Forex Trading Signals
A
forex trading signal or trade recommendation refers to a set of precise price levels at which
a forex trader may enter and exit a trade in such a way as to earn a decent
profit or incur a minimal loss. Generally, the forex trader has to decide
what instrument to trade, what time frame to use and whether to go long
or short. Having done that, the professional forex trader then proceeds
to set a target at which to exit the market at a profit and another
target for downside protection. This
includes precise price levels for either a market order or limit order,
take profit order and stop loss order and may also include a trailing stop
order. A market or limit order specifies the market entry point and would normally
be made based on pre-set rules from the trader's forex trading strategy
or a combination of forex trading
strategies. The take profit and stop loss/trailing stop orders attached
to an open trade specifies possible market exit points and depends on the
traders exit strategy. A day trader trading on a 30-minute or 1-hour chart
would usually exit the market with smaller profit or loss compared to a
swing trader trading on a 4-hour or day chart, or a position trader trading
on a daily, weekly or monthly chart. Scalpers use smaller time frames
with even smaller levels of profit or loss. A forex trader's success often
depends on how successful their exit strategy is. Some traders set their
take profit and stop loss orders based on a risk/reward ration of say
2:1. Others
estimate take profit and stop loss orders by drawing support/resistance
trend lines.
Risk/Reward Ratio
Many traders use a risk/reward ratio of at least 2:1 to estimate take profit and stop loss levels, which is part of the exit strategy a trader would adopt. A 100% return on risk capital as against 100% loss is equivalent to a 1:1 risk/reward ratio. The ratio is calculated mathematically by dividing the amount of profit the trader expects to make when the position is closed (i.e. the reward) by the amount he or she stands to lose if the price move is unfavourable (i.e. the risk). The optimal risk/reward ratio differs widely among trading strategies. When computing risk/reward ratio per trade, the maximum drawdown for a given trading strategy is a very important defining factor. The maximum drawdown is the largest loss or set of consecutive losses following a profitable trade. Since the ideal scenario for forex trading success is for gross profit to outweigh gross loss, it is necessary to keep the risk/reward ratio at a minimum of 2:1 so that the net gain is positive.
Support and Resistance Lines
A support line is drawn by joining 2 or 3 of the most recent lowest price
levels at which a downtrend reverses. A resistance line is drawn by
joining 2 or 3 of the most recent highest price levels at which an uptrend
reverses. These two lines, which can be horizontal or slanted depending
on whether the market is ranging or trending, form a price tunnel within
which price oscillates. Perhaps, more popular is the use of Pivot
Points to estimate Support and Resistance levels.
Regardless of which method is used, it is safer to set take profit
level within
the price tunnel so as to be more certain of securing profit before price reverses. Conversely,
it is better to set stop loss outside the price tunnel to increase your
chances of reaching your take profit level before prematurely exiting
the market at the stop loss level. Another risk with stop loss execution
is price spikes where a sharp rise in price is followed by a sharp decline
or vice versa.
If stop loss is hit before take profit, which happens momentarily and
not the result of a trend, then we have a bad case of using stop loss
order. Some traders even blame their broker for always executing their
stop loss thereby instigating failure of their business. Still, some
traders stop using stop loss order altogether which is against good
money management best practices. It is always better, with the
exception of sufficient capitalization where margin used is under 2%
of trading capital, to use stop loss
order so as to avoid getting a margin call or reaching zero balance in the
case where the forex broker does not operate margin call policy.
There is no such thing as trading without losses only that your gains should
be much more than your losses. This is particularly true when the
trader has inadequate trading capital.
SAMPLE FX TRADING SIGNAL
Instrument: GBP/USD
Action: Buy @ price ≤ 2.0592
Take Profit: 2.0631
Stop loss: 2.0562
Commercial system traders generate trading signals using rule-based trading systems. These signals are usually designed to alert subscribers audio-visually on their trading platform or set to be delivered by email or text message so that the ignorant trader who subscribes to receive them can trade successfully. InvesticsFX provides trading recommendations through a forex signal provider account with Zulutrade. Refer to the home page for details of this.
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