What Is the Key to Earning a Consistent Profit With Forex?
The foreign currency exchange market, "Forex," provides opportunities to earn substantial profits from betting on exchange rates. While the rewards can be large, the risks match these possibilities and it is easy to quickly lose most or all of your Forex trading capital. The key to success is consistency. While it is impossible to prevent losses, you can increase overall profits by focusing on trades with a low risk-to-reward ratio.
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Risk versus Reward
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Every Forex trade you take can potentially earn you money or lose you money. The key to earning a consistent profit with Forex is to take on trades where the maximum possible loss is much smaller than the maximum possible gain. This means you must have a pre-defined exit strategy should the trade move in either direction. If your pre-defined maximum loss, or risk, is smaller than the potential profit, or reward, then the odds are in your favor. You may still lose money, but over time the profits from the strategy should be positive. Having a pre-defined exit strategy also instills discipline to objectively exit a trade rather than hold onto it indefinitely from emotional bias.
Risk/Reward Ratio
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Traders typically express the relationship between risk and reward as a ratio, such as "1:3," which implies the reward is potentially triple the maximum possible loss. While individual strategies vary, a risk-to-reward ratio of at least 1:3 and even 1:5 are common among professional traders. The key is finding a strategy that lets you clearly see the possible gains and losses so you can calculate this ratio. If the ratio is too low, you avoid the trade.
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Trend Line Systems
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One example of a simple but powerful Forex trading strategy is the trend line system. It lets you visually identify the maximum possible losses and rewards well in advance of taking the trade. If you can draw a straight line that connects at least three consecutive rising low prices on a chart, this is a trend line. Prices tend to bounce off these lines, making the line itself a valid entry point for a trade. If price penetrates the line, you exit for a loss. The prior high price is the minimum expectation should the trend continue. Thus at any time, you can enter the trend knowing where you will exit in either direction. If you wait for prices to retreat to the line, your potential loss is minimal while your possible profits are large, making this a low risk-to-reward ratio.
Warning
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Forex trading is exceptionally risky due to the high leverage that brokers provide. Leverage refers to the ability to trade more currency than your cash balance actually allows. It is thus possible for a trader to become overextended with too much exposure in a single trade. Never trade Forex with funds you cannot afford to lose, and always test your strategies risk-free in a virtual or simulated traded account before risking real money.
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