It is easy for any individual to enter the foreign exchange market as it has low entry barriers. All it requires is as low as a computer, a good internet connection, a broking account, and a few hundred dollars.
Though low entry barriers don’t mean that the profitable trades too would be easy, there are many common forex mistakes that a trader needs to avoid. Some of these forex mistakes are as simple as trading without a stop loss or adding to a losing trade. Forex mistakes that traders should avoid in day trading are blind following mechanical systems, testing systems only a couple of years in the past instead of several decades, huge risk-taking, and overtrading.
Thus, you should consider all the scenarios before you start trading. Below we have listed the top 10 reasons why forex trading goes wrong!
1. Do Not Trade If You Keep on Losing
The two main things to keep an eye on in trading is the winning rate and the risk to reward ratio.
The winning rate is the number of trades that you have won stated in a percentage. For example, if you have taken 100 trades in total and if out of the 70 have proved winning, then the winning rate is 70 percent.
On the other hand, the reward to risk ratio is how much reward you get in terms of the risk you take. It also means how much you lose on average. If you are losing on an average of $50 and are winning $75, your reward to risk ratio is 1.5 ($75/$50). A reward to risk ratio of more than 1 is good as it means you are at least winning more than you are losing and can cover the commission or fees you have to pay over your trades.
You can still have profitable trades if your winning rate is lower, but the reward to risk is higher. You can mix and match strategies and decide your preferred settings. In general, a winning rate of 50% and a reward to risk ratio of at least 1.25 is good to go.
2. Mistake of Trading Without a Stop Loss
A stop loss is a must! Note that a stop loss is a must to save yourself from the misery of huge losses. If a price goes in the opposite direction, a stop loss helps you save yourself from the downside risk.
For example, if you buy a currency pair GBP/USD at 1.1110 and place a stop loss at 1.1100 if the prices go down from 1.1100, your order would automatically get sold and save you from the further slump in the currency.
3. Averaging Positions to Cover Your Losing Trades
Many times traders keep on adding positions to average their trades, which can be one of the biggest forex mistakes you can make. If the price moves in the opposite direction, you should better sell your positions. The forex market is volatile, and the currency pairs can go much in the opposite direction than you can think of.
The best thing you can do here is decide a proper trade size and place a stop loss. A stop-loss would stop you from losing more.
4. Taking risk More Than You Can Afford
Deciding how much your existing forex account worths and how much you should risk is an essential part of avoiding a big forex mistake. A day trader can afford to lose around 1% of their capital over a single trade on average. It also means that they place their stop-loss order so that they do not lose more than 1% in a single trade.
Losing is a part of trading, but how much you can afford to lose weighs more. You can lose a little in your trades, but losing more than 1% on every trade would eventually kick you out of the trading zone.
You are advised to set a particular percentage that you can lose in a single day. Suppose you can afford to lose 2%, strictly set your stop loss according to that. Losing can be an addiction as it comes with a poison called hope. So, be a disciplined trader and trade strictly within your limits.
5. Getting in a Trade to Win It All Back
Trading has to be done without emotions. With the entry of emotions, logic takes a backseat. Many a time, even if the risk management strategy is in place, you tend to ignore it for winning your losing trades back. But that’s a very destructive thing to do, as it can result in worst.
The chances of getting hopelessly hopeful are high when you want to convert a losing streak into a winning one. There will always be “one more” trade that you think would make it happen, and in most cases, “the next” trade is always that one more trade.
Just like profits, forex mistakes are keen to compound. More greed can result in you taking more margin trades than you can afford, and that also means you would not be able to afford it if you lose.
The best way you can make your forex trading going in the opposite direction is to stick to the percentage rate you can afford to lose. For example, if you can afford to lose 1.5% in a single trade and 3.5% in a day, do not go beyond that.
6. Indulging in Forecasting the News
Economic events across the globe affect the forex market. Thus, when you are trading currencies, try to avoid anticipating the moves. The currency pairs are susceptible to global news, and your wrong prediction can make you lose your hard-earned money. Instead, wait till the news is out and then trade accordingly.
If you think that placing a trade before the news burst will make you win big, that isn’t the case. Forex prices tend to move in both directions, very rapidly and sharply. As a result, you being in the wrong trade has higher possibilities, and within seconds, you would have a big losing trade.
Also, another problem here is liquidity issues. When news breaks, the bid and ask spread (the highest rate to buy and the lowest rate to sell) is big, and it can result in you not being able to exit a trade on time.
However, there are a bunch of strategies that you can use instead of predicting the news. One such strategy is the Non-Farm Payrolls Forex Strategy. You can profit from the volatility and can avoid unnecessary risks by using it.
The Non-Farm Payrolls Forex Strategy is a strategy for EUR/USD, in which a trader takes a trade before the release of the non-farm payroll data. The data is released on the first Friday of every month (see Non-farm payroll dates). It states how to enter a trade, which position to take, the position size, and all the other aspects of managing the risk.
7. Opting for a Wrong Forex Broker
Apart from trading, one of the biggest forex mistakes you can make is choosing a suitable and reliable broker. If the broker you have chosen is not stable enough, and the accounts are poorly managed, you can get into financial constraints. In addition to that trading, forex scams are also not new!
While choosing a broker, try to find answers to various questions like why you choose this broker, what you want to achieve, the advantages you would get, the credibility of the broker, etc. You can also try the broker by using the demo services or by trying a small amount.
8. Taking Multiple Correlated Trades at the Same Time
Diversification is great, but diversification requires a great deal of knowledge and experience of the forex market. Following the diversification rule, you can get inclined towards taking multiple trades in a day to spread the risks. But, the wrong selection of trades can increase the risk instead of diversifying it.
If you take similar kinds of trades in the forex market, the chances of them being correlated are high, resulting in the same type of risk but multiple times dangerous! If you win, indeed, you would win big, but if you lose, you may lose more than what you can afford. To avoid it, take multiple trades, but the trades should not be correlated.
9. Mistaking Long-term Singles for Short-term Trading
To gain knowledge of the financial markets, it’s good to read financial newspapers and update real-time data. You may read a news piece and may feel that it has some specific implications on your currencies. But the probability that it has opposite implications on the day you trade that currency pair is high.
Fundamental news is good for long-term trades, thus avoid to trade that information on short-term targets. Remember, economic news and fundamental updates affect the long-term trading prospects more than the short-term. Thus having an opposite bias from this can make you get distracted from your trading plan. Also, avoid gambling in your trade; it has to be systematic.
10. Getting into a Trade Without Planning
A trading strategy is an outline that says how your trade should be. It states all the aspects of a trade like when to enter, what to trade, how to trade, how much to trade, what should be the risk, etc. It is a kind of analysis for your trades.
Lack of a trading plan is nothing else but mere gambling. The best way to stop your forex trading from going wrong is to try your trading plan or strategy on a practice or simulator account. It would ensure that you do not lose your real money.
Forex trading has gone wrong in a day trading.
The most common trading forex mistakes in day trading are:
- Huge risk-taking: risk-reward ratio is bad. Trader risks hundreds of pips to gain few pips.
- Overtrading: Trader trade a lot of trades, too often without patience.
- Blind following of mechanical systems: Untested mechanical systems from Expert Advisors can destroy the portfolio.
- Testing systems only a couple of years in the past instead of several decades. Good trading systems are robust, excellent in several decades.
The Bottom Line
These tips and tricks do seem generalized on how not to trade or, more precisely, gamble, but remember entering into a trade without considering various angles and aspects is actually gambling! Hoping to win and trying to win by applying strategies are two different things.
One of the biggest forex mistakes is thinking of ways to make “Easy Money” or getting involved in such schemes. It would help if you were the final executioner of trades, and your trades should be driven by your knowledge, skills, and experience. Also, take note of the fact that sometimes the best trading strategy is to avoid trading. Trading is not a compulsive act; it requires patience and discipline.
You can follow these tips and tricks to avoid the most common forex mistakes a lot of day traders make, and eventually, with practice, you would learn from your mistakes. The foremost things to have as a forex trader are a trading plan, risk management practices, and a strong, disciplined mind that stops you from deviating from the trading goals.