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Applying Warren Buffett's Rules To Forex Trading
Warren Buffett is arguably the world's greatest stock investor. Overtime he has made mistakes and made great investment decisions by looking towards the fundamentals behind stocks. We can use these rules he has made from stocks and apply it to a Forex scenario.
"Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1."
He's referring to the mindset of a sensible investor. Don't be frivolous. Don't gamble. Don't go into an investment with a cavalier attitude that it's OK to lose. Be informed. Do your homework. Buffet invests only in companies he thoroughly researches and understands. He doesn't go into an investment prepared to lose, and neither should you.
What we can do as Forex traders is take a few key points from this. His main thesis is that he only invests in companies he thoroughly researches and understands. As a Forex trader you do not fully understand what a currency may do in the future without analysing all factors of an economy. To do this you need to use fundamental, technical and sentimental analysis to understand the behaviour of not just one economy but a pair, as in the spot Forex market you only trade currency pairs. Only once you've used all three types of analysis do you then look to trade, not to gamble your money away through price patterns.
"If the business does well, the stock eventually follows."
"The Intelligent Investor" by Benjamin Graham convinced Buffett that investing in a stock equates to owning a piece of the business. So when he searches for a stock to invest in, Buffett seeks out businesses that exhibit favorable long-term prospects. Does the company have a consistent operating history? Does it have a dominant business franchise? Is the business generating high and sustainable profit margins? If the company's share price is trading below expectations for its future growth, then it's a stock Buffett may want to own.
There's no surprise Forex traders are at a disadvantage, analyzing economies is difficult and time consuming. However, Buffet mentions if a good business does well then the stock follows. This also applies to currencies: "If the economy is doing well, the currency will eventually follow". Therefore, from this we can learn that analyzing fundamentals is a key factor Forex traders need to understand.
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"It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."
Buffett is a value investor who likes to buy quality stocks at rock-bottom prices. His real goal is to build more and more operating power for Berkshire Hathaway by owning stocks that will generate solid profits and capital appreciation for years to come. When the markets reeled during the 2007-08 financial crisis, Buffett was stockpiling great long-term investments by investing billions in names like General Electric and Goldman Sachs.
Forex traders can learn from this by understanding the correct times to buy and sell a currency. When you're selecting your currency pairs, ask yourself is it overbought or is it discounted enough to buy. Same with is it oversold or is it at a high enough price to sell. This can be done by choosing relevant areas of buying and selling, using long time frames "Daily and Weekly" to map out where major buyers and sellers of currencies are. This is so that you can also choose to get out or get in at these levels and hold trades for longer periods of time.
"Our favorite holding period is forever."
How long should you hold a stock? Buffett says if you don't feel comfortable owning a stock for 10 years, you shouldn't own it for 10 minutes.
This is a huge factor for Forex traders as you may know many Forex traders are lured into only trading small time frames, this causes them to only trade over short time horizons and inevitably failing. Remember Hedge funds hold positions from 1 to 18 months.
These are professionals who make money consistently over a long period of time. Forex Traders need to learn to let go of the dream of scalping and day trading as the age of autonomous bots and arbitrage trading bots take over the lower time frames. Longer time periods will not only make you trade less often, it will keep your pockets safe as you pay less commissions to the broker.
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