Forex trading can be fraught with dangers, but by laying out examples of what you shouldn’t do, we can hopefully make the path ahead a little safer for you. Here are some common mistakes beginners make that you should avoid, to make your trading as low risk as possible.
Lack of direction
It’s no secret that the Forex market can be highly unpredictable. It is vital to not confuse this “unpredictability” with “randomness” as many beginners do. Often people start by going on to trade as randomly as they believe the market to be. Sometimes they win, sometimes they lose, but they never learn how to do either reliably. You have to learn to react to the volatility of the market, not give into it.
So, how do you work your way through the seeming madness of it all? The first step (and most crucial) is to have a trading plan. Another important part is learning from the losses that you’ve made in the past and why they happened. The best way to do that is to record them in a journal.
By keeping tabs on every trade you make, you will start to notice where it isn’t performing as well as it should be, or other factors are influencing outcomes. Having this plan and being able to change it based on the results is vital in Forex trading.
Not having a stop-loss
A stop-loss is an order designed to stop you from losing too much money on any one trade. It is an essential part of Forex trading and the longer you go without it the more you leave yourself open to risk. You should decide how much you’re willing to lose on any one trade and assign your stop-loss order accordingly.
Just as importantly, you should avoid moving your stop-loss order just because your instincts tell you one trade is eventually going to be a winner. Always let your head rule your heart, and never allow your emotions to make trading decisions for you. Everyone will experience some loss when trading, but by putting in place a stop-loss you are protecting yourself from losing too much, too quickly.
Trading overseas is fraught with challenges, and one important thing is to keep an eye on domestic currencies.
Averaging down and selling early
Trading is not just a numbers game, it’s a game involving your own emotions and instincts. Nowhere is this clearer than in the mistake of averaging down. Although this error is more common in the trading of stocks and shares, it is important to understand why it is a bad idea for beginner traders.
Averaging down is the practice of adding additional funds to a trade that you’ve already invested in at a lower rate than you initially purchased. You might do this because you invested in a trade, and you decide that it would be best to invest more while it’s cheap, and wait for the value to go back up. This is a sunk-cost fallacy, and you may be waiting a long time for any return, missing out on more profitable opportunities in the meantime.
Not diversifying enough or diversifying too much
Overtrading exposes many beginners to too much risk. By doing this, you are not insulating yourself from the market. In fact, you might as well be trading randomly. You should only trade when you think you have the advantage, and ensure you always trade according to your plan.
An even larger risk for beginners is over-diversifying by trading too many positions at the one time. By doing this, you leave yourself open to market risk, making it much harder to spot which positions and trades work. This also increases your risk of trade duplication, and overlapping positions, which can effectively double your losses on a bad trade.
Trading too much of your capital is another easy mistake for people to make. By risking large amounts of capital, you are likely to lose out in the long run because you have exposed yourself greatly to market risk. By mitigating your risk you can spread out your capital. Investing a maximum 2% of your total capital loss strategy rule, protects you from losing too much too quickly, when the market works against you.
Forex trading for beginners is a long learning process. It’s best to make sure you’re doing plenty of research, taking advantage of demo accounts and learning the markets, before you start depositing real money. Through your efforts, you can make Forex much less risky.
Adam Truelove is global trading director at Learn to Trade
It’s one of the biggest variables in business today, so a roundtable conversation on managing currency risk generated some interesting conversation.