Top Ten Mistakes Of Forex Traders
When you think about investing, what do you think of first? Which aspects of investing are important, which are essential, and which ones can you take or leave? You be the judge.
The 10 Most Common Mistakes of a Trader are...
1. Not Having a Trade Plan.
2. Not Having Money Management
3. Not Using Protective Stop Loss Orders
4. Taking Small Profits and Letting Your Losses Run
5. Overstaying Your Position
6. Averaging a Loss
7. Increasing Your Commitment With Success
8. Overtrading Your Account
9. Failure to Remove Profits From Your Account
10. Changing the Trade Plan Mid-Trade...
1. Not Having a Trade Plan...
It truly amazes me that, trade after trade, that the most common
"losing trader"approach is the same. A trader who thinks a market
is about to go up will usually say something like -"I think the
EUR/USD is going up to $1.2000. Where do you think I should buy
it?" My response is usually something like, "Well, what are you risking
on the trade? In other words, where are you going to get out if you are
wrong?" Often there is silence, or perhaps a puzzled "Huh?" They never
thought about being wrong, they never thought about where to put their
stop. My next question -- "Well, if it does go up, how and where are you
going to get out?" -- often receives the same response.
Better than 90% of the Forex traders that I come in contact with have no
trade plan. That means that they do not know what to do if they are wrong
and they do not know what to do if they are right. The large paper profit
they made often turns into a large loss because they did not know where
to get out.
The most important move a Forex trader can make is to develop a trade
plan, before they enter the trade, consisting of these guidelines.
o Know how and where you are going to enter a the trade.
o Know how much money you are going to risk on the trade.
o Know how and where you are going to get out if you are wrong.
o Know how and where you are going to take profits if you are right.
o Know how much money you are going to make if you are right.
o Have a protective stop loss in case the market does the unexpected.
o Have an approximate idea of when a market should meet your objective; when it should begin to make a move, and if it has not done so, get out!
2. Not Having Money Management...
I am constantly amazed at how few Forex traders and brokers have no concept
of money management. Money management is controlling your risk through
the use of protective stops, while balancing your potential for profit against your
potential for loss.
An example of poor money management I see almost daily... many traders
refer to a trade that might lose them $500 if they are wrong and make them
$1000 if they are right as a two-to-one risk/reward ratio - a "decent" trade.
Yet, that is wrong because it is just as important to knowing proper win/loss
ratio of knowing how much you are going to lose if you are wrong and how
much you are going to make if you are right, but what are the odds of making
money... of being right? What are your odds of losing money, or being wrong?
Good money management means you know your profit objective and the odds
of being right or wrong, and controlling your risk with protective stops. You
are better off with a trade where you might lose $1000 if you are wrong and
make $500 if you are right, that would work eight times out of ten, than to
take a trade where you would make $1000 if you are right and lose only
$500 if you are wrong, but works only one time out of three. Obviously,
this mistake can be overcome only by developing and testing money
management concepts. An entire book could be written on money
management principles... but the key is knowing your win percentages
along with proper risk/reward ratios.
3. Not Using Protective Stop Loss Orders...
This fits right in with a trade plan and money management. It is the failure
to use protective stop orders once you enter a trade -- not mental stops,
but real stops that cannot be removed. All too often Forex traders use
mental stops because in the past they have been stopped out and then
watched the market move in their direction. This does not invalidate the
use of protective stops, it means their stop was most likely in the wrong
place as they did not have a good technical stop. When a protective stop
that was determined before you entered the trade is hit, it means your
technical analysis was probably incorrect... your trade plan was wrong.
With a mental stop, as soon as the market has gone through your protective
stop price, you no longer act like a rational human being. Now, you are most
likely to make decisions based on fear, greed and hope.
How many times have you had a mental stop then tried to make a decision
whether or not to take a loss? Typically, by the time you make the decision,
the market has run an extra $300 against you. You invariably decide to hold
onto the trade hoping that you can get out on a Fibonacci retracement to your
previous stop price. Unfortunately, in many cases I have seen, it never touches
that price again and you take a huge loss. Or you make the mistake of holding
the trade an extra day because you hoped it would go higher the next day.
But the next day it is lower yet, and by then your loss is so large you can't "afford"
to get out -- and what should have been a small loss turned disastrous. There is
an old saying that the first loss is the smallest. It is also the easiest to take, even
though it may seem hard at the time.
The only way to overcome this mistake is to have an unbreakable rule (and the
discipline to follow it!) that a protective stop loss order must be placed on every
trade entered. I have found the easiest way to take a loss is to place the protective
stop order the moment or immediately after entering the trade. Do your homework
when the markets are closed or slow, and place your order while the market is still
quiet. Another rule to follow; under no circumstances should an initial protective
stop order be changed to increase your risk.. but only to reduce it.
4. Taking Small Profits and Letting Your Losses Run...
So far, we've uncovered some interesting facts about investing. You may decide that the following information is even more interesting.
A very common mistake among Forex traders is taking small profits and letting
losses run. This is often the result of not having a trade plan. After one or two
losing trades, you are very likely to take a small profit on the next trade even
though that trade could have turned into a large winner that would have offset
all your losses. Letting your losses run often happens to new traders and is
not uncommon among even professional Forex traders. After entering a trade,
you don't know where to get out. Once you start losing money on a particular
trade, your tendency is to let your loss get larger and larger as you hope that
the market will retrace to let you break even -- which of course, it seldom does.
This mistake is overcome by using pre-determined protective stop loss orders to
prevent your losses from running, and following your trade plan to take profits at
your profit targets.
5. Overstaying Your Position...
One of the most common mistakes of trading currencies is overstaying your
position, or simply failing to take profits at a predetermined level. There seems
to be a natural law that the market is only going to allow one individual so much
money before it starts to take it back. Yet, it is when you have these profits,
especially real profits in your account, that you often try to get the last nickel
out of a trade.
If the market meets your profit objective and you are still in the trade without
an exit order, then you are overstaying your position... period! All too often the
market breaks sharply through your "mental stop" and from that price level, you
watch your profits disappear before your eyes. Then you decide to hold onto
the trade for a small rally, and the market never rallies enough. It drops back
to break-even, and now you really begin to hope. Next thing you know you
have a loss. Be aware that a large profit can turn into an even larger loss.
The only exception would be if price action is going strong in your direction.
In this case, you can move your protective stop to your profit target or use a
trailing stop.
6. Averaging a Loss...
This is usually a holdover from trading equities or futures, lord know I have been guilty of this one myself on more than one occasion. In Forex, with 50:1
or greater margin, averaging a loss can be disastrous to say the least. A typical
approach is that after you have went long and it drops lower, you might figure
that since it was a good buy then, it is a better buy now. You may justify averaging
down by figuring you will have a lower average entry price and require a smaller
move to break even. Unfortunately, you will lose twice as much if the market
continues against you, as it almost always does.
There are approaches that will allow you to buy a market at one price level, add
on at a lower level and add on again at even a lower level, as long as this was
your predetermined game plan before you entered the trade initially. You must
also have an unmovable protective stop loss order that takes you out of the entire
position. This mistake is easily overcome by having a strict rule that you never
average a loss unless your predetermined trade plan called for averaging the trade
incase the market moves against you... As long as you have a pending unmovable
protective stop loss order to exit your entire position if it is hit.
7. Increasing Your Commitment with Success...
One of the most common mistakes I see with Forex traders is increasing your risk
exposure because you think you are on a winning or losing streak. Just by being
successful on a few trades, you will risk more dollars per trade because you have
more money. But, because you have more money (and confidence) when successful,
you are also likely to take larger percentage risks. Not surprisingly, this ruins more
Forex traders than a series of small losses. You can overcome this mistake by not
allowing your risk percentage to unreasonably increase as you realize profits and by
maintaining your protective stop loss discipline. What I mean by unreasonably is
this... on a typical trade, your risk should be 1-2.5% of your account size depending
on trade confidence. As you see yourself on a winning streak, you are tempted to
increase risk percentages. Never never increase your risk percentage more then 5%
of your account balance on any one trade. In addition, I have seen the psychology
of traders telling where they risk more after a losing streak and risk less on a winning
streak thinking that after a string of winners, a loser has to come at any moment...
Or, increasing their size after a string of losses thinking they gotta have a winning
trade now. Don't fall into this thinking trap!
8. Over Trading Your Account...
Or risking too large a percentage of your account balance on any single trade,
either with too large a dollar risk per contract or by trading too many contracts
for any single trade or by trading too many currency pairs. This also happens
after a period of choppy consolidation when you "know" that the market is going
to do something. You are so certain that this is going to be a really big move
that you risk much more than the maximum 5% of your account balance.
Already emotionally out of balance, all it takes is a couple of limit moves
against you and you are bust. To prevent this mistake from occurring, you
must have a hard and fast rule that you can risk no more than a certain
percentage of your account balance on any trade regardless of how good
the trade looks.
9. Failure to Take Profits from Your Account...
It is almost a natural law that the Forex markets over a given period of time
will allow you to make only so much money and then you are going to have
to start giving some back. Yet, probably no more than 1% of all Forex
traders I know have a rule to take profits out of their account. (But, they are
quick to put money into their accounts as their accounts levels drop to untradable
levels). You can't believe how often I see traders leaving profits in their accounts
and go for the "big trade" -- the one that will give them a real "killing" -- which
usually kills their profits. This can be overcome by predetermining an equity level
at which you will remove profits from your account. When you make profits in the
Forex markets, take some money out and put it somewhere else. You, as all
Forex traders, will move in cycles. You will make some, lose some, make some,
lose some. By taking money out of your account when you are profitable, you
will not make the mistake of losing larger amounts of money when a down cycle begins.
10. Changing the Trade Plan Mid-Trade...
During prime trading hours you are subject to emotional reactions of fear and greed
much more than you are when the market is quiet. Have you ever noticed that when
you sit down during the slow Asian session, you can very calmly figure out what you
want to do during the often busy London session? Yet, shortly after the London
session opens or when the market gets busy, you do exactly the opposite of what
you had planned. With rare exception, the best approach is to not change your
trading strategy during prime trading hours unless there is a breaking news event
or market reaction. Overcome this mistake by developing your trade plan before
busy market hours and having the discipline to not change your trade plan afterwards.
Those who only know one or two facts about investing can be confused by misleading information. The best way to help those who are misled is to gently correct them with the truths you're learning here.
