How do you make money trading?
Trading makes money based on movement of financial markets. You can trade, that is, make a decision that a financial instrument will move up or down in price, on just about any financial instrument. Each time the price moves in your favour, you earn a little more money. So what’s stopping you from holding onto something until it moves heaps?! There’s a range of factors that you will be competing against, including the price going the opposite direction to what you wanted, losing money.
It’s not just about picking a direction, you need an account with a broker to access the markets and instruments in the first place. You also need money in your account, money is what you use to place a trade. You may be able to enter a small trade for around $40. As an example you might use a portion of your account balance to allocate towards a trade which becomes “Margin”. The margin is the used amount of money to hold that trade open while the market moves up and down. The margin is based on the leverage of the account, often 1:100, and it simply means the broker is giving you access to trade 100,000 units for the same value as 100 units of margin put to the trade. It gets a bit confusing at first, but just remember the key point is will this financial instrument go up or down. To recap, leverage reflects how many units or lots you can trade compared to how much money you need to allocate to the trade, otherwise known as margin. For example, if you traded 100,000 units of the AUD/USD, you might need the margin of around $100. It will always be a little different depending on what you are trading and your account currency as the currency rates need to all convert between each other to. There’s a ton of calculations that don’t really matter that much once you get the hang of placing orders and knowing how much you need to put on and risk. Think of all these calculations a bit like walking. Do you need to know the physics of every motion in your leg, the pressure of the air and the gravity effect of the ground when you lift and step, not to mention how the weight shifts from left to right to maintain balance? Or do you just walk? Trading is similar, there’s ton’s of things that are quantified, but only one thing really matters.. Did it make money?
Remember, trading is simply the act of making a decision on price, up or down. Don’t make it complex, that’s all it is. If you have one market, will it go up or down, that’s it. Of course there’s techniques to help make decisions more accurate, but that will develop over time. Just like an Artificial Intelligence program, it takes practice, seeing something happen, then seeing it again and developing patterns and a deeper understanding. When the market moves up by this much, often it comes back down by this much.
How do you increase or decrease your profit and risk?
You can adjust the amount of money earned or lost each time the market moves by increasing or decreasing the lots traded. This is known as volume, units or lots and as it adjusted higher, the greater the change in money each time the market moves.
Movement or Volatility
The further a trade moves in your favour, the more the profit you will make. This is also the same for losses if the market moves the opposite direction to. You might see increased volatility during periods of uncertainty, and around news events.
So now that we have covered profit and how to increase or decrease it, it’s time to talk about managing risk.
You might hear people talk about instruments that are highly volatile as ‘risky’ but its not always the case. The risk in the sense of volatility is only an issue if the instrument does not have the volume (or orders from other people) in the market to allow you to exit your trade at the price you choose. Volatility does not necessarily mean risk, as risk can be controlled appropriately by other means. Adjusting the volume lower allows a market to move further with less impact. So in a sense, volatility may increase the risk, which can be counteracted with a lower volume to allow for more movement in price.
General practices state that a set percentage of risk is used when trading. Many traders use risk between 0.05% to 4% of their trading account balance. This means that with an account balance of $100, using 1% risk, your maximum loss would need to be $1. If the instrument price reaches your stop loss price, your loss shown in the account history should be $1.
Risk is generally relating to how much you expect to lose on a trade if it goes the wrong way. This is controlled by the stop loss, in particular, how far the stop loss is from the entry price (where you enter the trade). A stop loss is a price that is set where the instrument will not go any further, when the price reaches the stop loss price, the platform closes the trade automatically for you so that you are no longer in the trade. Unfortunately, there will be a loss of money on the trade, but it stops any further loss if the instrument kept going the wrong way. In essence, a stop loss helps you to mitigate the risk of a losing trade continuing to lose more and more money.
Risk is also controlled by the volume or lots traded on the instrument. Let’s break it down:
With a stop loss that is 100 pips away, your risk might be $10. Using the same volume on the trade (lets just assume it is 0.01 lots) and setting the stop loss to 20 pips away instead makes the risk on the trade $2. Now, if we moved the stop loss to 200 pips away, the risk would now be $20. So adjusting the stop loss price up and down will increase the risk as it moves further from the entry price. The stop loss can be adjusted at any point during the trade. The cool thing about a stop loss is that when your trade moves into profit territory, you can move the stop loss into break even or profit territory to lock in a certain profit while the trade keeps running.
Volume, Lots or Units
Volume is the amount of units or lots traded on the financial instrument. Most instruments will have a minimum of either 0.01 or 0.10 depending on the symbol. Using the same example as above with a stop loss of 100 pips and a $10 loss, and a volume of 0.01, let’s try adjusting the volume. The higher the volume, the more risk on the trade. Placing the same trade but with a volume of 0.05 would mean the loss could be $50 instead of $10, or 5 times the volume.
So, you have two tools to help manage risk, moving the stop loss and using different volume when you trade.
With a demo account, practice placing any order and moving the stop loss. When you move it, hover your mouse over the red line that represents your stop loss and when it’s in the right place you will see a box pop up. In that box, you will see a negative profit amount which tells you how much you will lose if the price reaches your stop loss. Move the stop loss up and down to see the change it makes to the profit/loss amount in the popup box.
Now, on a demo account, practice placing any order, this time with different lots/volume/units. Check your stop loss again by hovering your mouse over the red stop loss line and see the effect of different volumes to the profit and loss.
The whole idea of trading is to develop a repeatable consistent skill where you know that you can take a series of trades and be profitable at the end of those trades. There will be losing trades, there will be winning trades but the only important thing is being profitable at the end of those trades. Also, being able to repeat this process over and over, and that the risk is not too high. If the risk is high, there is much higher chance that one event could remove all of your hard work in one go.
Alternate ways to make money trading
Its not all about trading and making money for yourself. Traders that are good make money through a range of methods, which all basically involve placing orders and making money an on account.
That account might be for someone else (an investor who gives you money) and you get a cut of the profits.
It might be on a social trading platform where you are paid money for your trades.
It can be through training and education.
It can be through employment like a job at a bank.
There’s many ways you can monetize trading. But you need skill and knowledge to make it happen!