Trading in the Forex market is an exciting and lucrative endeavor, but unfortunately for a number of investors, the challenges outnumber the rewards. Despite the fact that traders can be really profitable with a properly structured trading strategy, there are those who do not have one and fall into certain pitfalls with the risk of losing a considerable amount of funds. In this article, we have listed the top most common mistakes made by Forex traders and a few simple tips to help you avoid them.
Using Too Much Leverage
A major magnet of Forex trading is the ability to trade on margin, or - as it is often called - leveraged trading. One of the most popular mistakes made by traders is using too much leverage. Over-leveraging is when you have a small initial deposit and make a disproportionately big trade. In that case, if the market moves against your position by just a small amount, it can lead to sizable losses.
Trading with a smaller account balance still gives the ability to open quite big positions, thus it is imperative not to get carried away when deciding on a trade size. There is a great risk that you could bear a loss equaling to some or even all of your funds.
Traders over-trade by opening too many trades at once. Those who try to be a “Jack of all trades” usually turn out to be a “master of none”. If you spread yourself too thin by attempting to trade too many different markets at once, you won’t have the proper information to make right decisions.
Opening multiple trades is very risky, especially when these trades are all interrelated. For example, if you open short trades on NZD/USD, AUD/USD, NZD/JPY and AUD/JPY, you will have four open positions that will frequently move in one direction simultaneously. Consequently, if you are incorrect on one trade, you are probably wrong on all four of them and lose it all in a heartbeat. Most professional investors recommend that traders should only trade on one or two markets.
Ignore Risk – Reward Ratio
Many traders make the mistake of not pursuing a bigger reward than the loss they are risking. In financial terms, this is typically called a “risk/reward ratio”. A good r/r ratio is 1:2, which means that, for example, you target a profit of 100 pips with a risk of 50 pips. Traders who use this ratio can be right on the direction of only half of their trades and still earn profit, because they make more money on their successful trades than losses on their unsuccessful ones.
It is advisable to always use a Forex system with a minimum of 1:1 r/r ratio, which means risking to lose the same number of pips as you anticipate to gain. That way, if you are correct only half of time, you will at least break even.
Not Use Stops and Limits
Traders most often do the fatal mistake of failing to use stops and limits. A stop loss order is a threshold where the trade automatically closes, in case that the market moves to a specific point. A good practice is to set stop-loss and limit orders to a r/r ratio of 1:1 or higher from the outset and stick to it. Investors who use them, not only have better overall results, but positive results are more consistent.
The distance to set your stops and limits is determined by the market conditions at the time, such as currency pair movement, volatility, and support and resistance lines. You also have to ensure that your profit target is at least as far away from your entry price as your stop-loss is. For example, if you have a stop level of 50 pips away from entry, you should also have a profit target at least 50 pips away.
Not Following a Trading Strategy
Without a Forex strategy, your trades do not stand a chance. A trading plan is essential for all traders’ success, beginners and professionals alike. A proper Forex system should lay out a trader’s periodical pip targets, the maximum amount of funds he/she is willing to lose in a given time period, the currency pairs to be traded and maximum number of trades, as well as risk management issues.
A good Forex strategy doesn’t need to be overly complicated, but it needs to clearly set out the planned time of day to trade, technical indicators and trading signals to use, estimated r/r ratio and daily stops and limits to protect your investment. You should maintain consistent with your plan and review it frequently to see your progress, as well as the things that you are doing wrong.
Not Doing Any Homework
Some Forex traders trade without having appropriate knowledge of the financial instruments they are trading, how they correlate and how they are affected by international events. This knowledge help traders to make well-informed decisions when important financial figures hit the news-wires, adjust their trading strategy and avoid making failed trades.
Although Forex can be extremely rewarding, it is also quite demanding. The most successful traders are the ones who have made a commitment to do whatever it takes to become the best. They’re willing to stay in the know and study charts or learn new techniques, so they are always ready for what the market throws their way. Once you’ve made that commitment, you’ve taken your first step towards trading success.
Now that we’ve looked through some of the most crucial mistakes that traders make, there’s only left one thing to say: Don’t waste your money – learn trading!
Here at TeleTrade, we are determined to not only provide you with quality free Forex training and practice to hone your trading skills and avoid pitfalls, but also to give all the trading tools you need to succeed in financial markets.