Learn Forex Trading Lesson 14 – Avoiding Failure

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In the last tutorial, we looked at how to start developing a strategy.   But before we get too carried away, because we want you to be in the top 2% of successful traders, it will be a good idea to examine some of the pitfalls that the other 98% fall into at the first hurdle

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Poor account management. As one of the most accessible markets in the world, the barriers for entry to forex trading are falling all the time.   Currency traders, unlike equity traders, can open an account with little initial investment and open positions all day long, therefore the opportunity, and temptation, to jump in with both feet is always sitting on the inexperienced traders shoulder. This lack of discipline can soon lead to a dwindling account balance as panic sets in and loss follows loss.

Heavy leverage and low margins. The naivity of the inexperienced trader often leads to the setting of unrealistic goals, particularly trying to make more from a trading position than they should. Trying to make enough money to retire on from your first trade, whilst rather an extreme example, is nonetheless a good analogy of what members of the 98% try to do. Dreams that a small account can be transformed into a six-figure treasure chest will only result in over-leveraging the assets you hold and a depleted trading account will soon follow. There is no problem starting with low start-up capital. You will still go through the same learning curve whether you have £500 or £500,000, therefore it is best to acknowledge these limitations and learn without risking to much of your start-up capital. Over leveraging is a big danger that is exaggerated in forex markets and it is one that traders need to be aware of or end up taking an “early bath”.

Inflexibility. When losses start to occur, the inexperienced trader can all too easily become irrational.   In the trader’s mind the market is expected to behave in a certain way and and so their trades should be successful.   Unfortunately the market doesn’t see it that way and it doesn’t care which latest trend you are following, which trendline you are buying into or which economic release you consider most influential.  The successful trader realises that it is important to adapt to changes in market activity, base decisions on probabilities and leave emotion out of the ‘workplace’.

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So how do we start to avert these pitfalls? This is where we take a look at pre-defined parameters that we can use to control our trade.   By ”parameters” we  need to talk about three levels: the trade entry, the stop loss and the profit target.

  • The Trade Entry: This is where, as a trader, we decide to put money into the market based upon some rational that we have formualted from our predictions. As we are focussing on technical analysis, this will typically originate from a chart formation (candlesticks etc).   It could also originate from an economic release, or both. This is our indicator that we can expect prices to move up or down. Without this basic decsion making criteria, we might as well toss a coin to see whether we enter the trade on not.
  • The Profit Target: When all goes well for the trader, we will be looking for signs to support a decision to close out a trade because you no longer expect prices to make any further gains.   As a technical trader, we wil be keeping our eye on the charts to identify a key support or resistance level is imminent. Other indicators might include the formation of a contrarian chart or the discontinuation of a trend line.  For fundamental traders, the consensus in the market may have been changed by the latest release of an economic report, which might be indicator that you are looking for.
  • The Stop Loss: This is a key parameter and one that, as a trader, we must define will logic and stick to!  Unfortunately, we have to accept that losses will occur, and sometimes we have to concede defeat.   But we may have to lose a battle to win the war.   The stop loss is the price at which we ‘bail out’  of the trade.   As a new trader, this will be one of the hardest aspects of trading to accept. However it is absolutely essential to define and execute correctly, because without a stop loss, assets will disappear rapidly.

Once these parameters are identified, they need to be respected faithfully.  A common mistake occurs when new traders move their stop losses if they are close to being hit.  The net effect is to allow your losses to run, which ruins your risk to reward ratio and will eventually deplete your trading account.  The root cause of this is the inability to differentiate between short-term gambling and long-term-investment.   Ah…. remember our mantra….The Long Term :-)

In conclusion, some final points to consider in avoiding failure.

  • Talk to other traders in the forex community in forums on the Internet. Very likely, they will have already made the obvious mistakes and they will be able to help you avoid some, if not all, of the difficulties you will otherwise encounter.   There are any people who have been where you are now and will be more than happy to offer the wisdom of their experience.
  • Risk and money management is a critical element of your trading arsenal, just as important as monitoring techinical charts or economic releases. Why? At the end of the day, this is the only measure of success…. what is happening to your trading account in terms of risk and exposure. Develop rules and stick to them!   In this way you won’t take on bigger risks than your account can handle and achieve realistic gains.

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