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The Worst Mistakes to Avoid When Trading Forex

When someone tells you that trading Forex is easy and you can make tons of money with a few flicks of a finger, know that he is either a fool or a charlatan. Before anyone gets to become a successful Forex trader, he will take a lot of knocks and make plenty of mistakes because the learning curve here is as steep as it gets.

If you are new to trading, make peace with the fact that the Forex markets are full of pitfalls, but you can reduce the harm by avoiding the most common trading mistakes, which we have outlined in this article. It's as von Bismarck said, "Only a fool learns from his own mistakes. The wise man learns from the mistakes of others." Learn from these mistakes and let the profits be with you.      

Failing to establish proper risk management rules

There is a popular belief that trading Forex is no different from gambling - trading indeed bears enough similarities with betting on sports, playing poker, or casino games. For instance, most participants have only a faint knowledge of why a certain market would move south or north or why a certain team or an athlete might defeat an opponent. Also, both trading and gambling provide no guarantee of a positive outcome.

But the fundamental difference between the two lies in the fact that the risks associated with trading foreign currencies can be mitigated through money management - a skill, or art, if you will, of reducing the negative impact from wrongfully opening a position after which the market moves in the opposite direction, and scooping up the largest possible profit from the trade in case the market moves in concordance with your prediction. Simply speaking, when gambling, a player has little to no control over his bet once it has been made, whereas a currency speculator could keep a grip on the situation through risk (money) management. Therefore, the failure to learn and apply risk management is the first mistake to avoid when trading Forex.

These rules are necessary for both the good and the bad trades in order to be able to squeeze the maximum profits from the market while also protecting the balance against a "disobedient" currency pair and making sure that a couple of bad trades wouldn't annihilate all the gains made over an extended period of time.

A proper risk management system in Forex contains plenty of elements, all of which will be covered in this article. But it's important to remember that establishing the risk management rules needs to be done even before you get to elaborating a trading strategy. And most importantly, stick to those rules at all times, deviating from them only in the case of force majeure. This will not only keep your trading account from shrinking but also instill self-discipline, which is a crucial trait for a successful Forex trader. One can be a wizard of technical or fundamental analysis, but without the following risk management formula, his trading account would remain exposed to big losses due to unexpected market conditions.

The trading plan is key to success

Never trader Forex without first establishing a trading plan. Diving into the stormy waters of foreign currency trading without a plan is one of the most common Forex trading mistakes made by many nascent speculators who then see their trading accounts evaporate. We'll go into the intricacies of trading plan composition in the next section of the article, but it's important to note beforehand that, like with risk management, sticking to the plan at all times is a must for all those who want to be consistent at reaping profits from foreign currency trading.  

Calculate the risk/reward ratio

Always consider the risk/reward ratio before entering a position. Calculating this ratio isn't overly complicated, though many retail traders tend to overlook it, which usually leads to inconsistent trading and losses even when a trader has a decent percentage of winning trades.

For instance, you want to enter the GBP/USD market that is currently trading at 1.4500 and appears to be aiming to the upside. If the trader decides that he will take profit at 1.4650 while having the stop-loss placed at 1.4450, it means that he is looking for a profit of 150 pips while being prepared to risk 50 pips on a single trade, thus giving us the optimal risk/reward ratio of 3:1, which is considered to be the one that allows traders to maintain the consistently positive P&L.

Forex traders who routinely calculate this ratio notice that it forces them to be much more cautious and picky when sifting through the markets in search of an interesting play. With such a meticulous approach, you might miss out on some immediate profit-making opportunities, but it will pay off handsomely in the long run.          

Be mindful of leverage

Leverage risk is another factor that has to be taken into account if you use such an instrument as margin trading that provides means for significantly expanding the asset base and generating greater returns. However, we caution the inexperienced traders against getting involved in margin trading too soon because doing it wrong would be the fatal Forex mistake that could even decimate the trading account and leave you in huge debt if the margin call happens. But if you feel certain about your ability to trade with leverage, then it would be wise to start small; for example, go for the leverage ratio of no more than 1:5.

Liquidity matters

Also, when devising the risk management framework, you need to consider the liquidity risks in different markets. The higher the liquidity, the easier it would be to buy or sell a currency on demand. The major Forex pairs like EUR/USD have excessive liquidity, which translates to smoother price action and faster trade execution.

Small liquidity, on the other hand, could result in a significant execution delay, meaning that a currency won't be sold at the expected price that will lead to reduced profits or even losses. Moreover, when trading some exotic Forex pair with low liquidity, you won't be able to offload large positions without triggering unnecessary price fluctuations. Therefore, in order to avoid making this mistake, try sticking to the major currency pairs like the mentioned EUR/USD, and also GBP/USD, USD/JPY, USD/CHF, and other markets with very high liquidity so that the trades would be executed in a timely fashion.          

Elaborating on the trading plan

Many Forex traders, especially those who have just stepped into the game, tend to disregard the necessity to devise a trading plan before making a move in the selected market, which constitutes probably the biggest Forex trading mistake of all. It's essential to treat the process of buying/selling foreign currencies as if it's a real business. Otherwise, it would be nothing more than gambling with its rash decisions, occasional profits accompanied by consistent losses, all of which would happen due to a lack of structured approach.

Remember what every entrepreneur does before launching either a brick-and-mortar or an online business? First, he lays out a business plan that highlights the set of actions that has to be undertaken in order to start reaping profits. So, if Forex trading is a business, one would, logically, need a trading plan. Without one, a trader will be doomed for failure, if not immediately then within the next couple of years. According to the statistics, more than 80% of those who ignore the plan or fail to stick to it at all times are quitting Forex within a year because they suffer unbearable losses. There isn't a universal formula for the preparation of a trading plan, mainly because a good plan tends to be highly personalized in order to fit a particular trading style, but we will highlight the main points that have to be taken into consideration.

First off, you need to establish your strong points as a Forex trader and use them as the foundation for a viable trading plan. Are you a swing or a positional trader? Which time frame do you prefer? Do you have any edge over the crowd? Ask yourself these questions and start building on that.

Next, you have to determine the level of risk that you are willing to take on any given trade. We will delve into that topic later in the article, but the rule of thumb is to risk no more than 5% (or even 2%) of your total account on a single trade. Set this bar, and don't jump over it regardless of what the market brings you.

Develop a set of entry rules that will determine when and where you'd be entering the Forex market that is about to make a move. These rules can be based on candlestick patterns, indicators, moving averages, or even trading signals or tips, whichever has proven its efficiency to you during the period of paper trading.

But when it comes to entry rules, it's important to avoid setting too many conditions because that would create a lot of confusion and leave you feeling stuck and not being able to take a position. Keep it on a simpler side but make sure to always monitor the efficiency of your entries and adjust the conditions if necessary. The strict adherence to entry rules could force you to miss some immediate opportunities, but you will see the benefits in the long run.

Naturally, you'd need to have the exit rules in place in order to be able to reap the profits before the market starts going in the opposite direction. In fact, not knowing where to exit constitutes a bigger problem for Forex traders than entering a position, and that's where the properly calculated risk/reward ratio comes in handy. Exit rules apply not only to winning but also to losing trades, because not knowing, or not having enough courage, to "bail out" when the market goes the wrong way is yet another Forex mistake to avoid. Cutting off losing trades without remorse is the foundation of risk management on Forex, so don't ignore it in your trading plan. It's better to lose 50 pips and move on than risk losing 100 or more pips and be forced to hold the bag indefinitely.        

Don't get caught in the FOMO

FOMO stands for "fear of missing out," an emotion that the overwhelming majority of Forex traders experience at a certain point in their careers. Interestingly, numerous studies have shown that millennials are the ones that suffer from FOMO the most, with 69% of traders out of this age group actually ignoring their trading plans when the opportunity to make a quick profit presents itself, especially if it arises in highly volatile markets that can move a few dozen pips in a short period of time. You can get lucky and catch the tail of a big move, but more often than not, getting cut in FOMO leads to losses after the market turns the other way abruptly.

Falling for FOMO is more of a psychological mistake that Forex traders make even if they have years of experience under the belt. It can be triggered by some news and rumors that start circling around Forex communities and social media, the latter being the most dangerous of all because it could easily create an illusion that everyone has already jumped onto the "profit wagon" while you are being left biting the dust. When it comes to the fear of missing out, letting the social and news media influence your mental state and decision-making capability is probably the biggest mistake a disciplined trader can make.

Traders often fall into this trap when they get on a prolonged winning streak when it seems that you have developed the Midas touch that turns every entry into profits. Such a clouded judgment forms a direct path to huge mistakes that would humble even the most successful Forex trader. At the same time, repetitive losses might also lead to the case of FOMO because a trader would be desperately looking for a win, even if it means taking higher risks than determined in the trading plan.

Avoiding the deceitful FOMO is simple in theory: just don't enter the market that had already made a huge breakout past the resistance level and got stretched to the visible extreme. Remember that there is always another day, another market, and another opportunity to enter the position. Shut down your emotions, turn off the greed and let the rally run its course, and enter when the market goes into a retracement. But if you do have an itch that needs to be scratched, feel free to do some FOMO-ing, but only with an amount that you are willing to lose for good. But better stay calm and collective while looking to enter a play on the basis of your analysis and trading plan, not the hot topic on Twitter.      

Concentrating on small time frames

Picking the right time frame could be a tricky task for a newcomer who hasn't figured out his trading style yet. The majority of rookie speculators are too impatient to trade on the daily or even 12-hour time frame because they are eager for action and quick profits. That is why they are jumping straight to the 5-minute or even 1-minute chart where the price action changes direction very frequently. And that's what makes one of the biggest, but also easily avoidable, mistakes when trading Forex.

The thing is that in order to be profitable on small time frames, you should have a profound experience in scalping, which is the most demanding trading style since it requires a lot of mental stamina to execute dozens of trades per day while having to calculate the risk/reward ratio, the spread, position size, and also read the tape, all in a matter of minutes while the price movement is still brewing. That requires a lot of competence and discipline, something that novice traders lack, which leads to making huge mistakes due to being fooled by the noise that saturates these time frames.

Therefore, diving straight into small time frames can be considered a costly mistake that will lead to a loss of a certain percentage of the account until you figure out the trading style that suits you. Besides, if you only have a few hundred dollars on the trading account, it would be totally wrongful to trade Forex on small time frames because, with such a small size, your potential profits would be minuscule while the spread and the fees would constantly be nibbling at your capital. But even if you have tens of thousands of USD to your name, chasing quick profits without knowledge and experience would pave the road to a disaster.  

The rule of thumb here is to start on the highest available time frame - usually, it's the monthly one - and work your way down to the 15-minute time frame, setting the levels of support and resistance and highlighting any interesting patterns along the way. Make a daily time frame a central axis of your trading activity and check with it regularly. If you still want to feel the thrill of day trading, opt for a 15-minute time frame where you will encounter less noise. But an hourly or a 4-hour time frame should be the prime choice if you want to avoid making mistakes on Forex.   

Relying too much on trading signals

The idea of trading foreign currencies using Forex signals that can be provided by a broker or by an online service might seem like a lucrative one for beginner Forex traders who don't have enough confidence or knowledge to execute their own decisions. You can handle some other errands or just relax and engage in trading only upon receiving a "signal" - a special message sent via push notification or social media alert (Telegram is a popular place where you can find groups that provide signals for a paid subscription). And while the concept of such signals isn't bad in itself: professional traders sharing insight in exchange for a moderate fee, contributing to the good of the entire trading community, the reality turns out to be quite the opposite.

We have conducted a study where we analyzed 1000 Forex signals received from different brokers and groups - some of them were established and well-advertised, others were little-known and close to being shady. The success rate of signals received from reputable sources stood at 58%, which is not that bad of a result percentage-wise. At the same time, the win rate of trading alerts that came from less transparent platforms barely reached 46%, which would have put your account downright in the red if you were to follow their signals blindly.

But stats aside, there is also a psychological aspect that has to be taken into consideration. Relying solely on signals is detrimental to your confidence as a Forex trader because trading is, first and foremost, about your ability to carry out an in-depth analysis of things like price action, financial reports, the geopolitical situation, changes in interest rates, and then executing your own research-based decisions.

Once you have acquired sufficient knowledge of the markets, you also form confidence in your plan of action. So that when the market takes a wrong turn at some point, you would have more certainty that it would bounce back and continue the way you have foreseen, and the trade that seemed like a loser at first would reward in full later. Whereas making entries or exits on the basis of signals is likely to lead to uncharted waters of which you have no knowledge and plan of action. And this is the recipe for disaster because the trading activity is likely to become erratic if the entry turns sour, and you wouldn't know whether to hold onto this position or cut the losses.

We could offer dozens of examples of both good and bad outcomes of signal-based Forex trading, but the bottom line is that signals can be used as an additional confirmation for a trade that has already been brewing in your head. You can also use signals to scout for interesting markets, but diving head-first into trades just because the alert said BUY GBP/USD at 1.4003, is the most common mistake Forex traders make.    

Adding to a losing position

Forex traders sometimes confuse the method called averaging down the trade entry with adding to trade size. The former refers to the practice that involves hedging an open position for the purpose of adjusting the point of entry into a trade. Adding to trade, on the other hand, means providing more weight to the current position that can be either a losing or a winning one.

Adding to a losing trade is considered to be one of the worst Forex trading mistakes when performed by an inexperienced trader who didn't master the risk management discipline. So, don't think of these two methods as the same because adding to a loser usually goes after averaging down goes wrong. You can supplement the losing trade by utilizing the rented orders, by fixing a single position, or by using the Martingale approach. But we won't go further into detail about each of those methods because we consider these techniques to be extremely risky even for seasoned traders, and applying them wrongfully is surely among the costliest mistakes Forex traders make throughout their careers.

But the worst thing that the habit of adding to a loser does to a fledgling trader is that it pushes the buttons that trigger all those harmful emotions and desires like hope that the market will soon reverse and go in the right direction, which then gets superseded by frustration when seeing that instead of expected recovery, the market keeps on heading in the opposite direction while your losses get exponential. And if you are trading with leverage, then your whole balance will be in real jeopardy. Instead of making the Forex trading mistake of scaling into a losing position just because you nurture the hope that the market will move in your favor soon, you should cut the loser and exit the trade as soon as you realize that the drawdown from the movement in the wrong direction would exceed the afforded risk and threaten your deposit.

Not keeping your trading journal meticulously enough

We can't stress enough the importance of keeping the logbooks in a meticulous manner - it's one of the most important aspects of being a successful Forex trader. If you fail to adhere to this requirement, then you are most certainly on the way to having erratic performance and the evaporation of your deposit. When the trading journal doesn't reflect all activities that you have undertaken and the results of your decisions, it is particularly hard to identify and analyze the negative trading results that might have formed into a pattern, which is usually the sign that the trading system has stopped working and generating profits, so there is a dire need to adjust it in accordance with the present market conditions.

Basically, not keeping a trading journal means that you are simply gambling, which is the biggest mistake a Forex trader can make. Remember that in order for the logbook to be as detailed as possible, it has to have all of the following items: the reason for taking a long or a short position in a certain market; the exact time of entry in the market, and the price at which it was made; the established risk/reward ratio; the position size; the price levels at which the stop-loss was placed; the precise duration of the trade; the reasons for exiting the position; the amount of money made or lost on a particular trade, plus the commission and the spread. You may also add some notes that reflect your fundamental analysis and motivation for trading a given currency pair and the general observations of the market.

And don't forget to add screenshots that depict the entire move from entry to exit. Once the trade is closed, you need to carry out a thorough analysis of all things done right and wrong: perhaps, you could have added to the trade size or exited when the market was clearly overheated and not when it already began to retrace. Without the trading journal, you won't be able to reflect on your performance properly, learn from your mistakes, and evolve as the Forex trader.   

Overtrading and position sizing

Overtrading is definitely the scourge of nearly all beginner Forex traders who literally get hooked on the thrill of price action. They think that buying and selling foreign currencies more often will result in larger profits and better overall performance, and that's when they are making a huge mistake because, in this business, frequent moves in and out of the market rarely results in a consistently positive performance, unless you are a professional scalper, which is the whole another matter.

Some trading firms establish specific rules concerning the number of deals that traders can make during the day - getting above that threshold usually leads to traders' decisions becoming counterproductive. But when it comes to independent Forex traders, the situation usually gets far worse because there is no one to look over their shoulders and warn when the trading activity becomes dangerously excessive.

The simple reason why overtrading is considered a serious mistake when trading Forex is that out of all those trades, only about a half (usually far less) would be winners - the statistic shows that the percentage of profitable trades tend to decrease after a certain period of time mainly because the mental fatigue impacts the decision-making and makes traders impatient and eager to lock the profits too soon or add to a losing position which, as we have already explained, constitutes another mistake that might have disastrous consequences for your trading account. Once the losers start to pile up, the profits will get diluted by the cost of commissions and spread, especially if by the end of the day the trader gets engaged in the so-called "shotgun trading" that involves buying impulsively all markets that contain even a slight hint at profits without doing sufficient research and analyzing the disposition of forces on the market.

In order to prevent overtrading, you need to exercise strict discipline, adhere to the trading plan, and apply risk management rules, explained above. Another thing that suffers during the episodes of overtrading is the ability to adequately determine the position size for each of those multiple trades, often going above the recommended 1% - 2% of the deposit, thus deviating from the trading plan and creating conditions for uncontrolled losses.          

Neglecting the stop loss

Stop loss is the special type of order that implies exiting the trade some pips below the price at which the position was opened in order to avoid further losses, should a market move in the wrong direction. Perhaps there is no need to say that trading without stop loss, or with the so-called mental stop loss, is a critical mistake that every disciplined Forex trader must avoid.

However, there are also many nuances when it comes to the stop loss placement, not knowing which will result in bad trades. Putting the stop too tight to the entry point is the most common mistake that even seasoned traders often make.

For that reason, always take into account the pair's volatility and leave the market some breathing space. Also, remember that it's better to estimate the breadth of stop loss before assessing the percentage of the deposit that you are willing to risk on a single trade and calculating the position size. A lot of Forex traders do the opposite and let the position size determine the distance to the stop loss. And please, never make the mistake of positioning a stop right on the support or resistance levels - that is a childish error for which the Forex market will punish you soon enough. 

Being afraid to cut the losers

The ability to accept losses is an integral part of Forex trader's psychology, a norm if you will, because even the most prominent foreign currency speculators with a great track record get their trades wrong all the time. The difference between them and the amateurs that are destined to lose money lies in the fact that pros are capable of recognizing a bad trade at the early stage of its development and cutting it off without any remorse. However, this state of mind is achieved through great effort because ordinary people are wired to avoid the losses at all costs, especially if it concerns money.

Being afraid to lose some percent of the deposit is totally counterproductive for a Forex trader because, in that case, he or she will make another dangerous mistake of holding onto a losing trade or even trying to add to a losing position. Once again, clinging on a losing trade has a lot to do with the hope that the market would eventually reverse in your favor, and as we have already noticed, both the hope and the delusion that you can control the market, or the market oughts to do something, are some of the costliest mistakes in Forex trading. So, turn off the emotions, abandon the hope, and cut off the losers mercilessly.  

Author: Alex Paulson for Forex-Ratings.com


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