Market Overview

Four Forex Mistakes That Kill Day Traders

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There are several mistakes which are very common amongst struggling traders. By knowing what these mistakes are and taking a more suitable course of action, a trader can greatly increase his/her chances of success in the forex market.

Currency trading provides ample opportunities to make money. High amounts of leverage, 24 hour trading, and seemingly endless volatility are all characteristic of the forex market. These features, however, also carry significant risks. By not adequately understanding common mistakes, a trader puts himself/herself at a grave disadvantage.

1) Risking Too Much Per Trade

Risking too much on individual trades will bring a trader to ruin quicker than any other mistake. There is no guarantee a given trade will work out, as losing trades are a frequent occurrence amongst even the best traders. To combat this, risk must be minimized on each trade to increase a trader's chance of longevity and long-term profitability. Successful currency trading is the result of steady gains, which will undoubtedly include a combination of both losses and profits. However, if the losing trades are too large, the profitable ones will not be able to compensate for the equity drawdown. With this in mind, risk should be limited to less than 1% of trading capital per trade.

As the retail forex market has expanded over the past several years, so too have the types of accounts that traders can choose from. Even participants with small amounts of capital can find trading account types which allow for strict risk management.

Micro trading accounts allow a trader to trade micro lots, which amount to approximately $0.10 per pip movement. When compared to mini (approximately $1 per pip movement) and standard (approximately $10 per pip movement) accounts, micro accounts allow for amazing versatility in controlling risk.

The risk on a trade is the difference between the entry price, and where the stop loss is placed. If a long position is taken in the EUR/USD at 1.4050 and the stop is placed at 1.4000, it equates to a risk of 50 pips. In a standard account this would represent a $500 risk. Abiding by the “1% rule,” that trader should have at least $50,000 of trading capital in his/her account. If the trader has a mini account, however, the same trade represents $50 in risk, requiring $5,000 in suggested trading capital. In a micro account, lastly, 50 pips represent a risk of $5, necessitating only $500 of suggested trading capital.

2) Betting on News and Trading in the Aftermath

It may be tempting to take a position right before or right after a news announcement in hopes of grabbing a quick profit in the ensuing chaos, but this amounts to gambling, not trading. The multi-directional volatility that usually accompanies news announcements can stop a trader out at a loss even if he/she ends up being right on the eventual final move.

As big news releases hit the market, currency pairs jump and dive in response. The quick, massive moves may appear to be easy money, but do not be fooled. The lack of liquidity in such moments, accompanied by the inability to get filled at the expected price, makes trading these moves in real time much more difficult than it may appear. Because breaking news usually triggers stops in a wide range due to the reduced liquidity and general lack of direction, trading without a stop in such cases is ill advised. Such an approach can leave market participants exposed to massive losses. Even if a trader uses stops in the vicinity of the prevailing market price, it is also likely to result in a loss due to the wild price swings.

Therefore, it is best to wait for the news to be absorbed by the market, the direction to become more clearly defined, and the liquidity to return before entering a position. Make no mistake, there will be plenty of remaining profit to be had after the “weak hands” have been cleared out.

3) Averaging Down Losing Positions

When a trade is losing money, a common mistake is to keep adding to it. Adding to the position “averages” the price of price of the transactions, lowering the “breakeven point” in the process. Applying the “averaging down” method to day trading is a very dangerous endeavour, as the time frame is extremely limited. Intraday currency trends can be sustained much longer than anticipated, and losses will more than likely need to be taken at some point, but now on a larger position.

Forex day traders are far better off managing their position by setting exact entry and exit criteria for their position. If the stop is hit, exit. If the profit target is hit, exit. By averaging down, the entire trading plan is thrown out the window, as the trader is now exposing himself/herself to a greater risk than was initially planned for.

4) Not Having a Trading Plan

When a currency trader does not have a plan, mistakes are much easier to make, making losses a much more common occurrence. A trading plan involves creating precise entry, exit, and money management criteria, which will allow the trader to control risk while hopefully extracting a profit over the long run.

A methodical and detailed plan will give the trader a step-by-step course of action for all market scenarios. Such plans should lay out how and why trades are entered, how and why they will be exited, and the associated risk/trade management criteria.

Psychology issues such are fear and greed are minimized if a trader has a concrete system to follow. Trading (especially currency trading) takes discipline, and such discipline is exemplified by creating and then applying a detailed set of rules for engaging in the markets.

Summary

Successful currency trading, or any trading for that matter, involves avoiding certain behaviours and activities which are common amongst almost all failed traders. A market participant greatly improves his or her chances of success by risking only a small amount of capital on each trade, not placing trades right before or right after news events, not averaging down, and by following a detailed trading plan.

Remember, an estimated 90% of all forex traders fail. While following these rules may not guarantee success in the currency market, it is a damn good start.

Posted-In: Financial Advisors Forex Psychology Hot Markets Personal Finance Trading Ideas General Best of Benzinga

 

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