The international currency market has very low entry barrier, making it one of the most accessible day trading financial markets in the world. If you have a personal computer, an internet connection, and few hundred dollars, you can theoretically start forex trading. However, just because it is easy to start trading doesn’t usually mean it is easy to make a profit. There are tons of pitfalls new forex traders and investors faces.
In this high leverage game of retail forex trading, there are some certain practices that, if used frequently, are likely to lose a trader or investor all he has. There are five common mistakes that retail forex investors often make in an attempt to significantly increase returns, but that end up resulting in lower returns or even losses. These five potentially devastating mistakes can be completely avoided with discipline, knowledge and an alternative approach.
Pre-Positioning for News
Forex traders and investors usually know the news events that will move the financial market, yet the direction is never known in advance. An investor may even be fairly confident what a news announcement may be – for example, that the Federal Reserve will not or will raise interest rates – but even so cannot conclusively predict how the financial market will react to this expected news item. Often there are additional figures, statements or forward-looking indications provided by news reports that can make movements extremely illogical.
There is also this very simple fact that as volatility increases and all sorts of orders hit the market, stops are triggered on both sides of the market. This often results in a whip-saw like action before a trend finally emerges.
For all these valid reasons, taking a position before a news report or announcement can seriously jeopardize an investor’s chances of success. There is no easy money in forex trading; those who believe there is may encounter larger than usual losses.
Trading Right after News
A news report or announcement hits the markets and then the market starts to behave aggressively. It looks like easy money quickly to hop on board and grab some pips. If this is executed in a non-regimented and untested manner without a solid trading strategy behind it, it can be just as costly as placing a gamble before the news report is out.
News announcements and reports often cause whipsaw-like movement because of a serious lack of liquidity and hairpin turns in the market assessment of the report in question. Even an executed trade that is in the money can turn easily and quickly, bringing large losses as large movements and swings occur back and forth. Stops during these crucial times are largely dependent on liquidity that may not be present, which generally means losses could potentially be much more than imagined.
Forex traders should wait patiently for volatility to subside and for a definitive trend to develop after news reports and announcements. By doing so, there is likely to be much fewer liquidity concerns, risk can be effectively managed and a more stable price direction is likely.
Risking More Than 1 percent of Capital
Excessive risk does not usually equal excessive returns. Virtually all traders and investors who risk large amounts of capital on single trades will eventually lose in the long-term. A common rule is that an investor should risk (in terms of the difference between stop and entry price) no more than 1 percent of capital on any single trade. Professional traders usually risk far less than 1 percent of their trading capital.
Day trading also deserves some special attention in this area. A daily risk maximum should be rigorously implemented. This daily risk maximum can be 1 percent (or less) of trading capital or the equivalent to the average daily profit over a 31 or 30 day period.
The real purpose of this method is to ensure no single day of trading or single trade hurts the traders account significantly. By adopting a well-calculated risk maximum that is equivalent to the average daily gain over a 30 or 31 day period, the investor knows that he will not lose more in a single day/trade than he can make back on another.
Forex traders soften stumble across averaging down. It is not usually something they planned to do when they began trading, but most investors have ended up doing it. There are several challenges with averaging down.
The main issue is that a losing trading position is being held – not only potentially sacrificing money, but also time. This money and time could be utilized for something else that is proving itself to be a better position.
Also, for every trading capital that is lost, a larger return is needed on remaining capital to get it back. If an investor loses 50 percent of his capital, it will take a 100 percent return to bring her back to the original trading capital level. Losing large chunks of funds on single days of trading or single trades can cripple capital growth for long periods of time.
While this strategy may work a few times, averaging down will inevitably result in a large loss or margin call, as a trend can sustain itself far longer than an investor can stay liquid.
Unrealistic expectations in forex trading come from many sources but often result in all of the problems mentioned above. Our own expectations are often imposed on the market, leaving us expecting it to act according to our wishes and trade direction. The market really doesn’t care what you want. Investors must accept that the market can sometimes be illogical. It can be volatile, choppy, and trending all in short, medium and long-term cycles. Isolating each move and profiting from it is just not within the realm of possibility, and believing so will often result in frustration and constant errors in judgment.
The best way to do way with unrealistic expectations is to formulate a trading strategy and then trade it. If it yields steady profit, then don’t alter it – with forex leverage, even a small pip gain can become large. Accept this return as what the market gives you. As your trading capital grows over time, your trading position size can also be increased to bring in higher returns.