The 11 Most Common Mistakes of a Trader are…

forex trading

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forex psychology

1. Not Having a Trade Plan…

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I have published several advisory services over the past 8 years and have had thousands of contacts with the new and very experienced traders. It truly amazes me that, trade after trade, that the most common “losing trader” approach is the same. A trader who thinks a market is about to go up will usually say something like ・i think the EUR/USD is going up to $1.2000. Where do you think I should buy it?・My response is usually something like, Well, what are you risking on the trade? In other words, where are you going to get out if you are wrong?・ Often there is silence, or perhaps a puzzled huh?・They never thought about being wrong, they never thought about where to put their stop. My next question — Well, if it does go up, how and where are you going to get out?・– often receives the same response.

Better than 90% of the Forex traders that I come in contact with have no trade plan. That means that they do not know what to do if they are wrong and they do not know what to do if they are right. The large paper profit they made often turns into a large loss because they did not know where to get out.

The most important move a Forex trader can make is to develop a trade plan, before they enter the trade, consisting of these guidelines.

  • Know how and where you are going to enter a the trade.
  • Know how much money you are going to risk on the trade.
  • Know how and where you are going to get out if you are wrong.
  • Know how and where you are going to take profits if you are right.
  • Know how much money you are going to make if you are right.
  • Have a protective stop loss in case the market does the unexpected.
  • Have an approximate idea of when a market should meet your objective; when it should begin to make a move, and if it has not done so, get out!

2. Not Having Money Management…

I am constantly amazed at how few Forex traders and brokers have no concept of money management. Money management is controlling your risk through the use of protective stops, while balancing your potential for profit against your potential for loss.

An example of poor money management I see almost daily… many traders refer to a trade that might lose them $500 if they are wrong and make them $1000 if they are right as a two-to-one risk/reward ratio. Yet, that is wrong because it is just as important to knowing proper win/loss ratio of knowing how much you are going to lose if you are wrong and how much you are going to make if you are right, but what are the odds of making money… of being right? What are your odds of losing money, or being wrong?

Good money management means you know your profit objective and the odds of being right or wrong, and controlling your risk with protective stops. You are better off with a trade where you might lose $1000 if you are wrong and make $500 if you are right, that would work eight times out of ten, than to take a trade where you would make $1000 if you are right and lose only $500 if you are wrong, but works only one time out of three. Obviously, this mistake can be overcome only by developing and testing money management concepts. An entire book could be written on money management principles… but the key is knowing your win percentages along with proper risk/reward ratios.

3. Not Using Protective Stop Loss Orders…

This fits right in with a trade plan and money management. It is the failure to use protective stop orders once you enter a trade ・not mental stops, but real stops that cannot be removed. All too often Forex traders use mental stops because in the past they have been stopped out and then watched the market move in their direction. This does not invalidate the use of protective stops, it means their stop was most likely in the wrong place as they did not have a good technical stop.

When a protective stop that was determined before you entered the trade is hit, it means your technical analysis was probably incorrect… your trade plan was wrong. With a mental stop, as soon as the market has gone through your protective stop price, you no longer act like a rational human being. Now, you are most likely to make decisions based on fear, greed and hope.

How many times have you had a mental stop then tried to make a decision whether or not to take a loss? Typically, by the time you make the decision, the market has run an extra $300 against you. You invariably decide to hold onto the trade hoping that you can get out on a Fibonacci retracement to your previous stop price. Unfortunately, in many cases I have seen, it never touches that price again and you take a huge loss. Or you make the mistake of holding the trade an extra day because you hoped it would go higher the next day. But the next day it is lower yet, and by then your loss is so large you can’t affordto get out ・and what should have been a small loss turned disastrous. There is an old saying that the first loss is the smallest. It is also the easiest to take, even though it may seem hard at the time.

The only way to overcome this mistake is to have an unbreakable rule (and the discipline to follow it!) that a protective stop loss order must be placed on every trade entered. I have found the easiest way to take a loss is to place the protective stop order the moment or immediately after entering the trade. Do your homework when the markets are closed or slow, and place your order while the market is still quiet. Another rule to follow; under no circumstances should an initial protective stop order be changed to increase your risk.. but only to reduce it.

4. Taking Small Profits and Letting Your Losses Run…

A very common mistake among Forex traders is taking small profits and letting losses run. This is often the result of not having a trade plan. After one or two losing trades, you are very likely to take a small profit on the next trade even though that trade could have turned into a large winner that would have offset all your losses. Letting your losses run often happens to new traders and is not uncommon among even professional Forex traders. After entering a trade, you don’t know where to get out. Once you start losing money on a particular trade, your tendency is to let your loss get larger and larger as you hope that the market will retrace to let you break even ・ which of course, it seldom does.

This mistake is overcome by using pre-determined protective stop loss orders to prevent your losses from running, and following your trade plan to take profits at your profit targets.

5. Overstaying Your Position…

One of the most common mistakes of trading currencies is overstaying your position, or simply failing to take profits at a predetermined level. There seems to be a natural law that the market is only going to allow one individual so much money before it starts to take it back. Yet, it is when you have these profits, especially real profits in your account, that you often try to get the last nickel out of a trade.

If the market meets your profit objective and you are still in the trade without an exit order, then you are overstaying your position… period! All too often the market breaks sharply through your mental stop・and from that price level, you watch your profits disappear before your eyes. Then you decide to hold onto the trade for a small rally, and the market never rallies enough. It drops back to break-even, and now you really begin to hope. Next thing you know you have a loss. Be aware that a large profit can turn into an even larger loss.

The only exception would be if price action is going strong in your direction. In this case, you can move your protective stop to your profit target or use a trailing stop.

6. Averaging a Loss…

This is usually a holdover from trading equities or futures. In Forex, with 50:1 or greater margin, averaging a loss can be disastrous to say the least. A typical approach is that after you have went long and it drops lower, you might figure that since it was a good buy then, it is a better buy now. You may justify averaging down by figuring you will have a lower average entry price and require a smaller move to break even. Unfortunately, you will lose twice as much if the market continues against you, as it almost always does.

There are approaches that will allow you to buy a market at one price level, add on at a lower level and add on again at even a lower level, as long as this was your predetermined game plan before you entered the trade initially. You must also have an unmovable protective stop loss order that takes you out of the entire position.

This mistake is easily overcome by having a strict rule that you never average a loss unless your predetermined trade plan called for averaging the trade in case the market moves against you… As long as you have a pending unmovable protective stop loss order to exit your entire position if it is hit.

7. Increasing Your Commitment with Success…

One of the most common mistakes I see with Forex traders is increasing of your risk exposure because you think you are on a winning or losing streak. Just by being successful on a few trades, you will risk more dollars per trade because you have more money. But, because you have more money (and confidence) when successful, you are also likely to take larger percentage risks. Not surprisingly, this ruins more Forex traders than a series of small losses.

You can overcome this mistake by not allowing your risk percentage to unreasonably increase as you realize profits and by maintaining your protective stop loss discipline. What I mean by unreasonably is this… on a typical trade, your risk should be 1-2.5% of your account size depending on trade confidence. As you see yourself on a winning streak, you are tempted to increase risk percentages. Never never increase your risk percentage more than 5% of your account balance on any one trade. In addition, I have seen the psychology of traders telling where they risk more after a losing streak and risk less on a winning streak thinking that after a string of winners, a loser has to come at any moment… Or, increasing their size after a string of losses thinking they have to have a winning trade now. Don’t fall into this thinking trap!

8. Over Trading Your Account…

Or risking too large a percentage of your account balance on any single trade, either with too large a dollar risk per contract or by trading too many contracts for any single trade or by trading too many currency pairs.

This also happens after a period of choppy consolidation when you know that the market is going to do something. You are so certain that this is going to be a really big move that you risk much more than the maximum 5% of your account balance. Already emotionally out of balance, all it takes is a couple of limit moves against you and you are bust.

To prevent this mistake from occurring, you must have a hard and fast rule that you can risk no more than a certain percentage of your account balance on any trade regardless of how good the trade looks.

9. Failure to Take Profits from Your Account…

It is almost a natural law that the Forex markets over a given period of time will allow you to make only so much money and then you are going to have to start giving some back. Yet, probably no more than 1% of all Forex traders I know have a rule to take profits out of their account. (But, they are quick to put money into their accounts as their accounts levels drop to untradeable levels). You can’t believe how often I see traders leaving profits in their accounts and go for the big trade・the one that will give them a real killing・ which usually kills their profits.

This can be overcome by predetermining an equity level at which you will remove profits from your account.

When you make profits in the Forex markets, take some money out and put it somewhere else. You, as all Forex traders, will move in cycles. You will make some, lose some, make some, lose some. By taking money out of your account when you are profitable, you will not make the mistake of losing larger amounts of money when a down cycle begins.

10. Changing the Trade Plan Mid-Trade…

During prime trading hours you are subject to emotional reactions of fear and greed much more than you are when the market is quiet. Have you ever noticed that when you sit down during the slow Asian session, you can very calmly figure out what you want to do during the often busy London session? Yet, shortly after the London session opens or when the market gets busy, you do exactly the opposite of what you had planned.

With rare exception, the best approach is to not change your trading strategy during prime trading hours unless there is a breaking news event or market reaction.

Overcome this mistake by developing your trade plan before busy market hours and having the discipline to not change your trade plan afterwards.

11. Not Having Patience

Trading for the excitement, not the profit.

The average life of a Forex trader is between five minutes and nine months. Not all Forex traders trade because they want to make money. Many trade because they want the action. Think about it – must you trade every day, or can you patiently wait for higher probability trades, even if it staying Flat for 2 to 3 days or even a week?

For those of you who wish to learn how to make money in the Forex markets, rest assured you can. However do not expect to make money in each and every trade. If you concentrate on not breaking the 11 Common Mistakes of Forex Traders, you have a greater probability of making money over a period of time.

Certainly you will have losing trades. Certainly the markets will do the unexpected and at times you will lose more than you expected; but if you steadfastly avoid making these mistakes you must make money.

Self-Discipline

It has been my experience in trading Forex and helping new and seasoned traders, that the greatest cause of losses is the absence of self-discipline. You need self-discipline to follow your trade plan; to be patient; to take losses… and profits! And, to practice sound money management.

Fear and Greed

With the tremendous leverage Forex trading offers, you are frequently exposed to the basic emotions of fear and greed. At certain times throughout your trading career these emotions can make you completely and absolutely irrational, oblivious to what is really happening. It can make you rely on hope; hope that the market will do what you want it to do because it “must”! Otherwise, you will lose all of your trading capital.

Danger of Success

Each time I made one of these 11 Mistakes, I promised myself that I would not repeat the same mistake, but as I was once again successful, as I made money, I invariably became overconfident, sloppy, and ・Dangerous・ You are most likely to make these same mistakes when you are making money, not losing it. After several losses, you naturally tighten your discipline and become more conservative, or lose your trading account. After several losses you are likely to lose the least amount of money on a trade.

Overconfidence

It is following a string of profitable trades that you are most likely to lose large amounts of money. If you began trading with a $5,000 account and limited yourself to a maximum 3% risk, you could lose a maximum of $150 per trade. With profits increasing your account to $10,000, you can now lose $300 per trade. Worse yet, flushed with success you are more prone to break your rules and Wait a day・ when you should have been stopped out.

When I was a new Forex trader, I found that some of my largest losses have occurred from my smallest positions. After making large profits, I let these small positions run into extremely large losses because I was overconfident.

Balance

Trading Forex is a game of psychology. It is a game of balance. Emotional extremes create an imbalance. In your quest to make money, you will make mistakes of greed. In your reluctance to take a loss, you will make mistakes of fear. The tremendous emotional release you will feel when you finally close out a large losing position is amazing… You will fight the market, yet know it will to go against you, but wanting it to go in you favour – hoping for it, worrying about it, praying for it. After a few hours or a few days of that, it will feel as though the weight of the world is taken off your shoulders when you finally take the loss.

Hope

One of the early signs that you have made a serious mistake is when you change your routine and begin to tell your spouse and friends the seasons・for the market to go your way. Or, polling the internet looking for those taking your same position, asking your Forex broker what he thinks you should do; hoping that some government action will bail you out. This is not Forex trading; it is hope. Hope is the most devastating of all emotions in trading the Forex markets because it can lull you into complacency. You know when you find yourself hoping, that you are wrong, and should immediately get out of the market, but it takes an unusual amount of self-discipline to take that very large loss.