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Avoiding the Top 4 FX Trading Mistakes

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Avoiding the Top 4 FX Trading Mistakes

Post by Sean on Fri Sep 19, 2008 8:20 pm

Over my tenure trading currencies, I've watched as traders have made the same mistakes over and over. The traders' names and faces change but the habits remain the same.

I don't want you to fall into the same trap. So today, I'm going to take you through the most common mistakes I see beginning traders make in the Forex market. Trust me: If you avoid just these few pitfalls, you'll be well ahead of the pack.


Open the Wrong Account and You're Dead in the Water...
Before You Place a Single Trade
First of all, one of the biggest mistakes I see beginning traders make is they open trading accounts that trade way too much leverage. Remember: In the Forex market, you define your leverage by the type of "lots" you trade.

So many novice traders try to open trading accounts with lot sizes that are way too large for their balance. And if they err to one side, they usually err to the aggressive side.

Chances are your broker won't tell you which account you should open. Most industry market makers will allow you open up any type of account, whether it will benefit you or not.
The Quickest Way to Blow Up Your Account
Next you have the traders who try to apply mutual fund trading rules to the highly leveraged Forex market. They try to average down, or do what some call "dollar cost averaging." That's a mistake.

Again, this is fine if you are in mutual funds for over five to 10 years but it simply doesn't work for currency trading.

Averaging a loser is a huge mistake. Many times the trade will continue in the losing direction that is unfavorable to your trade, for longer than your account balance can hold up. This is because now you are essentially over-leveraged.

Never average down on a trade. If you end up picking a losing position, don't add to your losses by adding to that losing position. That only works in theory - it definitely doesn't belong in real life currency trading. There's simply too much leverage in the currency market and the trends are too strong for that to work out in your favor.


While Day Trading Is Sexier, Swing Trading Is Smarter
The final mistake I see traders make is that they want to be a "day trader." However, there are very few successful novice day traders in the market. In fact, I've never met a single one in all my years in the currency markets.

Why is this? You need time for most trades to flow your way, and day traders do NOT have time. Add to this that they pay way too many fees (actually they pay the "spreads" as their fees) to their brokers, because they're trading so often. So your potential gain compared to the spread costs just doesn't add up over time.

What many traders should be doing is what's called "swing trading." When you're swing trading, you take positions over the course of days or weeks.
To recap: Keep in mind that it's better to have a decent trading strategy with great risk management than have a hugely successful strategy with sloppy risk management. You could be right 80% of the time OR MORE on each trade and still empty out your account because of poor risk management.

Take it from a guy who's been around for some time...and seen every trading mistake in the book.



However, here's some general guide lines that I've found will help you to open up your first trading account. In my opinion, you should only open a "standard account" if you plant to fund it with around US$50,000. If you're using your standard account, you should only trade one standard lot for every US$50,000. (One standard lot controls 100,000 units of currency).

In my opinion, traders should have at least US$5,000 to open a mini account. Of course, you can trade with less. But if you're planning to trade often, I suggest a US$5,000 mini account. Then only trade 1 mini lot per US$5,000 in your account. (One mini lot controls 10,000 units of currency).

Following the rules above will actually solve three problems at once:

1. It gets you into the proper account type from the beginning.
2. It ensures your account is well capitalized.
3. And it ensures you're trading with the right amount of lots for your account balance.

All three of those are huge components of risk management. Risk management is very important in Forex trading. In fact, I would say it's just as important as picking the next winning trade - because if you do pick winners, but fail to control your risks properly, you will still end up emptying out your account within months.


Why You Need to Use Stop Losses Properly
Next, make sure you use stops on every single one of your Forex trades.

I often hear traders talk about trading with no stops. The problem with this is you are risking 100% of your account, 100% of the time you are trading.

That's a recipe for disaster. I'd guess the majority of traders who trade without stops lose their entire account balances within months at best. If anything, these traders are just fooling themselves.

Then we have the trader who is so scared to lose a dime of his account, that he places the most rigid stop-losses imaginable. In fact, he places them so tight, that he's stopped out of almost any trade - before it can move in his favor - so he never makes any money anywhere.

Generally speaking, if you are setting stops any closer than 30-50 pips, you are almost certain to get stopped out. Currencies need "breathing room" within the trade. And if you don't let your trades "breathe," you'll be stopped out before your currency pair moves to an advantage.

There's an easy way to solve this stop-loss problem.

Once you use the proper lot size, you can afford to have generous stops that are 80-100 pips away. Even then, you are still risking only a small percentage of your account but you've still greatly increased your chances of success by giving the trade some breathing room.

Sean

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