When it comes to trading Forex, your best offense is a good defense. What does that mean, exactly? It means that as long as you maintain a defensive mindset, your chances of becoming profitable increase exponentially.
For those of you who follow sports, you’ll recognize the saying as “the best defense is a good offense”. It was originally applied to American football by a famous coach by the name of Vince Lombardi. Coach Lombardi argued that if you can keep constant pressure on the other team, they won’t have a chance to score, thus putting you in a better position to win.
This may work well in sports, but when it comes to trading Forex, I say “your best offense is a good Forex defense“.
So how does this translate to trading Forex, you ask?
Simply put, your first job as a trader is to protect your trading capital. Your second job is to make money. If you can develop this type of defensive mindset, you will be well on your way to becoming profitable.
Here are a few of my favorite ways to think defensively.
Developing patience is by far the best way to defend your trading capital. Any professional trader will tell you that patience is key if you want to enjoy consistent profits.
This is especially true when trading the higher time frames. The truth is, a setup that’s worth your hard-earned money doesn’t come around very often on the higher time frames. You may find yourself sitting on your hands for several days or even a week before a favorable setup presents itself.
It’s during those down times that having a professional level of patience pays off. This level of patience means that you are no longer focused on making trades, but rather identifying the best setups. This equates to less trades and more profit, which is why we’re all here.
So how does one develop such an unwavering level of patience?
You have to change your mindset, first and foremost. You need to begin thinking of your trading as a business instead of a hobby. It’s perfectly fine if you enjoy trading so much that you don’t think of it as work, in fact that’s what it takes to become successful – a true passion for trading. But you need to start thinking in terms of profit and loss, just as a business does.
It all comes down to risk. If a business can control their risk by only investing in the products and/or services that offer the best opportunity to put them ahead, then they will likely do very well. How do successful businesses accomplish this? Very simply, they practice patience and only invest in the very best products and/or services. They are never in a hurry to spend money.
Your trading businesses needs to be treated the same way. Each setup needs to be scrutinized and you should never be in a hurry to put your trading capital at risk.
Does this setup give me the best chance of getting ahead in my trading career? Is it something I feel my business should invest in? If you can’t answer those two questions with a resounding “yes”, then your business is better off investing elsewhere.
Most Forex forums are filled with traders talking about how many pips they made on a particular setup or within a specific month. But nobody ever talks about what kind of risk they took to make those gains, which is what really matters.
Speaking of risk, one of the biggest misconceptions when it comes to risk management is the “2% rule”. If you’ve been trading for any length of time, I’m sure you’ve heard of the recommendation to risk 2% of your account balance on each trade.
However there’s a flaw with this level of thinking and it all begins with how we perceive information. Let me explain.
The problem arises when we begin to look at how we process information as human beings. It’s safe to say that most people don’t get emotional about the numbers they discuss in their statistics class. These numbers are inconsequential. In other words they have no material significance in our lives.
But what happens when we begin to think about money, especially money lost? Our subconscious mind immediately kicks in as if to remind us that “this is important, pay attention”. Not only that, but humans are naturally emotional creatures when it comes to dealing with money.
Why is this important? It’s important because if you only define your risk as a percentage, you’re only satisfying one side of your brain – the logical side. The emotional side is left wanting more. So when you risk the recommended 2% on a trade, and your account is down $400, you begin to panic. This is because you failed to mentally accept the $400 risk. In other words, you never accepted the fact that you could lose $400.
The best approach to define and accept risk is to use both methods. Identify the amount of money you’re comfortable losing on any one trade and then develop a percentage cap. Here’s an example.
Let’s say you have a $5,000 account. You’re comfortable losing $100 on any one trade. You set a percentage cap of 3%, which means that you can risk no more than 3% on any one trade. Your $100 risked equals 2% of your $5,000 account, so you’re well within your 3% cap.
Now when you go to open a trade, you know that you aren’t risking too much of your capital and you have mentally accepted the risk of losing $100. This is what it takes to properly defend your trading capital from the emotional tendencies that are all too common when risk isn’t properly defined and accepted.
It goes without saying that when it comes to thinking defensively, a stop loss is your best friend. Although this should be considered common knowledge, I would be remiss not to touch on the topic of using a proper stop loss strategy.
So what is a “hard” stop, you ask? A hard stop is simply a stop loss that you set within your trading platform. It’s the opposite of a mental stop loss. I always advocate the use of a hard stop over a mental stop for a couple of reasons.
A hard stop removes emotional tendencies
How many times have you been in a losing trade that turned out to be far worse than it had to be because you were hoping that the market would change direction? This is a common tendency among Forex traders, and one that can be detrimental to your defense strategy. A hard stop eliminates this tendency by removing emotion from the equation and allowing your position to be closed at a predetermined level should the trade go bad.
A hard stop works while you’re away
Let’s face it, you can’t always be at your computer, nor should you be. After all, the great thing about trading the higher time frames is that it frees you up to do other things, including sleep. A hard stop allows you to leave your trading desk without the need to constantly check on your position. Think of it as your virtual assistant.
Every trading platform has the ability to set a hard stop and I certainly recommend taking full advantage of it. In fact it’s the easiest change you can make to start thinking defensively.
There is one golden rule to using a stop loss of any kind – you must identify the level at which you will place the stop before entering the market. This is the only time you have a neutral mindset. If you wait until you’re in the trade to identify the level, it becomes far too easy for your emotions to get the best of you which can lead to an unfavorable stop loss placement.
Identifying your stop loss level before entering the market is also necessary in order to calculate your risk to reward ratio. This is key if your aim is to think defensively and ultimately become consistently profitable.
I hope this article has given you a good idea of where to start when developing a defensive mindset as a Forex trader. Just remember that your first job as a trader is to protect your trading capital, your second job is to make money. Keep this idea at the core of everything you do and you will be well on your way to becoming a successful Forex trader.
We’ve covered a lot of content in this article. Let’s recap some of the most important points.
As a Forex trader, would you agree that your best offense is a good defense? What are some other methods you use to think defensively when trading the markets?
Leave your comment or question below. I look forward to hearing from you.