Monday, September 13, 2010

How to Treat Forex Like a Business : Ten Things You Need To Do When You Trade

The internet is filled with people who advice and give their opinion about how others can succeed in forex trading. Many times this advice is extremely vague and does not have any practical implications with it that can actually help newer traders succeed. One of the most common examples of this is how more experienced traders tend to tell people new to the market to "treat forex like a business" while they give absolutely no specific advice on how you are supposed to do this. Sure, for successful traders this is obvious and the advice needs no further explanation - since they are already treating forex like a business - but for new traders the advice is totally meaningless since they do not know how to trade forex like a business or the steps they need to take to make this a reality.

On today's post I want to share with you 10 practical things you need to do to treat your forex trading like a business, after you do these ten things you will find that your trading will be much more organized, your goals will be much clearer and you will be on your road - or at least a much clearer path - towards long term profitability. Definitely treating your forex trading like a business is extremely important but what does this mean ? What practical decisions can you take to change the way in which you trade the forex market ? Keep reading to find out !

1. Think in terms of goals and expenses. The first change you must make is around the way in which you look at forex trading. If you are going to treat this venture like a business you need to think about it in terms of goals and expenses. In trading goals are profitability targets and expenses are both trading costs and losing trades. A great part of your success will fall into being able to look into your trading as a set of goals and expenses.

2. Determine your plan. This is perhaps the most important part of trading which is to determine how things will be done in your business. If you were opening up an aluminium can factory you would have to figure out how you are going to be making the cans, who will buy them and who your suppliers are going to be before you even think about starting your business. Forex is the same thing, you need to have a trading plan which is merely a set of rules (either mechanical or discretionary) that you will follow in your business.

3. Determine your goals based on your plan. Your plan provides the anchor which allows you to determine realistic profit targets. After you come up with a plan you need to deeply evaluate it - through reliable simulations - to obtain a given set of profit targets that you will be able to use. If your profit targets are not what you want they you can change your plan - and reevaluate it - to make them better. When you are happy with your goals, continue.

4. Determine your expenses based on your plan. The next important thing you need to do is understand what your expenses will be. What percentage of your account will you be losing in average every year before reaching your goals ? For how long will you lose that capital ? Accurately determining variables such as the maximum draw down, the average draw down period length and the probability to have a losing month are key aspects of your forex business plan.

5. Determine your capital requirements. Since you now have a plan with goals and expenses you now need to determine your capital requirements which is simply the amount of money needed to execute your plan. Certainly different trading strategies will require different amounts of money to be tradable. This also depends on the amount of money you want to make, if you are aiming to make 20K a year and your goal is 20% then investing 100K might be necessary while if the only thing you want to do is execute your strategy with the minimum possible capital you might only need 200 or 1000 USD.

6. Draw best and worst case scenarios based on your simulations. A very important thing you need to do is to come up with how future scenarios might look for your trading strategy. If your simulations were done in a reliable manner then you can use 10 year backtests to get a picture of how best and worst cases might look like. Your next year might be as profitable as the most profitable year of the past 10 years while it can also be as bad (or worse) than the worst year. Having these pictures is vital since it will allow you to see where your plan is going and if what you are experiencing is or is not normal.

7. Come up with a worst-case scenario. As in every business there can be a point when the expenses are way beyond those programmed by the plan and a change must be made in order to survive to the future. In your trading business you need to come up with a worst-case scenario so that - in case your strategy becomes too risky - you will know well before hand when to change it. I generally use two times the 10 year historical maximum draw down as my worst case scenario, something that has worked well for me.

8. Do monthly, quarterly and yearly evaluations. Another important aspect of treating trading like a business is evaluating how your business has performed in a monthly, quarterly and yearly manner. Just like all other business do you should generate reports and analyze how your strategy has performed during these time periods. It is always important to know if your expenses are what you expect from your plan (within the bound of normal draw down periods), if your goals have been met and if you have reached any of your worst case scenarios. Staying on top of your plan by evaluating it frequently is a vital part of survival.

9. Do not change your plan when it is working as planned. A big mistake - perhaps one of the biggest - new traders make is to jump away from a trader system just because profitability goals are not being met. If a trading system is losing money within the programmed expenses and the 10 year simulations you have made then there is no reason to run away from your trading plan. While your draw downs remain within what you planned when you evaluate the strategy your business is actually working as planned.

10. Do not increase your goals or your expenses. Another very common mistake made by traders who are not yet experienced at treating forex like a business is the change of their goals and expenses along the way. When a system performs well they increase the risk (to increase their profitability goals) and when it is doing badly they sometimes increase their draw down tolerance to allow the system "to recover". There is a reason why you have set goals and expenses and worst case scenarios and you should NOT change them just because of short term performance. Every change in the business plan needs a total reevaluation of goals and expenses which should always be done if any detail is changed. Committing to a set of goals and expenses and sticking to them is a big part of success.

Although the above advice is only a small part of treating forex like a business it does gather all the most important aspects you need to take into account when you want your trading to be something serious, more predictable and less emotional. Treating forex trading like a business with adequate planning, goals and expenses is a vital part of trading which most people new to the market simply ignore or are too lazy to develop. If you follow the above advice and develop a trading plan with an idea of what the behavior of your system might be then you will be miles away from the large majority of new traders.

If you would like to learn more about system evaluation and how you too can develop mechanical systems with reliable simulation results please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach automated trading in general . I hope you enjoyed this article ! :o)

2 comments:

Unknown said...

Daniel,

Thanks for a detailed discussion of the topic. Do you think it's possible to create a template (document), which could be used as a checklist?

Maxim

Daniel said...

Hi Maxim,

Thank you very much for your comment :o) certainly, that is a great idea ! I will try to come up with one within the next few weeks. Thanks again for being such a faithful reader :o)

Best Regards,

Daniel

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