This ease of entry doesn't mean everyone succeeds in forex trading. A multitude of issues can end your forex career quickly, so you must try to avoid them. Here are the eight most common mistakes new Forex traders make:
Don't go for the wrong broker
A broker can make or break your forex trading career. The selection of a broker is, perhaps, the most significant and most important decision you need to make since an unreliable one could potentially cause you to lose all your hard-earned capital.
To ensure you're not making the wrong decision, for starters, the brokers you're considering should be a part of the regulatory bodies of their respective countries. Luckily, many US forex brokers are registered with The National Futures Association (NFA) and the Commodities Futures Trading Commission (CFTC).
Choosing the right broker is a rigorous process, and you should spend a lot of time before you make a decision.
Never add more to a losing trade
Sometimes, when a trade is going wrong, traders are convinced that adding to their positions or averaging down, can help reverse the falling trend.
Despite its popularity, averaging down is a strategy that forex traders should avoid altogether. It's never a good idea to add more money to a losing trade and risk even more significant losses.
To avoid such circumstances, it's always better to have a stop-loss in place, so, in case the prices start going against you, the activation of the stop loss can end the trade at minimal damage.
Don’t keep trading if you keep losing
Every forex trader needs to keep an eye on two trading stats: the risk/reward ratio and the win-rate.
The risk/reward ratio is defined as the amount you win as compared to the amount you lose. On average, if your losing trades amount to $100 and your winning trades amount to $250, your risk/reward ratio is 2.5. You should at least aim to maintain your risk/reward ratio above one and ideally above 1.25 every day.
On the other hand, the win-rate indicates the number of trades you win as a percentage. If out of 200 trades, you win 140, then your win-rate is 70 percent. A trader should aim to maintain his or her win rate at above 50 percent every day.
A trader can continue to be profitable with a higher risk/reward ratio and lower win-rate or a lower risk/reward ratio and a higher win-rate. Ideally, though, both of these should be above the minimum range, and you should employ trading strategies that can help you achieve these numbers.
Always have a stop-loss in place
A stop-loss is essential every day you engage in forex trading. Even the most experienced traders aren't immune from losses in the forex market, and trading decisions can go wrong at any time.
Having a stop loss in place can help you get out of a trade when the price of a currency pair moves against your strategy by a specific amount. A stop-loss often acts as an insurance policy, and you should moderate your losses and use the amount to move on to the next trade.
Don't risk more than you can afford to lose
Risk management is a vital part of forex trading and determines how much capital you can afford to risk on every trade. On any single transaction, traders should never risk more than 1 percent of their capital. In case you're about to lose more than this amount, a stop-loss order prevents that.
A risk management strategy ensures that even in the case of losing multiple trades, you only lose a minimal amount of your capital. Similarly, if you manage to win 2 or 3 percent on every trade, you can recover your losses quickly.
Another essential part of an effective risk management strategy is managing daily losses. Even if you're risking a percent of your capital on every trade, but are engaging in several trades per day, you could potentially lose a large amount of your money.
In this case, it's crucial to have a daily stop-loss that prevents you from losing more than a specified amount every day.
Never go all in
Even with a risk management strategy in place, it's tempting to avoid it altogether and risk more capital than you're typically used to. Why one decides to make a decision such as this could be due to several reasons; you may want to recover previous losses or are feeling extremely confident about a specific trade.
Regardless of the reason, though, you should never defy your risk management rules. Risking more than the set amount can lead to mistakes, and these mistakes tend to grow one on top of the other. When a risk doesn't work in your advantage, you might end up canceling your stop-loss altogether in hopes that the trade will turnaround.
It's crucial to avoid such temptations in any circumstances and always abide by your risk management strategy.
Don't try to predict the news
Forex prices are highly susceptible to various political and economic news. Significant changes are likely to take place during scheduled news releases. It's easy to think you know which direction currency pairs will move and take a position based on those predictions.
However, this is never a good idea since price fluctuations during these times are incredibly likely, and prices are expected to move in both directions before settling into a stable course. This means you're likely to lose immediately after a news release.
While there are chances of that losing trade to turn into a winning trade, this losing trade may also remain a losing trade. Additionally, since the spread between the asking price and bid is more significant, the trade may not be liquid enough for you to get out of easily.
Hence, instead of predicting the direction in which the news will influence currency pairs, it's crucial to have a strategy in place that'll let you be part of the trade after the release. You can always profit from the price fluctuation without any blind risks.
Don't trade without a plan
A trading plan is a document that highlights your trading strategy. It covers multiple areas, including what, how, and when you will trade. This plan should be drafted in detail and needs to include what markets you'll be involved in and when. It should also cover the time you'll take out to analyze and make trades. Amongst other things, this trading plan should highlight your risk management strategy and how you'll enter and exit the trades (in winning and losing trades, both).
Trading without a plan is equivalent to a senseless strategy; without an idea of what you're planning on doing, you're bound to make mistakes. Hence, it's vital to create a trading plan and test it out on a demo account before you start risking your actual capital.
Forex trading is, undoubtedly, complex. It's a risky area that should never be entered without the right education and knowing what you should and shouldn't do. However, with the right mindset and the right commitment, you can easily succeed in forex trading by avoiding the mistakes that differentiate a novice trader from an experienced one.
What other mistakes should a forex trader avoid? Let us know in the comments below!