5 Forex Trading Mistakes
Forex or foreign exchange trading can be just as lucrative as trading stocks or bonds, or other asset classes. Forex traders trade spot currencies or futures contracts, and try to profit on macroeconomic trends. Currencies are traded relative to other currencies. For instance, a trader may trade the dollar-yen or the euro-yen. These currency pairs are called “crosses.”
Currency markets are the world's most liquid markets, and they are an essential part of global trade. When an American businessperson wants to buy goods from Japan, for example, he or she needs to exchange dollars for yen to buy the goods.
Currency traders seek to profit from global macroeconomic trends and trends in international trade. While currency trading can be extremely profitable, currency trading is also risky. Novice currency traders can lose significant sums of money easily in the currency market, especially if they don't understand the demand and supply underlying currency markets.
Here are some forex trading mistakes to avoid:
1. Trading just to trade.
One of the biggest mistakes novice traders make is trading just to trade. This either stems from boredom or a misunderstanding of what traders do.
Successful traders do not make money for trading. They make money for managing risk, and for entering bets where the upside significantly exceeds the downside. That means that there are often times when traders should do nothing, because there are no good bets to be made.
Novice traders struggle with this because most people are conditioned to believe that doing nothing is always worse than doing something. In trading currencies and in all forms of capital management, many times doing nothing is much, much better than any alternative. Successful traders learn to recognize these periods and stay away from the market.
Many traders also fall prey to overtrading because of sheer boredom. No one likes to watch price movements and to look at charts without any money in the game -- it's not exciting. But trading in this way just to alleviate boredom turns trading into gambling. Remember that you also pay transaction costs each time you trade.
Traders would do well to remember that patience is a virtue, and that no one ever went broke from not trading. Traders must pick their spots well and not overtrade.
The best that can happen from overtrading is the trader's capital gets worn down from excessive transaction costs. The worst is that the trader enters many unfavorable trades which turn against the trader, and the trader suffers significant losses.
2. Being over-leveraged.
While using leverage is routine in forex markets, forex traders need to know how much leverage is too much. It is a common forex trading mistake to use too much leverage in a given trading period. Even worse is the mistake of using too much leverage to make a single trade or group of correlated trades.
Traders should take an evenhanded view of leverage and appreciate its benefits while always being aware of its dangers. With a large amount of leverage, traders can make large gains with little capital. At the same time, over-leveraged traders can -- and do -- get wiped out when a currency moves against them even in a minor, transient way.
Be cautious about the use of leverage, and make sure that even an abnormal move against you will not cause a massive loss of capital. Look at what the losses to your portfolio would be under difference scenarios of outcomes, and use that to decide your leverage and position sizing.
3. Not understanding the economies involved.
One big mistake forex traders make is not understanding the economies underlying the forex markets they trade. Many forex traders are technical traders. But that does not excuse a lack of knowledge about the fundamentals of the underlying economies.
Good technical analysis might earn a trader big money, but none of that will matter if the trader misunderstands something fundamental about the underlying economy that wipes out his or her profits.
At a minimum, traders should seek to understand what factors drive the supply and demand for the currencies they trade, and how and why those factors may change in the future. That way, a trader can know when technical aspects of trading might take a back seat to fundamental concerns.
4. Not having a calendar of central bank meetings for the currencies traded.
Trading in a normal market and trading in a highly-volatile market can feel like playing two different types of games. Therefore it is absolutely crucial that traders know when the central banks will meet and make pronouncements for the currencies that the traders trade. There is no excuse for being caught off guard by a scheduled central bank pronouncement and the volatility that can follow in the market. A trader that doesn't know when central banks are meeting risks getting caught up in a highly-volatile market that could have been avoided or planned for.
5. Risking too much capital on one trade or day of trading.
This mistake is similar to using too much leverage, and the disastrous results of making that mistake can also follow here. Traders should take care not to risk too much capital in one trade or in one day of trading. Usually, traders should risk less than 1 percent of capital in any trade or day of trading. Risking more than this figure could cause a significant loss of capital, and putting more than 1 percent of capital at risk just to gin up returns is almost always a bad idea.
