Though I usually cringe at the thought of comparing Forex to anything gambling related, sometimes it is easier to do so for conceptual purposes. Please remember that by following sound trading principles Forex IS NOT gambling, though for some traders (judging by the way that they do trade) the line between gambling and speculation is rather gray. I am using the popular casino game to help describe this trading tactic - hope you understand. Lets look at the casino game to compare it to Forex for the purpose of learning this technique.
There are many aspects of the game of Roulette, we won’t be looking at all its variables but one in particular - the red black part of the game. In Roulette you have the option to place a bet on either the red diamond or the black diamond. This only presents a choice between the two options. Once the ball goes around the wheel and lands on some number a color is determined to be the winner; either red or black. Basically, this is a 50/50 game (lets ignore the green 0 and 00 for now). Essentially it's a coin toss, and statistically you’ll be right betting on either of the two diamonds (red or black) 50% of the time. In this game if you were to place a $100 bet on "red" then there is a 50/50 chance of winning or loosing. If you were to win then you would win the same amount you risked thus walking away with $200 (your original $100 plus the $100 you won). If you were to loose then you would walk away with nothing (having lost your original $100). In this same the "risk to reward ration" would be 1:1.
Ok, so now lets look at Forex. As you already know the Forex market can only move in three directions; up, down, and sideways. In reality, if you think about it, a "sideways movement" is really a temporary non-event. It is inevitable that sooner or later it'll end up moving either up or down. The equivalence to this in Roulette is when nothing has yet happened (like the ball is still spinning in the wheel but hasn't yet landed). The solution to a "sideways movement" is to simply wait... sooner or later it WILL go up or down.
So in Forex you see what on the surface now resembles Roulette. Just as in Roulette the ball can land on either red or black, in Forex the market can move either up or down - both on the surface appear to be a 50/50 proposition. With either you could theoretically "play' 100 rounds but in the end come out more or less even (ignoring green 0 & 00, or in Forex the spread). So how do you turn the "odds" in your favor? By using clever strategies you can put the "odds" onto your side to "win" consistently.
In Roulette gamblers have strategies to win, but to make a long story short, the only sure fire way to win at Roulette is to be the owner of the casino, not the gambler. Ultimately the odds favor the casino over the gambler. Gamblers do have strategies applicable to the red black aspect of the game but in the end statistically they'll loose. The two most common strategies are to play the opposite colors from the prior winning color, especially after a streak or bunching of the same color (as statistically they should balance out but the "law of independent trials" dictates that each roulette play is completely random and has nothing to do with any previous plays), and the most common "equity management" principle they follow is what is known as the "Martingale System" of doubling up on loosing bets to chase their losses back into gains. Simply put this is a stupid strategy because sooner or later the gambler would face the statistically inevitable event of either running out of money to continue doubling up on the losses or that they would reach the table maximum (maximum amount of money permitted to bet).
In contrast to Roulette gamblers Forex speculators do have a definite advantage. What gives us our edge is that we are familiar with the behavior of the markets and we have technical analysis tools to be able to predict what the market will do with better than just guessing accuracy. By combining trading wisdom with a 50/50 opportunity we hope to increase our frequency of "wins" to have a net profitable effect.
Lets say you have found a "lucky coin" on the street with which you make your trading decisions. By flipping the coin you decide to go either long or short in the market from wherever the market happens to currently be. Let's say that each time you flip the coin you'll enter a trade with a 100 pip stop loss and a 100 pip limit.
Chances are that after a series of trades you should have a net result of nothing - your gains equal your losses - or you may have a statistically probable discrepancy between how many winners vs losers resulting in a marginal net gain (your coin is lucky indeed) or a net loss (better get rid of your UN-lucky coin).
As intelligent traders lets get rid of our oracles (lucky coins, tarot cards, spin-the-bottles, or whatever) and use our knowledge of the Forex markets to make our predictions. The simplest way to describe the "Forex Roulette" technique is to use ANY successful technical analysis methods to determine the probable direction the market will go in, determine the probable distance the market will go in that direction, and determine the probability of the market not going sufficiently far in the direction of your stop, then placing a trade with an equidistant stop and limit based on the above determined predictions. The preceding highlighted sentence adequately describes the "Forex Roulette" method, and if you were to ponder it for a while you could certainly come up with countless applications for it, but I’ll do you a favor by elaborating upon some specifics in this article.
Lets say I have a six-sided dice, and lets say I were to proposition you with the following bet - each time I roll the dice if it lands on 1, 2 or 3 I’ll pay you $100 but if it lands on 4, 5 or 6 you pay me $100. Essentially this is a straight 50/50 proposition to which you might decline playing because ultimately it's pointless because the expected net result should be nothing (or you might play with me simply out of boredom). But lets say that I propose the game that if the dice lands on 1, 2, 3 or 4 I’ll pay you $100, but if it lands on 5 or 6 you pay me $100 (representing a 66%, 66/33 odds, or 2 to 1 in your favor). After you've made certain that I didn't have loaded dice (I'm not cheating here) you would be very enthusiastic of playing this game with me, and you would want to play this game with me as often as you could. Why? Simply because you know that statistically out of every three times we play the game you’ll be winning $100 net profit. If we rolled the dice 30 times you should be up (statistically) $1,000..
This "dice game" example described above is what we are trying to accomplish with the "Forex Roulette" method. Your technical analysis tools help you to slant the odds away from 50/50 into your favor. How steeply you slant the odds into your favor will depend on how skillful you are at technical analysis methods, but even if you are very new to Forex and have just begun learning you should already have sufficient skills to at least have a slight advantage. Because of this fact I would recommend the "Forex Roulette" method to novices, but it is also quite valuable to even the most advanced traders.
Having a "Trading Journal" (a note book or electronic document) where you record all your trades (including screen captures of the chart, reasoning for your trade, entry/exit prices, and results) is a great idea for you to keep. In your journal you should also record each "Roulette" trade you ve done so you can keep score of your statistics, most importantly your ratio or percentage of winning trades vs losers (also keeping a running tally of your profit/loss). This will become a powerful document for you to learn from (analyzing what worked for you and where you can make improvements).
After engaging in a bunch of trades (10 minimum, but 30 or more is far better) you can start to calculate what your success ratios are. Remember, you won't "win" every trade, but the higher your percentage is over 50% the better you will do in the long run. If you can get your predictions up to 66% (same odds as our dice example above) or better after some practicing then you’ve accomplished for yourself a "Holy Grail" because you have now cultivated a skill that can rack up significant profits over time. Is this a realistic expectation to accomplish? Of course it is! With practice your skills to make appropriate predictions will improve, so keep practicing.
Source: Forex Sailing
