FX markets can entice traders into committing irreversible mistakes...
Before taking a look at some of the common mistakes committed by FX traders, a quick summary of the FX markets-
- Forex markets are the largest traded financial instruments globally
- They are open for business 24/5, offering ample trading opportunities for participants
- Market participants comprise of Central banks, commercial and investment banks, hedge funds, corporations, non- banking forex companies, fund managers and retail traders
- The currencies with the highest volumes and largest participation are usually free- floating currencies, which can rise or fall to any extent on a given day
- Controlled currencies are constantly monitored and managed by the “Central Bank” of the respective country, leading to lower volumes & volatility compared to their free- floating counterparts
The role played by the foreign exchange or FX markets is manifold. Some of the most important ones are-
- Currency conversion
- International trade
Forex markets provide ample opportunities for traders to enter & exit trades. This is because countries have different time- zones and since forex trading is carried out over the counter by a network of computers and telephone lines, they can afford to remain open unlike centralized exchanges which have restricted trading hours. In spite of this, only a small percentage of traders remain consistently profitable.
Although trading psychology plays a very crucial part in determining a successful forex trader from the rest of the group, there are a few common mistakes that traders commit, some of which are highlighted below-
1. Investing life savings/ trading on borrowed cash-
“Invest only that part of the capital you’re willing to lose,” is a very practical maxim. A prudent trader wanting to test the forex markets should invest only that part of the capital that would not alter the existing lifestyle in the event of capital losses. Traders who invest their salaries/ savings or borrow money with the hope of earning a quick buck in the forex markets are making the biggest mistake of their lives.
2. Non- existence of a pre- defined exit strategy-
Be prepared with an exit strategy even before entering trades. Trying to find one in the midst of an existing trade or from a loss- making position could result in additional losses, more often than not.
3. Over- margining-
Forex brokers usually offer hefty leverage, often alluring traders to build large positions. Margining can be an effective tool with a number of advantages if used appropriately. However, over- margining can result in a trade being closed out even when it is incurring acceptable losses thereby leaving very little room for a strategy to perform efficiently.
4. Back- test results mean nothing-
There are a number of traders who assume they have an outstanding strategy since the back- test results have been overwhelming. Failure to comprehend and correct the gap between in- sample and out- sample results could be devastating.
Traders tend to hold on to profitable positions with the intention of squeezing in some more profits even after a well- tested trading system indicates a divergent view. Some of them open up trades in volatile markets with the intent of scalping a quick buck. Greed is not limited to a certain category of traders. This is something which even the most experienced traders go through frequently.
It can be a result of one or more of the above factors. Losing a part of your savings in the forex markets can definitely make any trader nervous. Without a good strategy in place, over- confidence in a strategy, exiting once profitable trades with losses due to the greed factor playing out can result in fear, adding extra gravity on an already stifled trader. The outcome is a panicky trader who will hesitate to even take on small risks while initiating trades and will eventually exit positions with scanty profits, losing out on large gains.
Although it is challenging to suggest a precise solution to avoid some of the common trading blunders and more importantly follow them, one way of keeping emotions in check would be to automate trades and monitor them from time to time. Most brokers have trading platforms that support automated trading, make the best use of them. Finally, plan your strategy before initiating trades, understand and resolve common mistakes by traders, step- up efforts to keep sentiments in check so that they don’t hinder with your trading principles.
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