In part 1 we looked at how human psychology pushes prices away from fair value.

When there are extreme moves away from fair value you can make a contrary trade to the majority and pile up big profits with low risk.

So what tools do you need? Lets take a look.

As a general rule these tools will work in any market not just forex markets.

What sets ups do you look for?

Generally you want a set up that is the news where there is “no end in sight” to a spike move.

This generally indicates that greed and fear have taken hold and the market being looked at is emotionally driven and away from fair value.

This happens all the time:

The recent spike in crude oil, the 87 stock market crash and many others including in the forex market.

First place to start

Is the chart look for huge price spikes in short time spaces accompanied by “experts” and the news telling you there is no end in sight.

Now delve a bit deeper to see the true picture.

Useful technical tools are:

RSI, Sochastics and Bollinger bands

Then add in these sentiment tools to the mix.

% Bullish

This indictor is a poll of people, expert’s, brokers etc that have a view or interest in the market.

When this poll indicates above 70% are bullish the market is in overbought territory and when below 30% is in oversold territory.

In the currency markets we like to look for even more extreme readings of below 20% and above 80%

Commitment of Traders Net – Traders Position Report

This is a tool used for years by futures traders and shows the breakdown of open interest among three main participants.

We will explain what it means in a minute buy here is its definition of the groups.

Hedgers – The smart money commercial traders

Large speculators – These are normally large funds with reportable positions

Small speculators everyone else.

The commercials are long term traders and are close to the fundamentals and move very slowly – they are hedging not speculating and not influenced by greed or far and are the “smart money”.

Speculators on the other hand, both funds and small speculators, are driven by greed and fear

If you see a set up where commercials start to move the opposite way to speculators at a market top or bottom and hold an opposite extreme, then prices have moved to far from fair value.

With the commercials taking and building the opposite position to speculators in a rampant bull or bear market you know prices are probably due to re bound.

You must only use extremes with this tool and this normally means 8 months to 2 years.

Breaking it down

Study chart first, look for experts telling you there is no end in sight to the move, then look at % bullish and then net trader report.

Finally, use the technical indicators to confirm the move.

These moves do not happen often.

Maybe a few times a year.

But when they do

You can zero in on a contrary trade that not only offers huge profit potential but offer low risk.

When I read a lot of accepted wisdom by so called experts, I wonder if these people have actually traded in their lives.

Here is some common advice that I see all the time, that if you follow it you will lose.

Don’t fall into the trap of accepting it or following it.

Here are 6 of my favorites:

1. Day trading is a low risk high reward way to trade

How many writers do you see talk about day trading and how successful they are at it?

Lots!

Now:

How many of them can show a real time track record of profits over the long term?

None.

This is simply the dumbest way to trade there is.

All short term volatility is random.

You can never get the odds in your favor and you will lose and lose quickly.

2. Knowledge is power

No its not.

Only the RIGHT knowledge is power.

Trading is made very complicated by many experts yet, simple systems work best and the real problem for most traders is acquiring self confidence in their own ability and discipline.

Most traders like to follow others and if you do that, you will more often than not lose.

3. Buy low sell high will make you money

Well we all want to do this:

Pick the market bottom and sell the market high but it’s simply not possible.

Take an example:

Prices are moving to support so a trader buys, trying to predict a bottom and hope support holds.

Well, that’s a good way to lose your money trading against price momentum.

You need to wait for the turn and see price momentum move back up.

Sure, you won’t get in at the bottom but the odds will be in your favour.

On the other hand, a breakout occurs of important market highs so the trader thinks:

Can’t buy that and waits for the pullback.

Of course, it never comes and the trader is left watching one of the biggest trends of the year accelerate away from him.

He should of course have bought the first break!

It’s a fact:

Most big trends develop from breaks of important market highs or lows and if you don’t follow them you won’t catch the big trends.

Fact is:

“Buying low and selling high” will never make you money Buying high and selling higher will”

4. Listen to the news.

This is a great way to lose money.

All those experts taking convincingly about where prices should go and it’s all so believable.

Of course, where prices should go and where they do go, are two different scenarios.

Experts are not traders and are there to entertain and give good stories.

More often than not their wrong – don’t listen to an expert, use your own brain and make your own mind up.

5. Paper trade will help you

Use a demo account and you will sharpen your skills. To a degree it’s true, but its use is limited in helping you become a good trader.

As there is no money on the line and no pressure paper trading is easy.

When you’re in the brutal world of real trading and thousands of dollars are on the line the experience is far harder.

6. Trail stops quickly

The idea here is to lock in profits.

Most traders become so obsessed with doing this they simply get stopped out of a trade and are never able to follow a big trend.

The fact is forex trading involves taking a risk.

Try and restrict the risk to much and you will simply never make any big profits.

Traders get so obsessed with avoiding risk they actually create it and guarantee they will lose.

These are 5 of my favorite accepted wisdoms that will see you lose and we will cover some more in part 2 of this article series.

If you are looking at online forex trading, in this article you will find some common errors that will see you lose.

Many of these are accepted ways to make a profit and you will see many writers give convincing stories that they will help you make money, but they won’t.

Make these errors and you will lose, so here they are:

1. You can day trade and make money

Yawn. How many times do you see day trading touted as a way to make money?

All the time.

Fact is it does not work and cannot work, as it’s based on logic that is simply not correct.

Any experienced trader knows that short term volatility is random, within daily and hourly time frames.

If you can’t judge where volatility will go in short time frames you can’t get an edge or the odds in your favour.

So, if volatility is random how you can get the odds in your favour and make money?

You can’t!

Don’t believe me? Then consider this:

There are millions of traders in the market each day trading trillions of dollars and the huge majority are not looking at daily ranges.

Try and find a day trader with a real time track record of profit ( let me know when you do) as most are selling systems and not dumb enough to trade themselves.

Good story, but a great way to lose your money – period.

2. You can use moving averages as a timing indicator

Really? This is a real gem.

How can you time entry with a lagging indicator?

Think I will stick to momentum indicators.

3. Brokers can make you lose

This is a story put around mostly by day traders who want to justify why they get stopped out.

Brokers hunt stops!

No they don’t – consider this:

The only participant with the potential to move a market and pick off stops by themselves is a central bank and even they don’t achieve this every time.

A broker trying to pick stops in a market that trades trillions of dollars a day is laughable.

Don’t fall for this story.

4. Currency trading is risky

A statement of the obvious!

To a degree this is of course true, but so to is life.

Crossing the road is risky, so do is driving a car, but there are two aspects to risk.

The market you are trading + your approach = Risk

You can make online forex trading as risky as you want, or you can control it by prudent money management and a sound trading method.