10 mistakes that forex traders should avoid

10 mistakes that forex traders should avoid

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Forex market accessibility has attracted lots of individuals of diverse ages and background, making it one of the most crowded trading markets in the world. The requirements for entering the club are trivial to say the least; having a computer, stable internet access and couple hundred dollars on your bank account is more than enough to start, as many brokers out there have substantial offering starting from $100, while having access to higher capitals will open endless possibilities to trader including low spreads, profound educational materials and rewarding bonuses to name a few. And while some traders do their homework and identify key principles which lie behind the profitability in this market, others rush headlong into the trading maelstrom and quickly wipe out the bulk of their trading accounts. There are tons of pitfalls new forex day traders face. Here are 10 common mistakes you want to avoid, as these are the main reasons many new traders fail.

  1. Day Trading With a Poor Win-Rate and/or Reward/Risk Ratio

There are two trading statistics that you want to keep an especially close eye on. Your win-rate and risk/reward ratio. Your win rate is the quantity of successful trades, usually displayed as a percentage. For example, winning 50 traders out of 100 will give you a win-rate of 50%. Though keeping the winrate above 50% is not fully required for satisfactory profitability on the forex market, keeping above this ratio is recommended.

Low winrate however can be fully compensated with healthy risk/reward ratio, which is a measure showing your average profitability against average losses. For example, a lost 50$ trade subsequently recovered with 75$ win trade would score a risk/reward ratio of 1.5(75/50 = 1.5) Keeping risk/reward ratio above 1 is absolutely necessary for success while higher risk/reward ratios can effectively compensate relatively low winrate levels.

  1. Failing to place a stop loss

Never forget to place a stop loss order on every trade that you make. A stop loss is a sort of limitation that automatically closes your trade when the price goes against your prediction by a certain amount. Having a trade without stop-loss is like sitting on a barrel of gunpowder. Most if not all forex trading platforms used by the majority of forex brokers have this option available. Failing to place a stop loss order is one of the most common forex trading mistakes and should be avoided at all cost. Placing a stop loss order should be an unalienable part of each trader’s discipline.

A stop loss is usually placed at the location where the trader believes the price might reach the point of no return. For example, when opening a position on what looks like a resilient level of support or resistance, place a stop loss slightly above or below the level where the trade is placed. For example, in case of buy order opened on the level of support, a stop loss can be placed slightly below, ensuring that losses will be minimized following the breakout of support. There is no common criteria on where the stop loss order should be placed but some trading platforms like Ctrader (used by Pepperstone and IC Markers to name a few) allow to calculate the percentage of account and dollar value the trader may lose on hitting the stop loss.

  1. Accumulating losses

While securing your trades with a stop-loss is a great way to mitigate risks, there is another problem that traders, especially inexperienced ones, commonly face. In many situations when the market just keeps going against the trader, he or she might attempt to recover the loss by adding more and more traders in the same direction, for some reason being sure that the market has finally reached the bottom and will reverse at any moment. Failing to acknowledge that markets simply cannot be predicted 100%, traders enter a deadly losing streak , in some cases wiping out substantial capitals in a matter of hours.  Not only does adding to a losing trade makes losses grow exponentially, but puts pressure on the trader and causes stress. Having a stop loss order placed on your trade might prevent you from proceeding unhindered with such practices. Always choose a proper position sizing and never let your trades spin out of control. This is one of the most essential habits that biggest forex traders have.

  1. Lack of proper risk management in forex trading

Maintaining proper position size is undisputedly one of most essential habits that every trader should have. It should be a part of risk management strategy regardless of your experience and history of success. Determining the percentage of account that trader is willing to risk for each trade is a number one priority when you start think about adopting a risk management strategy.

It is generally assumed that traders should not risk more than 1% of total account value. That means that in case of reaching a stop loss, your account balance should not go down by more than 1%. However, the risk/reward ratio justifies significant flexibility in this part of risk management.

For example, having a 3% loos/ 5% profit ratio could effectively help keep your account in plus. For example, let’s assume a trader opens one standard lot of EUR/USD with an account balance of 10,000$. The pip value for such position would be 10$, meaning you can afford to lose 30 pips (300$) before your positions should be closed. On the other hand, placing take profit 50 pips above or below the entry price assures that trader could make $500 in profits. If that’s the case, trader can afford to win only 4 trades out of 10 to guarantee profitability of such risk management strategy; (4* $500) – ( 6*$300) =  $2000 – $1800  = $200. As such, as you can see even significant losses ca be easily recouped with proper combination of risk/reward and position sizing. However, we urge the traders to be a bit more conservative and try to stick to 1%/3% for smooth and stress-free trading experience.

  1. Going all-in on one trade

As important as risk management may be, some might face hardships when developing those essential risk management habits that we have discussed in the previous paragraphs. Even when proper risk management strategy is employed, sometimes you will be tempted to get a little bit off the course and do it your way, with no adherence to any rules and strategies. A trader might have many reasons for that, which may include:

  • Attempting to recover after sustaining a losing streak
  • Overestimating your capabilities after showing good trading performance
  • Feeling very confident that you cannot lose on this particular trade and risking almost everything on it.

Regardless of the reason, never try to find a justification for reckless deviation from the risk management rules. Always  try stick to your 1% risk rule per trade or whatever small percentage you deem appropriate for your trading style and risk appetite. Always remember that no matter how good you are and how flawless you recent trading performance is, the market is driven by external forces which you cannot keep under control. As such, the figures a trader has set for his risk/reward and position sizing should not change based on what you feel about particular instrument and market.  Never risk more than a couple percent on a single trade, because if you start risking 5%, 10% or more of your account, you can start losing substantial sums of money very quickly.

If you risk too much you are already making a trading mistake, and mistakes tend to compound. If this big losing trade starts moving against you, you may feel regret which can lead to canceling your stop loss order in the hopes the price will turn around and you can avoid the loss. Worse yet, you may add to the position, hoping that if it turns around you can make an even larger profit. Avoid such situations in the first place. Stick to your risk management strategy, and avoid going “all in,” no matter what the reason.

Recklessly speculating on the news

Important economic indicators such as Non-Farm Employment Change or Federal Open Market Committee meeting Minutes cause currencies, commodities and other financial instruments rise or fall sharply. The extent to which these events can move the markets can vary depending on market conditions and other fundamental developments surrounding these news releases. As such, anticipating the direction the market will take following the release of important fundamental events is like looking for a needle in the bundle of hay; taking position before the news is released is a risky strategy that might cause disastrous repercussions for any trader irrespective of skills and past performances. And while many traders take pride in making high profits by speculating on the news, the reward is simply not worth the risk. The reasons for this include:

  • Often the price will move in both directions, sharply and quickly, before picking a more sustained direction. That means you will likely be in a big losing trade within seconds of the news release.
  • Due to the volatile nature of the market you may experience a slippage which may cause your stop-loss order to be executed at a less favorable rate than originally set in the order. In some cases the order may be even impossible to execute at the desired price.
  • There is always a margin of error when it comes to economic data and as such there is simply no reliable way to predict whether or not the actual data will meet the initial estimates.

On the other hand, checking historical data of underlying events might give you a glimpse of how the market performed in the past and as such calculate how much profit you could have potentially made if you had attempted to trade it in the past. Some events have 80% accuracy while others have less than 30%. Doing a bit of research and checking historical data is a step every trader should take before trading the news.  But even if you do your homework properly and realize there is small margin of error – the effort is simply not worth the risk. Rather than anticipating the direction news will take the market, develop a strategy that will allow you to take advantage of the news without risk. For example, news may push prices in one direction or another resulting in a breakout of important support and resistance levels. This could effectively corroborate the signal and simply create new trends on the market that every trader can follow. This approach is much less risky and would still allow you to profit from the volatility caused by crucial economic data.

  1. Not Researching and Testing Your Broker

Understanding what kind of forex broker you’re dealing with should be trader’s top priority. Choose only safe and reliable brokers which are licensed to operate in your jurisdiction. If your broker is a trading scam, poorly managed or in a financial trouble, you could end up losing part or all of your investment regardless of how good your trading skills are. Always research before making a deposit.

  1. Taking correlated trades without research

Diversifying your portfolio over a broader range of assets is a good thing. Warren Buffett said that “Diversification is protection against ignorance. It makes little sense if you know what you are doing.” Yes, it can make some sense if you know what you’re doing. Taking multiple trades at once might spread the risk as much as it can increase it. The thing is there are different types of correlation between currency pairs. Some are positively correlated while others  are not. For example, opening a buy positions on EUR/USD and USD/CHF could effectively put your around the break-even line as both pairs move in the opposite direction and have around 100% negative correlation. Or, if you take two CFD trades on both Gold and Silver you will most likely win or lose both  as these assets are 100% positively correlated. If you risk 1% on each, and take five trades, if you lose on one you will probably lose on all 5, resulting in a 5% loss…not 1%! By taking correlated trades, you have inadvertently increased your risk.

If you take multiple day trades at the same time, make sure they move independently of each other. And remember that trading portfolio diversification is not an easy thing and needs many variables to be taken into consideration to develop efficient and risk-free hedging strategy.

  1. Making short-term traders off long tern fundamental data

Long-term economic outlook makes little difference when you’re day trading. And while it can push the market in one direction or another in the long term, there is no way you can take advantage of that in the short-term. Use fundamentals to plan long term traders that you can hold for weeks or even months but remember that any long-term biases can cause you to deviate from your plan and disrupt your trading performance.

 

  1. Failing to make a trading plan

Trading without best forex trading plan is a road to failure. A trading plan is a written document that outlines when, what and how much you will trade daily and gives approximate monthly expectations base on this data. Everything we have discussed in the above paragraphs should be included in your trading plan.

  • Your plan should include what markets you will trade, at what time and what time frame(s) you will use for analyzing and making trades.
  • Your plan should outline your risk management rules, discussed above.
  • Your plan should also outline exactly how you will enter and exit trades, for both winners and losers.

Trading without without a plan could be called gambling to say the least. Is a reckless and irresponsible practice doomed to failure. There is high likelyhood you will fail in your journey to becoming a successful trader if you trade without a plan.