Join one day the stressful world of the forex market and you will soon understand that this is an information jungle in which it is very difficult to navigate in. Under a constant pressure to increase short-term returns, many traders, especially beginners make mistakes that leave them most often at the edge. In this article we will discuss the three most common mistakes a beginner should try to avoid. To survive long term, arm yourself with an adequate knowledge of the forex market to avoid wasting valuable time and finally seeing all your savings go up in smoke.
I suggest you go through three errors that seem to be most common when someone starts in forex trading.
First Mistake: Responding Too Soon on Financial News
You're excited because you spotted today an economic event that will influence the market and create high volatility. Either you have your own idea on what will happen, so you stand before the release of the figures, or you know nothing but that doesn't keep you from remaining glued to the screen, ready to draw conclusions the slightest fluctuation.
In the Forex market, economic news often causes whiplashes. Significant fluctuations can occur due to twists, undervalued reports, or simply an inaccurate perception of the situation. A lack of liquidity and management plan febrile capital leaves many traders with significant losses once it appears that the news should have been dealt with in a different way.
The slightly smarter traders take a step back and wait a clearer picture of the market situation. They remain calm, follow their management plan, responding rationally. Rather than taking your pulse, first allow a stable trend emerge. Before the first movement, make sure you have a solid business plan. This will allow you to minimize the risks by controlling and reducing the exposure of your capital in strong inversion.
Second Mistake: The Average Down
Almost all traders get to know one day or another the average down. This is a very sensitive technique that can be used effectively by experienced traders, but the beginner can quickly get into trouble by applying it.
To put it simply imagine the following situation:
- You buy EUR / USD at price X because you think the price will go up soon. - Gold continues to drop but you are convinced that it will soon go up. - Suddenly you still buy EUR / USD at a lower price to your starting X price, just to make more profit when prices will begin to rise. - By doing this you can further reduce your overall average purchase.
Unfortunately the market trend that you had anticipated did not occur, so you have to undergo a loss that could have been avoided very easily.
This kind of scenario is very common and many traders sooner or later are faced with this situation. However, averaging down, is valuable time lost and unnecessary resources put on a losing trade.
Firstly, your time would be better placed in positions with greater financial viability and prospects for long-term gain.
Second, it is difficult to replace the "invested" capital in what is essentially a sinking boat. For any capital spend, the adequate profit needs to be made in order to achieve a healthy balance. By injecting money to save a losing position, you cripple your overall capital growth.
While some may argue that many average downs were successful for most traders the final result often ended in a loss. Trends last longer than traders' liquidity and particularly traders whose horizon is very short. So the first rule is to avoid wasting your resources via average down.
Third Mistake: Risking large sums of money
Investing all your capital on one position does not mean that you will increase your chances of becoming profitable. Almost all traders who risked large sums on specific positions ended up losing. If I had to summarize this form of trading activity I would say it is more or less bad risk management. Hotheads do not last long in the forex market, or in any other investing forms of business.
A general rule shared by many traders, says that no more than 1% of your capital must be invested in a single position. This percent is to be understood in the context of the difference between the input value (position) and the output level.
Here's a management rule that you can follow in order to avoid excessive exposure of your funds:
- For a day's trading risk a maximum of 1% of your average daily profit in a month
This will help you avoid putting your capital at severe risk with any of your transactions. Whatever losses may incur, they can easily be regained in a period of about a month, leaving you enough time to make up for the lost income.
To conclude we need to stress the fact that all these mistake occur in the absence of risk management. To avoid falling into these traps, make sure you always have an alternative and realistic plan that takes into account long-term growth. In the case of the average down, have an exit strategy and know when to cut your losses. Remember, trading is all about management and not some random betting card game.