Top Reasons Why Forex Traders Lose Money
The forex market is often referred to as ‘the market that never sleeps.’ The reason is that it’s always open in some part of the world. When the clock strikes the midnight hour in New York, Tokyo is about to reach lunch hour, and while Sydney is winding up for the day, London is waking up to another day of energetic trading. That’s one of the reasons for the popularity of the forex market, which witnesses an average $5.1 trillion in currency exchanged every day.
The forex market offers flexibility, transparency and low transaction costs. And, of course, it offers several attractive trading opportunities daily. But the market that never sleeps can also give traders sleepless nights. While there are many advantages of trading forex, one needs to be aware of the pitfalls. Successful traders are those who understand the risks, make trading decisions after close consideration of these risks and have sound risk management strategies in place.
So, here’s a look at the most common mistakes made by forex traders, which can result in them losing money. And, how you can avoid making these mistakes.
Top Mistakes That Can Lead to Losses in Forex Trading
Lack of Knowledge
Some traders jump into the fray without any understanding of how the market works and what the key components are. Remember, your gut-feeling or luck may have helped you in the past, but these cannot be relied upon for stable payouts.
Forex trading is a skill. And, like any other skill, it can be acquired and honed. While trading in any asset class involves uncertainty, one can become better at predicting future market movements. The right set of skills, like reading charts, evaluating assets, understanding the impact of specific events and developing a suitable trading strategy, can go a long way in becoming a successful forex trader.
What You Can Do
Knowledge of the forex market can be broadly divided into two parts – theoretical knowledge and practical knowledge.
- To improve theoretical knowledge: Join a broker who offers diverse educational resources, including blogs, e-books, guides, tutorials and webinars. Also, read about experienced forex traders and their trading strategies.
- To improve practical knowledge: Open a demo account and get familiar with the platform, the elements on the charts and the market. Start trading with virtual money.
Starting with Low Capital
Many forex traders enter the market with the thought of making money quickly. This is an inaccurate assumption. It’s unlikely that you will make huge amounts of money within the first few trades you place. Forex trading needs some investment of money to be able to enjoy the possibility of attractive returns.
There are one of two things that happen to novice traders with limited capital. Either their trading account gets empty too soon and they leave forex trading, without giving themselves a fair chance to earn returns. Or, what’s worse, is they get tempted to overuse leverage without understanding how it works. With very high leverage, traders take on outsized risks even with a small amount of capital. This can lead to decision making based on emotions.
What You Can Do
Set aside an amount for trading and be prepared to invest this discovering your trading style and strategy. While you fund your trading account with sufficient money, avoid trading very large lot sizes. Doing so will not only lower mental pressure, but also improve your chances of long-term profitability.
No Risk Management
The importance of risk management in trading any financial instrument cannot be overstated. It is key to your very survival as a forex trader. It doesn’t matter how good you are in predicting market movements. With poor risk management, forex traders may find their funds wiped off with one unfavourable turn of the market.
What You Can Do
The two most important (and easy to use) risk management tools are:
- Stop-loss order: This is an order to execute a trade once the price reaches a specified level when the market moves against you. This is also known as the stop price. A stop-loss order is executed automatically when the market moves in an unfavorable direction. It prevents you from losing too much, without you having to constantly monitor the market and your open positions.
- Take profit order: This is an order to execute a trade once the price reaches a specified level when the market moves as you predicted. A take profit order is executed automatically and enables you to lock-in profits before the market reverses. By setting take profit orders, you book profits without having to constantly monitor the market and your open positions. Moreover, it’s a more disciplined trading style and prevents traders from taking emotional decisions based on greed or over-optimism.
Other ways to lower risks are:
- Place a larger number of trades of smaller lot sizes rather than putting all your funds into one trade
- Do not risk more than 1% of your capital on a single trade
- Avoid overusing leverage while trading lower volumes
Not Having a Trading Plan
You’ve read enough about forex trading and even practiced on a demo account. Now you have your trading account funded. What’s next? It’s impossible to arrive at a destination without a plan of how to get there. Your plan will determine when to open positions. It will prevent you from going long on a currency that has been on an uptrend and seems to be peaking or going short on a currency that appears to have hit a bottom. Your plan will also determine when to exit a trade. Without a plan, traders often make random entry and exit decisions and, more importantly, cannot identify their mistakes and are unable to prevent repeating them in future.
What You Can Do
Your plan will be based on your trading style and personal goals as well as on techniques that you have gained confidence in. Remember to document the process, which will help you identify what works and avoid repeating mistakes.