Common Forex Trading Mistakes and How to Avoid Them
Reading time: 12 minutes
What are the most common Forex trading mistakes that traders make? This article will discuss all of the major mistakes that traders commonly make in the Forex markets. From the most common ones, to the less common, this article will provide an overview of all the important things to look out for and avoid when you start trading Forex (or even for professional FX traders who might not yet be aware of them!).
All people that join the ranks of financial traders, Forex notwithstanding, do so with the intention of making money, however, only a few end up actually being profitable in Forex. What stops so many traders from being successful? And what is different in the trading of the few? Forex mistakes can be an expensive affair and rightly so.
Indeed, in a field where traders attempt to make money, a small mistake can prove to be costly. Just as with any other type of business, trading Forex also requires some guidelines and principles that one must follow. Interestingly though, Forex beginner mistakes can be easily avoided if you can recognise them first.
The Most Common Mistakes Made In Forex Trading
The first and biggest Forex beginner mistake is not having a full understanding of how the markets work. Forex beginners often think that simply having a good trading strategy is enough. However, they almost always end up losing their money. This is pretty the same as trying to set up a business in a sector you have no clue about. Sound familiar?
Addressing this problem is quite obvious in terms of the solution, and there is not much to discuss. Study like there is no tomorrow, getting a good Forex education is extremely important! Beginners tend to read only a few good trading books, and only a few articles before they start trading. They practise too little, forgetting that they are messing with an occupation that takes years to master!
In fact, beginner traders tend to know so little about financial trading that they often don't even know where to start. So how can traders avoid making the most obvious and the biggest Forex trading mistake of them all?
By studying, reading, watching webinars, attending trading seminars, practising on a Demo account. Whatever it takes. If you don't have the time, make the time! You never know which one will be the eureka moment, or how many it will take for you to reach consistent profitability.
Skipping the Trading Plan
You must have heard something about the positive effects of having a trading plan. Well, financial markets are no exception, and not having a Forex trading plan is one of the most widespread mistakes that Forex traders make. Possibly, the reason for this is due to traders not having a clear understanding what a trading plan looks like at all.
What is a Trading Plan?
A trading plan is a strict set of rules, half of which a trader draws from their trading strategy, and the other half is derived from their money management strategy.
Here is what it might look like:
- Specific market conditions for entering a trade
- The amount of money to risk in a trade
- Specific market conditions for getting out if you are wrong (stop-loss)
- Specific market conditions for getting out if you are right (take-profit)
- Approximate time for the market to reach your target
- Note down and record everything
Undermining Money Management
Things might get hectic in Forex trading quickly, because Forex brokers are allowed a lot of freedom in terms of leveraging their trading account, while beginner traders lag behind in terms of money management discipline. A combination of these two leads to high risk, hazard trading.
Here is a couple things a trader needs to ask themselves, to avoid making this Forex trading mistake:
- Am I investing only my risk capital? (Can I afford to lose this money?)
- What is the maximum % of my total investment that I am ready to risk in one trade?
- What is the maximum amount of trades I can have open simultaneously?
- What is the win/loss ratio that my strategy promises?
- Does it comply with my risk/reward ratio per trade?
Money management might sometimes get tricky, because it is strategy dependent. In some cases, you are better off with a strategy that promises a potential loss of $1k and a potential win of $500, that works eight times out of ten. Whereas, some other times you are better off with a strategy that promises a $500 loss to a $1k profit, but works two times out of five. Trial and error is therefore, an important part of the process, and another reason for why traders should use demo trading accounts prior to utilising their strategies in the live markets.
Setting the Wrong Goals
Which is a healthier approach to trading?: Doing things the right way, even if it potentially means making less profit or doing things in whichever way, as long as it potentially promises more returns? It's a tricky question, because what is healthier for both the trader and their account balance is to stop thinking about the money altogether. If making money is the trader's only goal, especially at the early stages of their trading career, chasing the money may soon become the very reason for failure.
Chasing money typically leads to breaking the rules of your trading plan. In rare specific trades, breaking these rules may lead to a higher yield. In the long run, however, which is hopefully your plan for financial trading, it almost always leads to an empty account balance. This may happen in one of the following ways, or via a combination of them: Overtrading, and Over-analyzing.
Overtrading: one of the mistakes many Forex traders make may come from insufficient capitalisation, resulting in a trader using high volumes that are simply too large, relative to their account balance, or it may come from a trading addiction, resulting in a trader opening orders too often.
Overtrading problem one - insufficient capitalisation:
Forex trading generally comes on highly leveraged accounts as it is. Not having enough money to manage simply improves the chances of a disaster occurring. It was mentioned earlier in the money management section, that a trader should always decide just how much money they are willing to risk per trade beforehand.
What about the traders that make it? How much do they risk? Do they use 100%? or 50%? Or even 10% of their account balance in a trade? The answer is none of them. Instead, 1% or 2% is the absolute ceiling you can go for. And how much of their capital can be involved at one time? And with all trades combined? The answer is: 5-7%. Such careful money management will allow you to make some room for the Forex mistakes that you will inevitably make, simply as a part of your learning process.
Well how much is enough then? Here is an example:
If trading you are trading a 0.01 lot (1,000 units of currency), which is the minimum Forex trading volume any broker can offer, you would need at least one thousand US Dollars in terms of investment, on an account with 1:100 leverage, to afford opening a single position at one time. And for that position, you can't set a higher stop-loss to just 50 to 60 pips, because that would make your total: 5-7%.
And we are talking about a fixed stop-loss, not a mental one, because as soon as the price goes through a mental one, a trader starts re-rationalizing their decisions, further diverting from their original fixed trading plan. Top tip: Never avert from the trading plan!
So how can traders avoid undercapitalisation without breaking the risk capital rule? The answer: Save money! You can do it. Warren Buffett saved up to around $10k during his college years by performing low-paid, miscellaneous jobs. It worked out for him just fine, even without the luxury of a 1:100 leverage!
Overtrading problem number two – trading addiction:
Trading financial markets, especially on short-term intervals, can be a very exciting activity. The markets move, the money flow is real, and it is live. An exhilarating experience indeed. It is almost as if the market wants to be traded. This delusion should not, however, dictate your trading. You have a plan to follow, remember?
Chasing money takes its toll. If one is aiming to increase one's profits, a trader bends their strategy just ever so slightly, entering where they should be patient, and exiting where they should be tranquil. Over-analysing comes hand in hand with overtrading.
Possibly one of the biggest mistakes made by Forex traders is thinking that they have control over the market. They don't. Successful trading is much like fishing, where the fisherman has no control over the fish. There is not much you can do until the fish has caught your bait. Once it has, act. Once the market price is just where you want it, you trade. But before that moment, all you can do is sit still.
Your strategy tells you exactly which market conditions you should wait for. If they are not there, there are simply not there. Not because you missed them, not because you should check for them on smaller time-frames, and not because there is a hole in your strategy. The sooner you start thinking about waiting for a market to set up right, to start saving money rather than losing it, the better off you are going to be.
Confusion of Purpose
This may come as somewhat of a surprise to some, and to many beginner traders it does, but trading financial markets is a business, while most treat it as entertainment or a hobby. Confusing why you want to be involved in trading is one of the main Forex trading mistakes to avoid. First of all, it influences the level of your commitment to trading.
Secondly, it defines your attitude toward the money you invest. Entertainment is for having fun. Business is for making money. In financial trading, you invest money to make a return on your investment, which essentially makes the concept of trading, a business. If you ever hope to make money on a consistent basis in Forex trading, act like a businessman.
Other Common Mistakes Made In Forex Trading
Being Too Greedy
One of the common Forex trading mistakes you can make is to fall into the trap of getting too greedy. Many Forex beginners have the wrongful impression that they can earn 20%, if not more, in terms of return within a single year. Unfortunately, this is a wild goose chase. You cannot realistically expect such high returns unless you are an exceptional trader, with a lot of experience, and a good education in trading. Setting the right trading goals can help you to avoid mistakes while trading forex, and can help you to become a professional FX trader.
Poor Risk Management
Risk and rewards go hand in hand in any market. The truth is that Forex beginners don't pay much attention to this. Risk management is an essential part that will define your success in trading Forex. You cannot expect to make profits by blindly following a trading strategy, or by soley using an expert advisor, or an automated trading solution. When you manage your risk effectively, achieving rewards becomes a reality, and not just a possibility.
Risk only the capital you can afford to lose, and nothing more. Believe it or not, there are numerous Forex beginners who trade with capital that they cannot afford to lose. This can be disastrous because the Forex markets, just like most other markets, such as equities or fixed income, are notoriously risky. There are no guarantees that you will always make money. Losses in trading are part and parcel of Forex trading. There is also additional pressure when you trade with money that you cannot afford to lose. It prompts you to make wrongful trading decisions, so try to avoid this if possible.
Ignoring the Psychological Aspect of Trading
Another mistake for traders is to ignore the psychological aspect that plays a part in trading. Psychology plays a big role in terms of avoiding making mistakes in trading Forex. The markets are after all, made up of traders just like you for the most part. Understanding market psychology and yourself is a good starting point in recognizing this mistake. You might already know that fear and greed are two of the most common psychological emotions that can affect your trading. To avoid this, you must not only train your mind, but you should also approach the markets objectively.
Studying, researching, planning, following your trading plans, taking notes of your progress, and doing all of that while protecting your investments, are some of the best steps you can take to avoid making Forex mistakes. Not following these simple techniques is the biggest mistake Forex traders can make. It goes without saying that you should practice as much as possible, before you implement your strategies.
Luckily, Admiral Markets offers a risk-free demo trading account that enables you to do just that! Trade with virtual funds and real-time data, in a risk-free trading environment, so that you can test out your techniques and perfect them, before making your transition to the live markets.
This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.