10 Trading Pitfalls To Avoid
Everyone learns by making mistakes, in forex trading as in life. But by having a heads up on the most common pitfalls that befall traders, you can learn to steer yourself safely away from the danger zones. Here is a guide to ten of the most common mistakes that even experienced traders make, and how you can avoid them!
- Jumping in with no strategy
Novice traders can tend to jump in with too little preparation, but this is little better than gambling! You must make a trading plan before you make any serious moves on the market. This will help you to minimise your risks, and avoid making decisions under pressure.
Your trading strategy should be determined by how much time you have to devote to trading, how high your profit targets are, and how much money you are prepared to lose on each trade. This last point is usually referred to as ‘risk tolerance’; in other words, it is the degree of variability you are prepared to accept in return for your investment.
It is advisable not to risk more than 1% or 2% of your total capital per trade at first, until you have gained more experience. Ultimately, how much you are prepared to risk depends on your personal financial circumstances, as this will dictate your comfort zone when it comes to withstanding losses.
At first, many new traders think the more, the better. However, forex trading is very much a game of quality rather than quantity, and less is more in most cases. Start with one trade at a time, and don’t be tempted to hold on to a losing position in the hope that it will turn around. Learn to be disciplined, and stick to your exit strategy.
It is rarely advisable for a novice trader to throw themselves full time into forex trading, in the hope of making a living from it. You will put too much pressure on yourself to make money, and this is never good news in the unpredictable world of trading. Remember, even skilled traders make losses, and consistent profits rarely happen in a short timescale.
- Letting your heart rule your head
Forex trading is rich material for psychologists, because on the one hand, it requires cool analytical logic, and on the other hand, it requires a certain amount of intuition and quick thinking.
Add into the mix the primal human emotions of fear and greed, which come to the fore when we are in danger of losing, or in sight of a lucrative reward, and it is quite fascinating for those on the outside looking in! Once you are in the thick of it, it is essential not to let your emotions get the better of you.
Of course, you need to stay alert to the risks of a losing position, and allow yourself to enjoy the satisfaction of turning a profit, or you would be somewhat missing out on the point of trading! The key is to question your decision-making process and every step, to check that your actions are aligned with your trading strategy.
If you are on a losing streak, don’t be tempted to keep repeating the same mistakes over and again in the hope of recovering your losses. Take a break, and look over your records to try and pinpoint where you are going wrong. If you have a run of success, allow yourself to enjoy it, but don’t become overconfident, as this could soon lead to poor decision making.
- Not keeping records
It is important to keep track of all your trades in as much detail as possible. This could be in a paper notebook, or a digital spreadsheet. At first, this might seem like an unnecessary encumbrance compared to the thrills of making your trades, but over time you will thank yourself for your efforts.
This is because detailed records allow you to analyse your performance. If you make a run of bad trades, look over your records to try and identify a pattern to see where you went wrong. Likewise, if you have a flush of success, work out what you are doing right, and fine tune your strategy.
This is not to say it will guarantee success every time, but forex trading is all about checks and balances, and small changes can go a long way. Review your trading journal once a month, regardless of how well you are doing.
- Not keeping up with data releases
The forex markets are highly dynamic, and move quickly in response to news releases. Some traders build their whole strategy around economic data releases, but this is best left to the more experienced. That is not to say that economic news is not important in forex trading.
The biggest factors to keep an eye on include the interest rate, the inflation rate, and the unemployment rates of the major economies, or for whichever currencies you choose for your trading pairs. Bear in mind that the US dollar is the most popular and widely used currency, so any US-based news is likely to impact the markets the most.
Keep an eye on the demand for the major commodities that the countries of your currency pairs produce. If the demand is currently strong for a certain product, then the relevant currency value is likely to rise, and conversely, if demand drops off, it will generally fall. Be aware that this can be influenced by seasonal and geopolitical events.
It is important to bear in mind that the major players on the forex market will have already made their moves ahead of any influential data releases, so the markets may not move in the way that you expect them to. Therefore, it’s best to wait a few hours to let any turbulence settle down before placing your trade.
- Setting numerical targets
If you set yourself a numerical goal, such as reaching a certain percentage of success ratio, or a profit target, you are setting a giant bear trap for yourself. This is because at some point you will make a decision that is not based on your strategy, but is based on reward, or to be less polite about it, greed. This will cloud your judgement, and it is self-defeating.
Remember that successful forex traders always make their moves based on risk management, and careful position sizing. Chasing the dollars is not their priority, as they know that profits are a side-product of a solid trading strategy, rather than a goal to pursue at all costs.
- Overthinking your trades
Of course, it is important to have a strategy, and educate yourself about the complex world of forex trading. However, it can be easy to fall down a rabbit hole of overthinking each move, and analysing charts constantly in the hope of increasing your profits. Remember, it is always discipline and sticking to a strategy that will win out in the long term.
If you find yourself meddling with your trades after you have placed them, and waking up in the middle of the night to study data releases, it is time to take a step back. Maintaining a healthy work life balance is important in the world of trading, to help you keep a sense of perspective and to avoid becoming too emotionally invested in your trades.
- Taking too much leverage
One of the attractions of forex trading is that there is a low barrier to entry. You can get going with a forex funded account even if you have relatively modest amounts of capital to play with. However, high amounts of leverage (or loaned money) mean that the risks are greater. It’s much safer to start small than to over-leverage.
Study risk to reward ratios to weigh potential profits against potential losses for each trade. For example, a 1:2 risk to reward ratio means that the potential profit is double the potential loss, which is a positive figure. Many novice traders ignore or overlook the importance of risk to reward ratios, but it should be a key part of your strategy.
- Taking inconsistent position sizes
Your position size always needs to be in proportion to your account size, and aligned with your overall trading strategy. Just because you have spotted a promising opportunity, it doesn’t mean that you should automatically increase your positions, and certainly not by any drastic amounts.
- Not working with a demo account
Demo accounts exist for a very good reason: they are there to let traders try out their strategies before risking real money. This is doubly important for newbies. Please do not be tempted to skip this step, no matter how keen you are to get going.
Even if you think that your strategy is watertight, you will still not be familiar with the nuts and bolts of using the account, and may be prone to making basic keying or admin errors. The demo account will give you experience of operating in live market conditions, and work through any problems before it actually affects your account balance.