Most trading mistakes are caused by poor judgment and a lack of preparation. When you don’t know where the traps are when trading, you cannot help but fall into them. When you are well informed about which mistakes to avoid, half of your problems are already solved.
So how do you know if you are falling into a trap? More importantly, how can you avoid them? Here, we will be going over the top six traps beginners fall into, and how to make sure you don’t fall victim to them.
TRADING WITHOUT A TRADING PLAN
It is amazing how many traders fall victim to this trap. We somehow convince ourselves that knowing how to trade is as simple as staring at a chart and being spontaneous. Simply put, this does not work, ever! Forex trading should not be a spontaneous endeavor.
If there is a single hard and fast rule in Forex, it is never trade without a plan. Every position taken without a plan is called gambling, NOT trading. After all, how many generals would send troops into battle without prior planning? This should be your mentality going forward.
A trading plan means, at the very least, having clear entry triggers and exit levels. You should also know well in advance why you are taking a specific trade. Is there a piece of news coming out that could impact your position? Did technical indicators show this was the right move to make? Know what you are trading and why you are trading it.
Your trading plan must be logical and make sense. Furthermore, you should trust it. Write down your plan and make sure it includes everything you need to consider when making your trading decisions.
Working from a trading plan will reduce the tendency many beginners have to second guess themselves. Furthermore, it will help you avoid making cumbersome adjustments to your positions half way into a trade.
TRADING BASED ON EMOTION
Do you trade based on emotions? Despite what Hollywood would want us to believe, trading is not an emotional game. When you let your emotions get involved, your judgment gets clouded.
Beginners always seem to follow a pattern. They trade emotionally, lose some money, get more emotional and lose even more money. Emotional trading is often the reason traders employ robots to do their work for them.
Trading is all about making decisions based on cold, predetermined and well-weighted probabilities. Ensure your trading psychology is well balanced. The trick is to leave your emotions outside when you enter the trading zone.
NOT HAVING A MONEY MANAGEMENT STRATEGY
One of the reasons beginners find trading to be so frustrating is that they fail to implement a money management strategy. A money management strategy is the business aspect of trading. It should outline how you treat your capital after you get started. Many traders do not have a clear money management strategy and consequently never build their capital.
Trading must be taken seriously, just like any other business. Do you have a plan for how you will build your account? How much of your profits will you reinvest into the account?
You should know if and when you will be withdrawing from your account. It is also important to find out what charges you will incur directly from your trading activities and account for them. These outflows must be incorporated into your overall plan to build up your account balance. If you do not have a plan for controlling the outflow of money from your account, make one now.
TOO MUCH LEVERAGE
More traders have lost their entire account because of overleveraging than any other practice. Greed causes you to add to the size of a position more than you normally would. When the trend moves even slightly against you, the losses hurt even more. The prospect of making a killing in just one trade is what causes most traders to overleverage.
Leverage is a double edged sword that cuts sharper when it moves against you. Long term success in trading is greatly enhanced by using leverage sparingly.
You can avoid the temptation of overleveraging by setting maximum limits for every trade and never exceeding them. You do not need to use all of the leverage available to you. Most professional traders never leverage their positions more than 8:1. Your sweet spot should be somewhere around this ratio.
Do you engage in excessive trading? Markets punish new and inexperienced traders in the most cynical ways. No sooner have you made a huge profit in one trade than you give it all back in the next few that you take. Most rookies become extremely preoccupied with mimicking any successful trade they make. After a while, greed takes over and they begin taking foolish positions.
Similarly when a trader takes an abnormally large loss, or a series of losses, they begin to focus on recovering their money. This practice is called revenge trading and is a sure way to cloud your judgment and lose more money.
Taking a break and clearing your head after a period of significant gains or losses is very much recommended. The dramatic change in your capital will affect your judgment, no matter whether you can feel it or not. Remember that there is always tomorrow.
Whenever there is a 10% or more change in your capital, (in either direction) in a single day, it may be a good time to stop trading and clear your thoughts, even if you’ve just logged into your platform.
IGNORING DEMO TRADING
Some Forex traders jump prematurely into live trading and quickly lose money because they have failed to develop their skills. Without demo trading, traders have no way of assessing their own trading expertise without risking money.
Demo trading is boot camp for Forex traders. It’s a rite of passage. Most people simply do not have enough money to loose over and over again, until they reach that moment where they feel comfortable and confident enough to trade seriously. Demo trading gives you a risk free way to practice. Never trust yourself with money unless you can show consistent profits on a demo account first. The trick is to take demo trading as seriously as you would a live account. Otherwise, what’s the point?
In Forex, there are many traps out there that you must be on guard for. What every trader comes to realize eventually is that your account could very well be wiped out if you fall into any one of the six traps outlined above.
That being said, you are now in a great position where you can avoid these six common mistakes. Being well informed and keeping a clear and level head is the best way to ensure your long term profitability in Forex trading.