Most people lose money in trading. In fact, 90 percent of all traders fall into the losing community. This fact is nothing to be amazed about because even corporate traders are included in suffering this agonizing fate!

Trading is never a simple business – nor is it an easy task. It is important for a trader to develop an effective trading system if he wishes to stay in the market for a lifetime. Put simply, an effective trading system should always have a low risk to high reward ratio. Since many losing traders will comment that this statement is easier said than done, in this article, we will discuss creating your own effective system in trading.

Develop Your Forecast Power

When you wish to enter the market, do not trust anyone teaching you to make fast money by scalping the market. Honestly, scalping in very short timeframes (even for just few seconds) is no more possible now in electronic trading that it was in the days on the trading floor.

Before you open a new trade, use any method that you have learned in the past to help you make your trading decision. You may turn to technical analysis or fundamental studies among the oceans of different teachings that we are not going to discuss here. However, it is a “must” for you to be able to foresee the near-future trend that you will eventually exit for the potential profits!

This power of forecasting the market to reach your price projection must tally with your stipulated time duration. In other words, if a trade is to be closed in the intraday timeframe, you must be mentally prepared to close it, otherwise it could be held to about three calendar weeks! Whatever you target to make in eventual potential profit, this is what we called “trade reward.”

Tighten Your Risk Management

After you have aimed at an expected exit target (potential profits), the next immediate task is to gauge your effective stop-loss point. Usually, this can be achieved by taking the previous labeled wave extreme as a level to safeguard your open position.

According to studies, many of the traders that eventually create mother-of-all-losses had the bad habits of opening new trades with these mal-practices – no contingent stop-loss order, sitting on random losses or shifting the stop-loss order further away when the market level approached! Unfortunately, almost all the losing traders that we came across in the past fell prey to one or all of these weaknesses.

Take note that the exit order at your potential profit-level and the stop-loss order should be placed simultaneously to safeguard your open position. In the worst case, if you have a secondary opinion of another market extension in your potential profits, you should at least place the stop-loss order first before putting in the exit order later!

By comparing potential losses with potential profits, the risk/reward ratio can differentiate a profitable trader from a trading newbie! In our opinion, this reward ratio on winning trades should be at least 3 to 1 in general trade activities. In cases where the reward factor is less than 3 times the risk factor, a reversal will soon end the trading career of the newbie in no time.

This is an excerpt from September 2009 issue of Trader's Journal.