How to Avoid Common Forex Trading Mistakes - dummies

By Consumer Dummies

No matter how long you’ve been trading on foreign exchange (forex) markets, you’re bound to experience lapses in trading discipline, whether they’re brought on by unusual market developments or emotional extremes. Following are the major pitfalls of forex trading. If you start to see any of the following errors in your own trading, it’s probably a good idea to square up, step back from the market, and refocus your concentration and energies on the basic trading rules.

  • Running losers and cutting winners: The most common trading mistake is holding on to losing positions for too long and taking profit on winning trades too soon. The key to limiting losses is to follow a risk-aware trading plan that always has a stop-loss order and to stick to it. No one is right all the time, so the sooner you’re able to accept small losses as part of everyday trading, the sooner you’ll be able to refocus on spotting and trading winning strategies.

  • Trading without a plan: Resist the urge to trade spontaneously based on your instincts alone without a clearly defined risk-management plan. If you have a strong view, go with it, but do the legwork in advance so you have a workable trading plan that specifies where to enter and where to exit — both stop-loss and take-profit.

  • Trading without a stop loss: Trading without a stop loss is a recipe for disaster. It’s how small, manageable losses become devastating wipeouts. Using stop-loss orders is part of a well-conceived trading plan that has specific expectations based on your research and analysis. The stop loss is where your trade strategy is invalidated.

  • Moving stop-loss orders: Moving your stop-loss order to avoid being stopped out is almost the same as trading without a stop loss in the first place. Worse, it reveals a lack of trading discipline and opens a slippery slope to major losses. Move your stop loss only in the direction of a winning trade to lock in profits, and never move your stop in the direction of a losing position.

  • Overtrading: Overtrading comes in two main forms: trading too often in the market and trading too many positions at once. When you trade too often, you always have a position open and are constantly exposed to market risk. Trading too many positions at once is like throwing darts at a board and hoping something sticks. It eats up your available margin collateral, reducing your cushion against adverse market movements. To avoid these mistakes, focus on opportunities where you think you have an edge and apply a disciplined trade strategy to them.

    Also be careful about trade duplication and overlapping positions — a long USD/CHF position can be the same as a short EUR/USD or GBP/USD (all long USD versus Europe), while a short EUR/USD and a long EUR/JPY position nets out to be the same as being long USD/JPY.

  • Overleveraging: When you trade too large a position size relative to your available margin, even a small market move against you can be enough to cause your position to be liquidated for insufficient margin. To avoid this scenario, don’t base your position size on your maximum available position. Instead, base it on trade-specific factors such as proximity to technical levels or your confidence in the trade setup/signal.

  • Not adapting to changing market conditions: Stay flexible with your trading approach by first evaluating overall market conditions in terms of trends or ranges. If a trending move is underway, using a range-trading style won’t work, just as a trend-following approach will fail in a range-bound market. Use technical analysis to highlight whether range or trending conditions prevail.

  • Being unaware of news and data events: Even if you’re a dyed-in-the-wool technical trader, you need to be aware of what’s going on and what’s coming up in the fundamental world. You may see a great trade setup in AUD/USD, for instance, but the Australian trade balance report in a few hours could blow it out of the water. Therefore, make data/event calendar reading a part of your daily and weekly trading routine.

  • Trading defensively: After a series of losses, you may find yourself focusing more on avoiding losses than spotting winning trades. At those times, it’s best to step back from the market, look at what went wrong with your earlier trades, and refocus your energies until you feel confident enough to start spotting opportunities again.

  • Having unrealistic expectations: Face it: You’re not going to retire based on any single trade. The key is to hit singles and stay in the game. Be realistic when setting the parameters of your trading plans by looking at recent market reactions and average trading ranges. Avoid holding out for perfection — if the market has achieved 80 percent of your expected scenario, you can’t go wrong locking in some profits, at the minimum.