Let's consider the following statement. If it's true that the market can only go up or down over the long-term, then using the most basic 1:1 risk/reward ratio, there should be at least 50% of winners, shouldn't there? There isn't.
This article debates in favour of the notion that a trader is his own worst enemy, and that human error is at the root of most problems. In short, the main reason why Forex traders lose money is quite simple. It's the traders themselves.
Financial trading, including in the currency markets, requires long and detailed planning on multiple levels. Trading cannot commence without a trader's understanding of the market basics and an ongoing analysis of the ever changing market environment.
For those interested in investing and trading, read through the suggestions below and you should know how to avoid losing money in Forex trading.
Overtrading - either trading too big or too often - is the most common reason why Forex traders fail. Overtrading might be caused by unrealistically high profit goals, market addiction or insufficient capitalisation.
We will skip unrealistic expectations for now, as that concept will be covered later in the article. First, we will explore insufficient capitalisation.
Most traders know that it takes money to make money. One of Forex's biggest advantages is the availability of highly leveraged accounts. This means that traders with limited starting capital can still make substantial profits (or indeed losses) by speculating on the price of financial assets.
Whether a substantial investment base is achieved by the means of high leverage or high initial investment is practically irrelevant, providing a solid risk management strategy is in place.
The key here is to ensure the investment base is sufficient. Having sufficient money in a trading account improves a trader's chances long-term profitability significantly - and also lowers the psychological pressure that comes with trading.
As a result, traders risk smaller portions of the total investment per trade, while still accumulating reasonable profits.
So, how much capital is enough? Here is how to stop losing money in Forex trading due to improper account management.
The minimum Forex trading volume any broker can offer is 0.01 lot. This is also known as a micro lot and is equivalent to 1000 units of the base currency that is being traded. Of course a small trade size is not the only way to limit your risk. Beginners and experienced traders alike need to think carefully about the placement of stop-losses. As a general rule of thumb beginner traders should risk no more than 1% of their capital per trade.
For novice traders, trading with more capital than this increases the chances of making substantial losses.
Carefully balancing leverage whilst trading lower volumes is a good way to ensure that an account has enough capital for the long-term. For example, to place one micro lot trade for USD/EUR, risking no more than 1% of total capital, would only require a $250 investment on an account with 1:400 leverage. However, trading with higher leverage also increases the amount of capital that can be lost in a trade. In this example, overtrading an account with 1:400 leverage by one micro lot quadruples potential losses, compared to same trade being place on an account with 1:100 leverage.
Trading addiction is another reason why Forex traders tend to lose money. They do something institutional traders never do: chase the price.
Forex trading can bring a lot of excitement. With short-term trading intervals and volatile currency pairs, the market can be fast paced and cause an influx of adrenalin. It can also cause a huge amount of stress if the market moves in an unanticipated direction.
To avoid this scenario, traders need to enter the markets with a clear exit strategy if things aren't going their way. Chasing the price - which is effectively opening and closing trades with no plan - is the opposite of this approach, and can be more accurately described as gambling, rather than trading.
Unlike what some traders would like to believe, they have no control or influence over the market at all. On certain occasions there will be limits to how much can be drawn from the market. When these situations arise, smart traders will recognise that some moves are not worth taking, and that the risks associated with a particular trade are too high. This is the time to exit trading for the day and keep the account balance intact. The market will still be here tomorrow and new trading opportunities may arise.
The sooner a trader starts seeing patience as a strength rather than a weakness, the sooner they will make a higher percentage of winning trades. As paradoxical as it may seem, refusing to enter the market can sometimes the best way to be profitable as a Forex trader.
Assuming that one proven trading strategy is going to be enough to produce endless winning trades is another reason why Forex traders lose money.
Markets are not static. If they were, trading them would have been impossible. Because the markets are ever-changing, a trader has to develop an ability to track down these changes and adapt to any situation that may occur. The good news is that these market changes present not only new risks, but also new trading opportunities. A skilful trader values changes, instead of fearing them.
Among other things, a trader needs to familiarise himself with tracking average volatility following financial news releases, and being able to distinguish a trending market from a ranging market.
Market volatility can have a major impact on trading performance. Traders should know that market volatility can spread across hours, days, months and even years. Many trading strategies can be considered volatility dependent, with many producing less effective results in periods of unpredictability. So a trader must always make sure that the strategy he uses is consistent with volatility that exists in the present market conditions.
Financial news releases are also important to keep track of, even if a selected strategy is not based on fundamentals.
Monetary policy decisions, such as a change in interest rates, or even surprising economic data concerning unemployment or consumer confidence can shift sentiment in the trading community. As the market reacts to these events, there's an inevitable impact on supply and demand for respective currencies.
Lastly, the inability to distinguish trending markets from ranging markets, often results in traders applying the wrong trading tools at the wrong time.
Improper risk management is why Forex traders tend to lose money quickly.
It's not by chance that trading platforms are equipped with automatic take-profit and stop-loss mechanisms. Mastering them will significantly improve a trader's chances for success.
Traders not only need to know that these mechanisms exist, but also how to implement them properly in accordance with the market volatility levels predicted for the period and duration of a trade.
Keep in mind that a 'stop-loss to low' could liquidate what could have otherwise been a profitable position. At the same time, a 'take-profit to high' might not be reached due to a lack of volatility.
Paying attention to risk/reward ratios is also an important part of good risk management. The risk/reward ratio is simply a set measurement to help traders plan how much profit will be made should a trade progress as anticipated, or how much will be lost in case it doesn't. Consider this example. If your 'take-profit' is set at 100 pips and your stop-loss is at 50 pips, the risk/reward ratio is 2:1.
This also means that you will break-even at least every one out of three trades, providing they are profitable. Traders should always check these two variables in tandem to ensure they fit with profit goals.
How else do Forex traders lose money? Well, poor attitude and a failure to prepare for current market conditions certainly play their part.
It's highly recommended to treat financial trading as a form of business, simply because it is. Any serious business project needs a business plan. Similarly, a serious trader needs to invest time and effort into developing a thorough trading strategy.
As a bare minimum, a trading plan needs to consider optimum entry and exit points for trades, risk/reward ratios, along with money management rules.
There are two kinds of traders that come to the Forex market. The first are renegades from the stock and other financial markets. They move to Forex in search of better trading conditions, or just to diversify their investments.
The second are first time retail traders that have never traded in any financial markets before. Quite understandably, the first group tends to experience far more success in Forex trading because of their past experiences. They know the answers to the questions posed by novices, such as 'why do Forex traders fail?' and 'why do all traders fail?'.
Experienced traders usually have realistic expectations when it comes to profits. This mindset means that they refrain from chasing the price and bending the trading rules of their particular strategy - both of which are rarely advantageous.
Having realistic expectations also relieves some of the psychological pressure that comes with trading. Some inexperienced traders can get lost in their emotions during a losing trade, which leads to a spiral of poor decisions.
It's important for first time traders to remember that Forex is not a means to get rich quickly. As in any business or professional career there will be good and bad periods, along with risk and loss. By minimising market exposure per trade, a trader can have peace of mind that one losing trade should not compromise their overall performance over the long-term.
Understand that patience and consistency are your best allies. Traders don't need to make a small fortune in one or two big trades. This simply reinforces bad trading habits and can lead to substantial losses over time. Achieving positive compound results with smaller trades over many months and years is the best option.