The importance of risk management and how we target profits.
We are starting this beginner forex trading course off with risk management as it is likely the most important dynamic of the market that traders need to understand and determine before executing their trades.
As traders, you are entering a trade based on the speculation of price movement (you either expect it to go up or down). When we refer to going long (we are wanting to buy), when we are talking of going short (we are wanting to sell).
You should not enter a trade before determining your risk factor, without it you will have no structure with regards to your profit / loss. There are many different ways you can pre – determine your risk, but remember, it is up to the trader, based on how much they wish to target and how much they wish to risk to gain this target.
A very conservative and safe risk / reward ratio is 1:2. This means you would be risking 1% of your account to make 2%, so essentially you are looking to have a target which is 2X the value of what you are risking.
EG: If you have a R5000 account and you would like to enter a trade using this R/R (risk / reward), then you will be risking 1% which is R50, and you will target a reward of 2% which is R100.
Let’s say for example you want to enter four trades using this concept…
If you enter four trades and lose 2 of them, you will be in a negative of 2% of your account, if you win the next 2, you will be up 2% of your account. So, as we can understand, if you are consistently using this strategy, your account is not vulnerable to being wiped out by one trade.
Understanding and incorporating your lot size to determine your risk factor.
Before lot size is explained, you will need to understand what a PIP is. The direct meaning of a PIP is ‘Points in Percentage’. When the market moves, it moves in a measurement of points, to get from points into pips we would divide the number of points by 10 (ten). A PIP movement shows us how far the market has moved from one point to another, but now we need to have a ZAR value based on these PIPS or they mean nothing to us to determine our R/R.
- Click on your ‘crosshair’ (ctrl + f) on your chart.
- Click and drag from one point of the chart to another (the middle number is points, so divide by 10 for PIPS).
EG: If EUR / USD is trading at 1.15382 then this means the value of 1 =10 000 pips / 1 = 1000 pips / 5=500 pips / 3=30 pips / 8=8 pips and 2=0.2 pips.
So, with this information we can understand that, if EUR /USD moves up in value from 1.15382 to 1.16000 then this means it has moved up 0.00618 (1.15382 minus 1.16000) which means the amount of PIP movement is 61.8.
Below is a screenshot of how we would measure the distance from Point A to Point B.
As we can see, the first number is the number of candlesticks from A – B, middle number is 2141 points (214.1 PIPS) and the last number is the price / exchange rate at Point B
Understanding how much the value of a PIP is in ZAR.
When traders speak of making profits, it is calculated in PIPS, but with PIPs we need to understand how much the monetary value of each PIP is to determine how much we can make, otherwise we would not have any risk management structure.
- There is no standard value of a PIP, it is dependent on the instrument you are trading, and the value of your account (see below for calculation)
- To calculate the value of a PIP: If we use a R / R ratio as mentioned above (1% risk for 2% gain), then you firstly need to calculate 1% of your account.
- EG: If your account size is R10 000 then your risk is R100 to make a potential profit of R200.
- You need to then measure, in PIPS, the distance from where you wish to enter the trade and where you expect to place your SL. (stop loss)
- Once you have determined this distance in PIPS (e.g., 214) you will then need to apply the following calculation:
- Lot Size = Risk / PIPS / Exchange rate of quote currency to rand / 10.
When you trade, you trade in pairs, which means the strength and weakness of two different currencies. The Base Currency is the first currency (first three letters), the Quote Currency is the last currency (last three letters).
For Example: EUR (base) / USD (quote)
EG: 100 / 214 / 15.00 / 10 = 0.003 which means we would trade at 0.03 as our volume (lot size)
Now to break this down: The value of R100 is 1% risk on a R10 000 account. The 214 is the number of pips (this number isn’t fixed). The 15.00 is the exchange rate in ZAR to the quote currency (USD) – you can find this rate by looking at live USD/ZAR. Lastly, we divide by ten to get our number to be equivalent to a value of PIPS.
Conclusion for Section 1: Risk is extremely important and knowing how much you want to risk before entering a trade will ensure you don’t lose more than what is necessary. If you do not calculate risk you could enter a trade with a huge exposure of your capital in the market and, if that trade goes against you, it could wipe out your account or it could take a while for you to make up for those large losses.
What is Technical Analysis and how we use it to trade.
When we look at the chart of the market for the first time it can be very intimidating as there are so many things to look at and it feels like you don’t know where to start or what to do.
Technical Analysis in trading is using past price movements and patterns to predict future price movements and patters. As traders, we take advantage of the smallest movement in the market, whether the market is going up (long) or down (short), we can enter trades in either direction.
History repeats itself in trading, and we have tools at our disposal (through the Khwezi Trade Platform) to enable us to predict these possible movements. In this section you will learn the different components of technical analysis which helps to predict price movements.
Please do take advantage of the videos for practical examples.
What is a trend and how can we determine it?
Throughout your trading career the most common aspect that you will hear is ‘What is the trend today’ or ‘The trend is looking bullish or bearish’, to understand these terminologies, you need to understand what a trend is.
In simple terms, a trend is the overall strength of the market, and where the market strength is moving (up or down). The market does not trend all the time, but when it does trend, traders take full advantage of it as this is the path of least resistance in the market. The reason you want to take the path of least resistance is because you don’t want anything stopping your trade in the direction you predicted. If the trend is going UP, you BUY. If the trend is going DOWN, you SELL. Trend trading can become very profitable when you identify it, but the problem for traders is that currencies trend around 30% of the time. With currency, traders target trends to maximize profits and ride the trend until the end.
How to identify a trend.
It is simple to determine whether the market is going up, or whether it is going down. Trading is unfortunately not this simple, there are rules that we need to follow to accurately identify market components and movements… without these rules it will be difficult to keep a structured analysis.
There are two types of trends in the markets, UPTREND and DOWNTREND. As stated earlier, when you identify a downtrend, you are looking to sell as the strength of the market is moving down. When you identify an uptrend, you are looking to buy as the strength of the market is going up. Now we need to understand how to identify a downtrend / uptrend and know where we should buy / sell respective of the trend.
How to identify an UPTREND.
The markets are based on highs and lows, these are the ‘pivot points’ in the market where we can see it gaining strength or gaining weakness.
For an uptrend to be confirmed, we need two things: A Higher High and a Higher Low.
By viewing this example, we can depict that there are highs and lows in the market. What makes a trend an uptrend is when we see that the current highs are going higher than the previous highs, and the current lows are going higher than the previous lows.
This proves to us the market strength is going up.
How to identify a DOWNTREND
By viewing this example, we can depict that makes a trend a downtrend is when we see that the current highs are going lower than the lows than the previous lows.
This proves to us the market strength is going down. there are highs and lows in the market. What previous highs, and the current lows are going.
How we use a trend to locate our entry.
This is a very important component of our education. Once you determine the trend and have confirmed if it is an up or a downtrend, you need to try and locate where you want to enter the trade, and where you can enter the trade to have maximal potential profit with minimal risk.
We now understand that the market moves in ‘waves’, this means the market will not just point straight up or down, it will make small counter-moves which we call retracements.
Retracements happen when the market goes in the opposite direction of the overall trend. As we can see when the market is moving from a higher high to a higher low, that is the retracement. When the market is moving from a lower low to a lower high, that is a retracement. It is the small ‘pull back’ the market generates before continuing its trend.
Finding the optimal point to enter a trade in a trending market.
Once again, this is a very important concept to understand when trading. Know and understand these rules below.
- In an Uptrend we BUY on the Higher Lows.
- In a Downtrend we SELL on the Lower Highs.
This concept is straight forward, if you think about this logically, you want to BUY when the price is at its lowest in an uptrend, which means it should go up and you can continue to ride the trend towards the higher high.
You want to SELL when the market is at its highest point in a downtrend which means you can continue to ride the trade down towards the lower low.
Let’s go over the general rules for trading in trends
- First identify the trend by locating the Higher Highs, Higher Lows / Lower Highs, Lower Lows.
- If it is a downtrend, you sell on the Lower Highs. If it is an uptrend you buy on the Higher Lows.
As you can see, there are rules to follow before determining whether to buy or sell.
Always buy on a low, always sell on a high. This ensures maximum potential profit and minimal potential losses.
You always want to buy at a low because this means the market theoretically should not go any lower and we can place our stop loss very close (below) to where we enter to ensure we risk as little as possible in the event we are wrong and target as much as possible if we are right
You want to sell at a high because this means the market theoretically should not go any higher and we can place our stop loss very close (above) to where we enter to ensure we risk as little as possible and target as much as possible.
Why retracements are so important.
As we know, and as we have learned, we have a retracement which is the shorter movement in the trends (red arrow).
The reason for this being so important is because we are wanting to predict where this retracement ends which will mean we have predicted the highest point in a downtrend and the lowest point in and uptrend.
If we predict this retracement stopping point accurately, we can expect a potential continuation of trend which will mean we sell on the Lower High and hold the trade for the lower low. For an uptrend we will buy on the higher low and hold the trade towards the higher high. This is also easy to say, but now let’s get into the fun part…
Support and Resistance.
Before we go any further, we need you to understand all of the ‘sections’ individually… do not try to correlate the trend to support and resistance YET. We will get to that later in this course but, for now, just understand and study each section by itself so you don’t confuse yourself by putting it all together at once. Let’s walk before we run.
We are sure you have heard the saying ‘History repeats itself’, and nothing can be more relevant to this saying than to relate this to trading. In trading, price patterns and movements tend to repeat themselves and it is up to the trader to locate the previous patterns / movements and try their best to predict where they could potentially affect the current market by looking at previous market movements.
Support is seen as a ‘floor’ for price, Resistance is seen as a ‘Ceiling’ for price.
This means that, if we locate support, the price should not go any lower, and therefore we could buy at this level. Opposingly, resistance means we can expect price to not go any higher, and this could give us an opportunity to sell.
Locating support and resistance.
As stated above, price patterns tend to repeat themselves and by using this logic we can determine previous support and resistance levels with expectations of them affecting current or future price.
Another important point to make note of is that past support can turn into future resistance, and past resistance can turn into future support.
In simple terms: Support is where price touches a level and goes up… resistance is where price touches a level and goes down.
An important note to take from support and resistance is that there is support and resistance everywhere on your charts… its essentially the reason the market changes direction from one point to another, that’s why we try to consider all components of trading and use them in conjunction with one another to increase our chances in the markets. We see the strength of support and resistance based on the reaction of price when it touches the specific level and either moves up / down quickly or slowly. The quicker it moves away from the level, the stronger that level becomes.
There are also different forms of support and resistance in the market, and we need to be able to accurately determine these levels in order to find the turning points in the market and take advantage of these.
Support / resistance acts as a barrier for price, when price breaks that barrier, it then closes to form a new barrier (past support = future resistance, past resistance = future support).
What is Fibonacci?
In the above sections, we have now come to understand that support and resistance is an important component of the market and to predict where we expect the market to stop (and turn) so we can take advantage of that and enter our position in the market.
In this section you will be learning about a very popular ‘tool’ we can use to predict where retracements (which are movements against major trend) should end to find an appropriate level to enter the trade before that trend continues in its original direction after retracing.
Fibonacci (FIB for short) is also seen as a form of ‘support / resistance’ in the market because, when price gets to our FIB level (1 of 3), we can expect price to turn and continue its trend in the overall direction of the market (up / down).
There is a lot of information on Fibonacci and how the theory behind it has evolved, but that isn’t what we need to focus on in this course as you don’t need to understand the math behind it to use it in the markets.
To summarize FIB: It is a ‘Golden Ratio’ in the market that is also applicable in everyday life. We have three ‘Golden Ratios’ which are: 38.2%, 50% and 61.8%. When we see price approaching these three different levels, we could expect a reversal of price depending on the reaction once price touches those levels. These numbers mean that the retracement of price in a trend should only move back a certain percentage before continuing.
Before we go into a demonstration of FIB levels, one needs to understand that we use these tools in the market with other tools to increase our probabilities in the market, if we just used FIB to trade the market that means we are relying on one tool, whereas we have many tools at our disposal.
How to analyze the charts using Fibonacci
There are certain rules with everything we have learned thus far. You always need to confirm your analysis with rules, otherwise you are entering a trade blindly, and this could be detrimental to your account.
To repeat, Fibonacci acts as support / resistance in the market, and we need to understand that even the slightest or rather ‘weakest’ support and resistance level could affect price in the biggest way, so we can NEVER DISREGARD A LEVEL of support / resistance.
We know that a retracement is a slight ‘pullback’ before the price should move on in its original trend.
The retracement in an uptrend means price is moving down and pulling back to find a level of support which should prevent it from going down further, and when it finds this level and reacts well to it, price should continue in its original and overall direction (up).
The retracement in a downtrend means price is moving up and pulling back to find a level of resistance which should prevent it from going up further, and when it finds this level and reacts well to it, price should continue in its original and overall direction (down).
Now let’s see the rules for a trending market and how to accurately draw your Fibonacci levels.
- In an uptrend, we always draw the level from our MOST RECENT low to our MOST RECENT HIGH.
- In a downtrend, we always draw our level from our MOST RECENT high to our MOST RECENT low.
Here are a couple of practical portrayals of what you will see when you draw a FIB level: