Numerous attempts have been made to simplify trading in the forex market, and while a degree of success has been achieved in this area, trading forex is more than installing a trading platform, funding an account and clicking a buy or sell button on your computer.
In fact, trading has often been compared to gambling since a high degree of risk and speculative activity is involved. Nevertheless, some very important differences exist between the two.
The sections that follow cover some of the distinguishing differences between gambling and trading, and offer some techniques to optimize your trading technique accordingly
Trading Versus Gambling
Occasional gamblers do not tend to have much of a game plan or strategy when gambling, and for this reason they do not tend to win consistently. In essence, they just pay the house to play.
In this regard, unsophisticated forex traders have a lot in common with the casual gambler. For example, the novice or not so savvy trader might start trading the forex market without ever having developed a well thought out trading plan. Read more on how to design a trading plan here.
Even if they do have a plan, they might not have thoroughly back tested and demo traded it before implementing the strategy in a live trading environment. Read more on getting a demo account here.
Basically, these traders make up the gamblers of the forex market that essentially just make bets on the direction of the forex market. Often, such traders will eventually wind up losing some or all of their trading funds as they pay for the entertainment of trading in the forex market.
Trading Forex as a Business
Although most people consider betting at a casino to be gambling, gambling on certain casino games can be approached as a business. This might include playing blackjack with a system for example.
A person playing blackjack who has achieved a high level of card counting proficiency can often get an edge on the house. This strategy can allow them to win consistently at the game, whether they need to count one, two or even five decks of cards.
The same idea generally holds true with a forex trader. First, the trader must have an underlying strategy which is applied consistently through a trading plan.
Second, the trading plan must be implemented with a high degree of discipline. Third, the trader will total up their winners and losers to obtain a net profit or loss. In this way, they endeavor to approach their trading activities as a business.
Furthermore, as they trade in this disciplined manner, the trader will have developed the sound trading methods which make up and objectify their trading system. This allows them to remove the risky elements of emotional involvement and gambling from their trading.
Of course, regardless of these measures, an inherent trading risk will always accompany the forex trading endeavor since the forex market moves, sometimes in rather unpredictable ways. Nevertheless, a trader with a sound trading plan and a businesslike approach will generally perform better than one who does not.
The Risk-Reward Ratio and How it Applies in Forex Trading
A very useful technique which can enhance your trading and lessen the gambling aspect involves assessing the risk reward ratio. Computing the risk reward ratio basically involves comparing the risk that you are willing to assume to the projected return you expect to make on any given trade.
Analyzing the risk reward ratio on every forex trade may require a bit more effort than just determining the upwards or downwards direction for a currency pair. Nevertheless, your overall success will be more consistent, and this will improve your chances of achieving success as a forex trader over the long term.
Choosing Forex Risk Reward Ratios
As a general rule, most seasoned forex traders will not enter into a trade unless the risk which they foresee for the trade is at least half of what the anticipated reward might be. This would make their minimum risk reward ratio 1:2, in that the trade involves taking a risk factor of 1 in order to obtain twice that amount if the trade works out.
Furthermore, by assessing your risk/reward ratio on a probability weighted scale, you can optimize your trading business and have a much better chance of success. Nevertheless, you want to avoid being too subjective about assessing the probability of different outcomes.
Basically, traders who prefer to gamble and fail to consider their risk reward ratio when taking positions in the forex market might want to ask themselves why they would want to spend their time playing around in a complex business that they have not taken the time and trouble to learn how to operate in successfully. Maybe their valuable time could be put to use more constructively elsewhere.
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