owner of www.fxrenew.com a provider of Forex signals from ex-bank and hedge fund traders (get a free trial). If you like Sam’s writing you can subscribe to his newsletter.
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