Forex trading is a skill, and just like every skill, it has to be learnt. However, by understanding some of the common mistakes that traders make, the learning curve can be shortened. Listed below are the some of the best ways to avoid losing money trading forex.
1. Trading Emotionally
One of the key reasons why forex traders lose money is because they trade emotionally. Avoiding emotional trading can be the best way to avoid losing money in forex. When we say trading emotionally, we mean things like revenge trading. People revenge trade when they lose money trading forex and then take ill-conceived trades to try recover that money back.
Another form of emotional trading is over-trading. Some forex traders get a buzz from being in a trade. It is this buzz that makes forex traders again take inappropriate trades just for the excitement.
Another example of emotional training would be traders not closing losing trades. They don’t close the losing trade because they feel it is bound to turn around, ultimately these can lead to huge losses.
2. Not Using a Stop Loss
Another reason why many forex traders lose money, and is somewhat linked to the above, is related to stop losses. Stop losses are a protection that traders can set to ensure they control the maximum amount of money they can lose on a single trade.
However, many new traders tend to not trade with stop losses. This is because they are told that trades need to be given ample space to move against them before moving into profit. This couldn’t be further from the truth.
If you take high probability trades you shouldn’t need a big stoploss, and if you do, you have taken the wrong trade. There are countless stories of people blowing up their accounts, sometimes owing more than what they started with, due to price spikes.
Depending on news events and other market reactions, prices can move extremely quickly. If you don’t have a stoploss, you have no protection against these huge swings.
Another mistake that forex traders make is moving their stoploss. This is a sure-fire way to lose money trading forex. When you take a trade, you should calculate your stoploss based on the percentage of the account you are prepared to lose on that single trade. This should be somewhere between 1% or 2%. It needs to be a figure that you are comfortable losing.
What new forex traders can often make the mistake of doing is moving their stoploss to avoid being stopped out, convinced that the trade will go in the right direction imminently. This means they continue to move there stoploss to a point where they actually can’t face losing that much money and therefore it becomes a self-fulfilling prophecy.
As they now cannot face losing that much money, they remove the stoploss altogether under the misapprehension that it has to turn around and bang goes the account. As a new forex trader you should never trade without a stoploss, and never move your stoploss unless you are moving it to lock in forex trading profits.
3. Trading Without a Plan
Yet another reason why forex traders lose money is trading without a plan. A trading plan is a set of rules that you use to determine whether you should enter a trade or not. This could be a simple plan like moving average crosses or a complex plan involving multiple indicators and confluences.
Whatever the plan sticking to it enables the trader to remove the emotions from opening a trade. If it doesn’t meet your plan you simply walk away, no questions asked. Once you have a trading plan you can then begin to modify it and look for patterns between successful and unsuccessful trades, refining your trading plan accordingly.
Not having a trading plan means that you are trading on gut instinct without any real understanding of what you are doing. This is tantamount to gambling, and is one of the biggest mistakes forex traders can make. A successful forex trader needs to be disciplined.
Think of a playbook for an NFL team, or a training regime for a boxer, they are the equivalents of the trading plan. How would an NFL football team do without a playbook? There is a saying, “plan your trade and trade your plan”, and this couldn’t be more true.
4. Over Leveraging
Over-leveraging in forex is another common way where traders lose money. Leverage is somewhat of a double-edged sword. People are attracted to forex trading because they can get leveraged accounts. This means that they have access to capital far in an excess of their actual account value.
That’s why so many traders can start with small account sizes, in some cases as low as $50. With high leverage they are able to access far more capital.
Let’s quickly explain what leverage is in forex trading.
Let’s say you had an account which had leverage of 200:1, and you deposited $1000. This would in effect mean that you had access to 200,000 units of your chosen currency. Clearly it is very easy to see that by having just $1000 and being able to trade with $200,000, a profitable trade can be very profitable. However, leverage also works in the opposite direction in that leverage enlarges your profits and forex losses by the same magnitude.
While the tendency is to use high leverage accounts to maximise your profits on a small account, you are much better using reasonable leverage and aiming for consistency with proper risk management.
5. Oblivious to the News
Finally, another reason that forex traders lose money is being unaware of news releases and economic circumstances. Currency prices are driven by both economic performance for a particular country as well as reaction to things that are happening around the world, such as wars or political instability.
Many forex traders ask the question as to whether technical or fundamental trading is better. The reality is that you need a bit of both to be successful. Technical trading is about finding opportunities on the chart where it is a good place to enter or exit a trade.
However, fundamental data and political news ultimately affects the direction. Let’s say you discover a head and shoulders pattern on a currency pair, and it’s about to break the neckline. That would suggest a good opportunity to enter the trade.
However, a couple of hours after you enter the trade the central bank of the currency you are selling suddenly increases interest rates. That instantly pushes the trade in the opposite direction and you are stopped out.
So while it’s important to use technical analysis to identify the entries and exits, it’s also vital to keep an eye on economic releases and political events to ensure that your technical analysis is in line with what fundamentally is going to happen to that currency. You don’t need an economics degree to understand fundamentals, there are plenty of resources that forex traders can use.
Just a basic understanding of fundamentals can be the difference between being a successful forex trader or unsuccessful forex trader.
I hope this summary of the best ways to avoid losing money trading forex is useful. There are many more pitfalls that you need to avoid as a new forex trader, but these are some of the most common. Keep an eye out for other articles focusing on other topics to help you become a successful forex trader.