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Monday, October 31, 2011

8 Things You're Doing Wrong in Your Forex Trading

So you’re new to forex? Or perhaps you’ve been trading for a while now and things just aren’t working out for you? Maybe you’re committing one of the errors below. Whatever you do, don’t be too hard on yourself. Many traders at one point make one (or all) of these mistakes.

Mistake 1: Risking too much

This is a mistake that all too many forex traders make. Sometimes people view the forex market as a get-rich-quick market and get burned as a result of it. With sensible risk management techniques, trading currency is great way to diversify your portfolio.
Professional traders recommend that you should not trade more than 2-5% of your equity per trade, and the max-draw-down (the absolute maximum amount you’ll let a trade lose) be no more than 5%. Invariably this limits your gains, but most importantly it limits your losses.
The fact is you’re going to have a bad trading day; it happens to the best of the best. But what separates the men from the boys is how they handle the bad days.
Don’t let a bad trading day be your last trading day.

Mistake 2: Improper risk-reward ratio

Did you know that you can have a losing trading strategy (meaning your strategy is wrong more often than it’s right) and still be profitable? In reality it seems that the inverse is more common: a winning forex trading strategy that is not profitable.
The culprit? Improper risk-reward ratios.
For example, assume you have a strategy that is right 80% of the time. Awesome, right? Well, if the average take profit is 15 points yet the stop loss is set at 75 points the strategy isn’t as awesome anymore.
Having good risk-reward ratios – letting your winners ride and cutting the losers early – just might turn an otherwise losing strategy into a winning strategy.

Mistake 3: Never admitting you’re wrong

Whenever you catch yourself saying, “It just can’t go any lower!” it’s time to step away from your trading. Don’t beat yourself up though; it’s human nature: we all hate being wrong and we hate cutting that losing trade.
Try this: instead of setting a normal stop loss when placing a trade, ask yourself, “at what point am I wrong?” This point might be market support or resistance, or when your indicator of choice reaches a certain point.
You might find that the point you are “wrong” isn’t as far away as what your stop loss would have been, meaning it could end up saving you a lot of pips.
Remember, the question is not, “how much am I willing to lose?”
The question should be, “when am I wrong?”

Mistake 4: Trading live before demo

Always, always, always! test your strategy out on a demo account first. Even if you’re implementing a winning trading strategy used by someone else you should still test it on a demo account.
When testing on a demo account, remember that back-testing is good but forward-testing on a demo account is best. Back-testing is great for getting a general idea of accuracy, but it can’t duplicate live market conditions nor evoke possible trader emotions (more on this later).
At a minimum you should forward-test a strategy for a few months. The longer the better.

Mistake 5: Too much leverage

The forex market is leveraged like no other market (which is one reason why forex is so popular). Many traders come to the forex market fantasizing about making huge gains overnight, but at the same time forget that they are more likely instead to sustain huge losses.
This leverage definitely can be used for good, but it requires first an intimate understanding of the effects of leverage and an absolute diligence with risk management: for leverage knows no mercy.
Leverage makes for larger profits, but also larger losses.

Mistake 6: Pulling trades out of thin air

We often think there are two different kinds of trades: buy and sell. But in reality there is a third kind that often gets neglected: hold. In other words, you can buy or sell, or you can do nothing.
Novice traders often think that they have to be trading in order to be profitable, and when their trading strategy isn’t giving any signals they go off looking for opportunities. More often than not, what happens is traders pull trading opportunities out of thin air and end up getting burned.
Raghee Horner said it best: Don’t look for reasons *to* trade; look for reasons *not* to trade. By having this mindset traders can (hopefully) prevent talking themselves into a bad trade and can (hopefully) look for possible reasons why a trade signal may not work out.
Sure, this cause you to not take some trades that would have ended up being profitable; but you might also find that you miss trades that would have ended up negative.

Mistake 7: Investing money you can’t afford to lose

No matter how good you think your trading strategy is, you should never invest money you can’t afford to lose. The saying “hope for the best, plan for the worst” definitely rings true here. What if your strategy had a horrible day? It happens. You may tell yourself that it’s extremely unlikely that such an event would happen to you, but don’t think for a second that it’s not possible (and if you’ve been trading the forex market long enough you know that the “extremely unlikely” just might happen sooner than later).
And if that happens will it affect your standard of living? Will your spouse want a divorce? If so, then you are investing money you can’t afford to lose.
Last, but definitely not least:

Mistake 8: Letting emotions control you

There is a theme to this article, that being that many of the pitfalls of trading are emotion-based. Emotions wanting us to risk it all; emotions wanting us to keep that losing trade in hopes that it willl become a winning trade; emotions rushing us to a live account instead of slowing down and testing on a demo account first; emotions wanting us to take that trade even though the signal isn’t that good.
Emotions may be the hardest thing for amateur traders to control, but the fact that it’s difficult highlights its importance.
One of the most important things you can do to combat emotions is to develop a well-rounded trading plan and stick to it. Having a trading plan can help you establish do’s and don’ts (i.e., do enter a trade when certain criteria is met, don’t let a losing trade lose more than 5%, etc.), thus helping to remove emotions that make us second-guess.
Another way to help you control emotions is to utilize fractional lot sizes available with all Interbank FX accounts. The emotions that come with trading are usually different between live and demo accounts, but traders can transition from demo to live by essentially trading cents. Even though you’re only dealing with nickels and dimes, the profit or loss is still real. And no matter how hard you try, that is not an emotion that can be duplicated with a demo account.
As discussed in Mistake #4, we recommend you start with a demo account, then transition to a live account by trading 0.01 lots and slowly work your way up to a proper risk level (as learned from Mistake #1).
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