Forex trading can be an exciting activity for anyone who has an interest in the financial markets. However, it comes with its risks, and it is a fact that more people end up losing money than profiting. A few mistakes can end up costing you real money, not just time and effort. For that reason, it’s worth taking a look at some of the most common mistakes that beginners make. Forex trading for beginners can be fraught with dangers, but by laying out examples of what you shouldn’t do, we can hopefully make the path ahead a little safer for you.
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1. Not having a plan
Forex can be a highly unpredictable market, that’s no secret to even some of the most novice traders. However, a lot of beginners make the mistake of believing that unpredictability means randomness. These beginners then go on to trade as randomly as they believe the market to be. Sometimes they win, sometimes they lose, but they never learn how to do either reliably. You have to learn to be able to react to the volatility of the market, not to give into it. So, how do you work your way through the seeming madness of it all? The first step is to have a trading plan. For instance, how are you going to cut your losses if the market suddenly moves against you? Have you set profit goals so you know to pull back when it moves in your favour?
What’s more, you should learn from the losses you’ve made in the past, as well. The best way to do that is to record them in a trade journal. The idea of keeping tabs on every single decision and trade you make may sound tedious, and that’s because it is. It takes effort, but you will notice moments where your psychology overrode your plan and you lost out because of it, or times where your plan didn’t work out, and therefore you can decide that it’s time to go back and change it up. Having a plan and being able to change it based on the results is a crucial talent in Forex trading.
2. Not having a stop-loss
A stop-loss is an order designed to stop you from losing too much money on any one trade. It is an essential part of Forex trading for beginners and the longer you go without it, the more you leave yourself open to risk. You should decide how much you’re willing to lose on any one trade and assign your stop-loss order. Just as importantly, you should avoid moving your stop-loss order just because your instincts tell you that one trade is going to eventually be a winner. Let the head rule the heart and be consistent. Otherwise, you could find yourself constantly moving-stop losses on a slippery slope until your actual losses grow to a disastrous size.
3. Averaging down and selling early
Learning about trading psychology shows that it’s not just a numbers game, it’s a game involving your own emotions and instincts. Nowhere is this clearer than in the very common mistake of averaging down. Although this error is more common in the trading of stocks and shares, we thought you should understand why it is a bad idea for beginner traders.
Averaging down is the practice of adding additional funds to a trade that you’ve already invested in at a lower rate than you initially purchased. You might do this because you think that you’ve already invested, so you may just as well invest more while it’s cheap and wait for the value to go back up. This is a sunk-cost fallacy, and you may be waiting a lot longer for your return, missing out on more profitable opportunities in the meantime. You might make back your money and even a little profit, but you’re not going to make back the time you wasted while you were waiting.
Inversely, novice traders tend to do the exact opposite when it comes to winning positions. They cut them off early, sell, and take profit as soon as they get a sniff of it. This is a very cautious manoeuvre and caution shouldn’t necessarily be warned against. However, you could be missing out on further profit by acting too early. It’s not as bad as averaging down, and you should never be too sad about making any profit. To avoid averaging down, make sure you have a stop-loss order and get used to the fact that you will be making small losses from time to time.
4. Not diversifying or over-diversifying
Overtrading is a very common mistake that exposes many beginners to too much risk. You might be trading too often in the market. By doing this, you are never insulating yourself from market risk and you might as well be trading randomly. Trade only when you think you have the advantage and make sure you always trade accordingly with your plan. But perhaps the larger risk is over-diversifying by trading too many positions at the one time. By trading too many positions, you are again leaving yourself open to market risk, and you are making it much harder to spot which positions actually work. You also increase your risk of trade duplication and overlapping positions which can effectively double your losses on a bad trade.
Just as big a mistake, however, is trading too much of your capital in one position and failing to diversify enough. If you risk large amounts of capital, you are going to lose in the long run because you have exposed yourself greatly to market risk. If you’re risking 2% or more on single trades, you are investing too much into them. Mitigate your risk by spreading out your capital a little more. The 2% maximum rule stops you from losing too much all at once when the market works against you. You should apply a 2% loss maximum strategy to the day’s trading as well, through the application of stop-loss orders. Finding the right balance between diversification and lack of exposure to market risk is crucial.
There are plenty more lessons to learn than just the typical mistakes made above. Forex trading for beginners is a long learning process, so make sure you’re doing plenty of research, taking advantage of demo accounts and learning the markets before you start depositing real money. Through your efforts, you can make Forex much less risky.
If you’re interested in learning more about the mistakes made by beginner traders and how to avoid them, register to attend one of our free award-winning Forex trading workshops.