Why good forex trading is never gambling.

It's 7:30am and the morning routine is done. This always starts at 6am prompt and is an important part of getting my head set for the day. It helps me to get a feel for the market – what happened yesterday, what occurred overnight and what I should be doing with my existing positions. In addition, are there any new opportunities in line with my rules that could present themselves today?

As I write this, I'm reminded of the song by Kenny Rodgers.

You've got to know when to hold 'em.
Know when to fold 'em.
Know when to walk away.
And know when to run.
You never count your money.
When you're sittin' at the table.
There'll be time enough for countin'.
When the dealin's done.

'The Gambler' offers important advice for any trader, and has become somewhat of a trading anthem for me. Before I continue, I should point out that good trading is never gambling, however bad trading often is. 

So what's the difference?

Well, trading without a strategy, without rules and based solely on your emotional state at any given time, is gambling. If you have an edge, rules to follow and accept the fact that you'll lose sometimes, but overall (by understanding the probabilities associated with your system) come out on top, you're not gambling, but instead are playing the odds.

It's a great song and the two key takeaways for me are as follows:

1. Know when you're right (hold), but accept when you're wrong (fold). If things move against you it could be time to cut your losses and get out.
2. Profit on an open position is not real until you take it. As well as knowing your entry point when you get into a trade, you must also know your exit point (the only time you count your winnings).

When to hold, and when to fold >

On the first point, your rules should tell you what to do and when to do it. Trading then becomes methodical – your decision to hold or to fold should never be emotional. As the most successful traders in the world consistently advise – you need to cut your losses quickly and hold your winners for as long as possible. 

While most traders accept this advice, in practice they find it something very difficult to do. Indeed, in practice if left unchecked they are very likely to do the opposite. Preferring to be right over profitable they hold onto their losers for too long, sometimes even moving their stop loss to give a trade more room. Eventually stopped out, on the next trade that finds itself in profit, they take profits too early – they need to pay for the previous loss and are scared of missing the profit on this trade. 

This approach creates an inverted reward-to-risk ratio. Good trading means giving your winners room to breathe (and accepting the ebb and flow of the market as the lifeblood of a potential further move in your favour). It also means choking off your losers as soon as possible. It's a delicate balance, but an important one to get right.

How do you know if you're in a losing trade or just in a temporary reversal, before the market moves in your favour? As always, the answer is in your rules and how based on your understanding and experience you choose to view the market – it's one of the many reasons a trading plan is mandatory!

Know your exit point >

On the second point, if you don't know when you're getting out when entering a trade it's impossible to calculate your reward-to-risk ratio. In addition, without clarity at the outset your decision to get out is likely to be an emotional one, and what's more, the wrong one. 

When I started trading this was one of my challenges. I'd get in with no clear idea of when I might possibly get out. This meant I took trades I never should have taken and regularly had initially profitable positions reverse to take me out for a loss. 

When entering a trade you'll never know how far the currency pair could potentially move, but you can make a best guess. 

I determine my exit point for any given trade on three levels:

1. Based on support and resistance levels, including the SMAs (Simple Moving Averages) I watch. I estimate how far the market could potentially move in my favour before new buyers or sellers are drawn in. This tells me whether I have a reward-to-risk ratio of 2:1 or greater. If I don't, I don't take the trade.
2. I set an order to take off 50% of my position once a 1:1 reward-to-risk position has been reached (I then add additional positions later if momentum continues to support my trade).
3. I watch the relative position of the 10 EMA (Exponential Moving Average), 30 EMA and 50 SMA. If the market begins to move against me, these signals tell me when to exit and I begin to lighten up on my position to reduce my overall risk exposure.

Ultimately, if I'm wrong and the market moves quickly against me, my stop will be hit. I never move this stop further away from my entry point. It's there to protect me and take me out for a level of acceptable risk.

As I write this, a spike in GBPUSD has just stopped me out for a loss at the top of a range. 

Of course, I'd prefer not to lose, but it's a necessary part of the game – it's the cost of doing business. In a manufacturing business, you have to buy raw materials to make a product you'll ultimately sell for more – this is your cost of sales. In forex trading, cost of sales equates to losing trades.

Incidentally, on my GBPUSD short my stop was placed at 1.2783 and the market traded up to 1.2784 before immediately retreating back underneath the range top. This may give me a second opportunity (in line with my rules) to try again, but I now need to wait until the 10am close to find out.

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[Please note, the information presented is general educational material and does not constitute trading advice.
Trading foreign exchange (forex) on margin carries a high level of risk and may not be suitable for you or your circumstances.
Before trading forex you should investigate all of the risks, including the possibility that you could lose more than your initial investment.
It’s important to consider your investment objectives, level of experience and risk appetite. If in doubt seek advice from an independent financial advisor.]