Professional FX traders almost always trade with a rationale. This is to execute highly accurate trades while maintaining a high win rate. Beginners in FX should imitate this approach and try trading with a clear rationale.
This time, we will explain how to find the necessary rationale for FX trading. We will also cover points to note and what to keep in mind when identifying a rationale, so please use this as a reference.
What is a rationale in FX?
A rationale in FX refers to a clear reason for entering or exiting a trade. Many professional traders and institutional investors analyze the market and buy or sell currency pairs based on this rationale. For example, let’s say the USD/JPY chart is trending upward. Currently, there are no signs of a downturn. Based on this result, entering a buy position on USD/JPY is a valid rationale.
To continue winning in FX, having a rationale is essential. Even if it’s just a little at a time, practice finding a rationale to improve your trading.
The reason why rationale is necessary in FX
The reason why rationale is necessary in FX trading is to avoid gambling-like trades. Other reasons include stabilizing the win rate and making trade reviews more effective. Here, we will introduce several reasons why rationale is essential in FX.
To avoid gambling-like trades
Among various investments, FX is relatively easy to enter. While this is an advantage, it also has the disadvantage of attracting many people who treat it like gambling. Incidentally, this is why FX often has a reputation for being risky.
Engaging in gambling-like trades comes with high risks. Some people may lose all the money they prepared for investment. Such high-risk FX trading is not recommended. To steadily grow your assets, it is advisable to trade safely with a clear rationale.
To avoid missing opportunities
Some people trade FX based on the flow of the moment. While there is nothing inherently wrong with this, it increases the likelihood of missing valuable opportunities. FX charts move due to various factors, including trader psychology and the economic conditions of different countries.
If you analyze charts in advance and check the news, you may capture opportunities that those trading on the flow of the moment miss. In particular, fundamental factors like key figures’ statements and economic conditions can significantly impact charts.
By identifying rationale through news and information, you can seize opportunities for significant profits in a single trade.
To stabilize the win rate
While it is possible to trade FX based on intuition, this approach does not lead to a stable win rate. For instance, you might earn a profit of 300,000 yen last month but incur a loss of 250,000 yen this month. This inconsistency is detrimental both to trading performance and mental well-being, so it’s important to aim for a stable win rate.
This is where rationale becomes crucial. By understanding the rationale that worked well in the past, you can focus only on trades based on that rationale, naturally stabilizing your win rate. Additionally, identifying areas where your rationale did not work can help prevent significant declines in your win rate. Creating rationale not only helps maintain a high win rate but also ensures consistent profitability.
To aim for significant profits
FX begins with entry and ends with settlement. For example, imagine a range of 0 to 100. Ideally, you would enter at 0 and settle at 100. Achieving this would allow you to earn a full profit of 100 without waste. While it is impossible to achieve this perfectly, you can get as close as possible. The key to this is rationale.
If you find rationale for entry timing close to 0 and settlement timing close to 100, you can earn profits without waste. As you gain experience, this will become more natural, allowing you to aim for significant profits in any situation.
To make trade reviews more effective
Reviewing trades is essential for improving in FX. While it’s ideal to review as much as time permits, trading based on intuition may leave you unsure of what to review. However, having rationale allows for effective reviews, such as:
– Identifying why the rationale worked or didn’t work this time
– Considering how the trade could have been improved in case of failure
– Exploring whether the rationale can be applied to other trades
Even reviewing once a week as described above can lead to significant growth in a year. Over time, you may identify commonalities in your rationale and achieve higher-precision trades.
To incorporate others’ perspectives
By utilizing distributed videos and social media, you can easily learn the perspectives of other traders. However, without your own rationale, you won’t understand why other traders arrived at their conclusions or notice differences in their points of focus compared to yours.
This prevents you from effectively utilizing valuable information. To grow by incorporating others’ perspectives, it is essential to have your own rationale for trading.
How to find the necessary rationale in FX
The necessary rationale in FX can be found by understanding the characteristics of currency pairs. It can also be identified through the use of resistance and support lines or moving averages. Here, we will explain how to find the necessary rationale in FX.
Understand the characteristics of currency pairs
In FX, various currency pairs are available, such as USD/JPY and ZAR/JPY. While they are all currency pairs, each has its own unique characteristics, so it is important to take note of this. Since it may be difficult to grasp the characteristics of all currency pairs, it is recommended to broadly categorize them into two types and learn their features.
| Classification of Currency Pairs | Characteristics | Currency example |
|---|---|---|
| Major Currencies | Highly liquid and stable in price movements Low to medium risk |
USD (Dollar) JPY (Yen) EUR (Euro) |
| Minor Currencies | Low liquidity and volatile price movements High risk |
TRY (Turkish Lira) BRL (Brazilian Real) CNY (Chinese Yuan) |
If you understand the characteristics of a currency pair, you can develop rationale suited to it. For example, with the major currency pair USD/JPY, you might form the rationale that “since its price movements are stable, it is well-suited for medium- to long-term trend-following trades.”
For more details on the characteristics of currency pairs, please refer to the following:
>What currency pairs should beginners choose? A thorough explanation of the characteristics of currency pairs and how to choose them!
Using Resistance and Support Lines
A resistance line (upper resistance line) is a line that caps the upper price of a chart. Conversely, a support line (lower support line) is a line that supports the lower price of a chart. These lines are used as a set. Below is an example of how to find rationale using resistance and support lines:
1. Confirm that a range market is forming.
2. Identify areas where the chart has rebounded at roughly the same price range at least twice.
3. Draw a resistance line at the upper price and a support line at the lower price.
4. If the range market continues, you can form the rationale that the chart is likely to rebound near the resistance and support lines in the future.
Using Moving Averages
A moving average is an indicator that consolidates the average closing price over a specific period into a single line. By looking at the moving average, you can determine the market’s direction. Use this characteristic to find rationale as follows:
1. Observe the direction of the displayed moving average.
2. If the direction is upward, you can form the rationale that an uptrend is forming; if downward, a downtrend is forming.
If the moving average is moving almost horizontally, you can judge that a range market is forming.
Using Bollinger Bands
Bollinger Bands are an indicator consisting of a moving average line surrounded by 2 to 6 lines called sigmas (σ). The chart is said to fall within the bands with the following probabilities:
– Probability of staying within ±1σ: 68.26%
– Probability of staying within ±2σ: 95.44%
– Probability of staying within ±3σ: 99.73%
Using this characteristic, you can find rationale as follows:
1. Wait until the chart moves near the ±2σ lines.
2. Since there is a 95.44% probability that the chart will stay within the bands, you can form the rationale that the chart is likely to rebound near the ±2σ lines and trade against the trend.
Using MACD
MACD is an indicator designed to improve the accuracy of buy and sell signals from moving averages. When using MACD, find rationale using the golden cross as follows:
1. Determine that a golden cross has occurred when the MACD line crosses the signal line from below to above.
2. Since a golden cross is a signal of chart upward movement, you can form the rationale that entering a buy position has a high probability of success.
Using RSI
RSI is an indicator useful for determining whether a currency pair is overbought or oversold. The chart fluctuates between 0% and 100%, with values closer to 0% indicating oversold conditions and values closer to 100% indicating overbought conditions. Use this characteristic to find rationale as follows:
1. Observe the chart moving within the RSI range.
2. Confirm that the chart has dropped below 30%.
3. Since values below 30% indicate oversold conditions, you can form the rationale that entering a buy position against the trend has a high probability of success.
Using Stochastics
Stochastics is an indicator that uses two lines, %K and %D, to determine whether a currency pair is overbought or oversold. If %K is above 75%, the currency pair is considered overbought; if %K is below 25%, it is considered oversold. Use this characteristic to find rationale as follows:
1. Confirm that %K is above 75%.
2. Confirm that %K has crossed %D from above to below.
3. Based on the fact that %K is in the overbought zone and a dead cross has occurred, you can form the rationale that a sell entry has a higher probability of success.
Checking Global Economic Conditions
FX charts are influenced not only by traders’ psychology and actions but also by global economic conditions. Therefore, check global economic conditions through TV news, newspapers, and other sources. From global economic conditions, you can form rationale as follows:
– Positive news: The price of the relevant currency is likely to rise.
– Negative news: The price of the relevant currency is likely to fall.
Points to Note About Rationale in FX
When finding rationale in FX, keep the following points in mind:
– Strong rationale ≠ absolute certainty.
– A single rationale is weak.
– Initially, focus on visually easy-to-understand rationale.
– It’s easier to understand rationale when viewed as zones.
– Prioritize rationale from longer timeframes.
Especially remember that “strong rationale ≠ absolute certainty.” There are no absolutes in FX. Taking high risks because of strong rationale may result in losing a significant portion of your assets, so always trade cautiously.
What to Keep in Mind When Using Rationale in FX
When using rationale in FX, keep the following in mind:
– Avoid trading with abstract rationale.
– Always follow your rules when trading.
– Check whether the rationale is highly reproducible.
– Avoid premature entries, as they are prone to failure.
– Look for areas that many traders are paying attention to.
In particular, consider whether “many traders are paying attention to that area.” Charts move based on traders’ psychology and actions. If many traders are not paying attention to a particular area, even with rationale, the chart is unlikely to move as expected.
Conclusion
This time, we explained how to find the necessary rationale in FX. Rationale is essential for stabilizing win rates and avoiding risky trades. It is also useful for reviewing trades, so always trade with a clear rationale.
Rationale can be relatively easy to find by learning the characteristics of currency pairs or using indicators. Start with simple ones and try to develop your own trading rationale.