Even big guys can lose their shirt… it doesn’t matter if it is Forex Trading, stocks, or gambling. As we have recently seen in the financial markets, bad choices and risky behavior can bring even mighty banks down.
How can YOU avoid the bad decisions and bad techniques that create account killing errors? Strangely enough it is status as a “little guy” that can be salvation for the non-professional trader. By adopting disciplined Forex trading behavior and realizing how you are vulnerable can make you a wining trader!
The fact is most Forex traders lose just because they’ve never heard of “Trader’s Ruin.” More commonly called “Gambler’s Ruin,” there are a couple of reasons that it is important that the Forex trader understand this concept.
1) Understanding this concept can easily make the difference between trading career success or failure.
2) Failure is a statistical, mathematical CERTAINTY if you don’t know the techniques required to beat Trader’s Ruin.
The Road to Ruin
It has been said that the difference between gambling and speculation (or trading) is that in gambling the odds are fixed and they are always in favor of the house and in speculating the trader uses his intellect to shift the odds in his favor. So logically, the GAMBLER, even if he wins in the short term, if he keeps gambling, in the long term he will certainly lose. It then seems logical, that the SPECULATOR (read Forex TRADER), who is adept at selecting Forex trading strategies where the odds are consistently in his favor, may win or lose in the short term, but over the long haul will come out ahead.
The SAD TRUTH is that this is NOT TRUE.
Even if you had a source for Forex trading signals that had more winners than losers, the statistical reality is that if one side of the trading dynamic (the Forex market) has more resources (deeper pockets) than the other side of the trade (read YOU), over the long term the player with more resources will statistically always wind up with all the money. OUCH!
For those of you that don’t care about the math an easy illustration is two traders playing a game of flipping coins. Trader One (T1) and Trader Two (T2) each have the same number of coins. Each trader takes turns flipping a coin and the other trader calling “heads or tails”. If the calling trader guesses right, he gets the coin. This is even odds, with each trader having 50% chance of winning any flip. However, if you repeat this process long enough, eventually one trader will have all the coins – it is a 100% statistical, mathematical certainty.
If one trader starts out with significantly more coins than the other, that trader is the one that will take all the coins. If you want to see the math it looks like this, where T1 and T2 are Trader One’s and Two’s probability of losing respectively and “n” is the number of coins held by each trader.
T1 = n2 / (n1 + n2)
T2 = n1 / (n1 + n2)
If you plug in different numbers you can see how it works. If Trader 1 and Trader 2 have equal numbers of coins – let’s say 100 coins each. Then the probability that Trader 1 will lose all his coins is 100/200 or 0.5 which is 50%. There is a 50-50 chance that either trader will lose all his coins to the other trader. BUT, if one trader has a much larger number of coins than the other watch what happens.
If Trader one has 1000 coins and Trader 2 has only 100 the chances of Trader one losing is 100/1100 or 0.091, this says that the chance Trader one will lose all his coins is only 9.1%, less than one out of ten. If Trader 1 is the Forex market, with essentially an infinite supply of coins, the chances of Trader 2 winning are infinitesimal. Translated in ordinary terms, this says that if there are two traders, each trader’s chance of going broke is equal to the ratio of the number of coins your opponent has to the total number of coins you both have. This means, that without some major aberration (called a real run of incredible good luck) that the trader with the smaller bank account will always lose.
It seems logical that this is true in Las Vegas, where the odds are always against you. But it seems so unfair in Forex market trading. The harsh truth is this applies to the stock markets, investment houses, hedge funds, large private investors and Forex Traders! It is all about “staying power.” The more money you have, the longer you can stay in the game, the better your chances of coming out ahead.
Little guys lose.
So do we all quit? Are we doomed? Yes and no. Unless you have a Forex trading strategy that protects your resources, you will inevitably lose. Losses and fees will suck the life out of your account. To beat the Forex markets you must discipline your trading behavior to grow and protect your resources.
Beating The Market And Its Minions At Their Game
In Vegas, the only way to win is to not play the game. But to accumulate true wealth, playing the markets is one of the only practical methods available to the ordinary trader. The financial industry knows this and everything it does, from asset allocation models, advertising, fees and commission structure is biased to keep you IN the markets ON THEIR TERMS. If you stop playing their game, they lose their advantage which is the root of your trader’s ruin.
The savvy investor needs to get off the Financial Industry train and take command of his or her own trading techniques. The statistical example above assumes that the Traders make a very structured “bet,” each trade is the same size every time and it is a “winner take all” bet. This is a way that many traders tend to trade, either intentionally or functionally by holding their trades too long when they are losing. Escaping this mentality and realizing how discipline can help you “beat the street” can move the results of your trading strongly in your favor.
The first lesson that must be learned is when the trade doesn’t go to your advantage, you stop playing as soon as possible. This requires iron-willed discipline on your part. You don’t need to be right every trade to win big in the Forex or any market, in fact you don’t even have to be right most of the time. Most Forex traders think in terms of what percentage of trades they win. Many Forex trading systems or Forex robot developers brag of results like “95% winning trades.” This is the WRONG way to look at a trading strategy.
The core concept a trader needs to understand is that a trading system should ensure that you win more money than you lose over time. You may lose many more trades than you win, but if you keep your losses small, you can overwhelm them with your winnings. Many of the best traders and investors often only make winning trades 40% of the time and build huge fortunes. They do this by ensuring that they “keep losses small and let winners run.” If the trade goes against the successful trader, he immediately quits the trade, and only plays the game when he is winning. This is the essence of Positive Expectancy (to be examined in another article) – small losses, large wins. If a trade turns against you, the sooner you quit the trade, the less you lose. When a trader holds on, hoping or expecting a trade to reverse or improve and takes even larger losses is when he enters the realm of trader’s ruin.
When the trade is going your way, let it go, watch it closely and continually adjust your stops to protect your profits. Whether the stops are 10%, $10, or 2 pips, the trader must have an inviolable rule that is followed without fail. If you win more, you can risk more but losses must be kept to a minimum. A trader’s frustration with being stopped out, and taking repeated small losses, often influences their trading techniques, leading them to make poor trading decisions leading to Trader’s Ruin.
One of the easiest ways to enforce the type of discipline required for real Forex trading success is through the use of automated Forex system trading or Forex trading robots – often called Forex Bots. These software based Forex trading systems are very sophisticated computer programs that use a variety of Forex trading signals. Many of them can trade in a completely automated mode, where all the trader does is watch and check his account balance. These programs enforce the type of discipline that provides positive expectancy. Automated trading systems can often open a trade, track it, set stop losses, and close the trade completely on their own, based on the rules programmed into the software using a data feed and an internet connection to the trader’s brokerage.
Typically, successful Forex trading software of this sort gets stopped out often and takes many small losses because the program restricts the amount of loss allowed for any trade. As mentioned before, being stopped out of trades for losses repeatedly frustrates a human trader and emotion enters the picture. Trading robots are mechanical Forex trading systems that feel no frustration. These programs also allow a winning trade to run until it “turns around”, some of the more sophisticated programs may widen the stops as a trade develops profits, but the percentage of the trade that might be given back is still very small and acted on immediately if exceeded. This is the method that creates success and profits in trading.
This is how the small trader can “refuse to play” the industry’s game and still make huge profits. Many of the automated Forex systems have 100% guarantees, provide complete setup and support service, and give a prospective customer the ability to paper trade on demo accounts in the real Forex market, so that traders can “try before they buy”. This website offers reviews of six of the best available Forex automatic trading systems. These Forex auto trade systems were selected based on a range of trading approaches, and each has the two very important primary attributes listed above, the ability to paper trade or otherwise test the system for at least 60 days and an unconditional 100% money back guarantee. Whether you decide to try automatic Forex trading systems or maintain your own iron willed discipline, the important concept to internalize is that by protecting your assets, derailing the financial industry train, and controlling how to day trade stocks system, you protect your resources and enhance your positive expectancy.
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