Foreign exchange trading can be a very profitable business. However, like any type of business, every gain is associated with some degree of risk. And some of the risks associated with Forex come with the signal or the account itself. For example, below is a sample of a trader’s experience regarding his account:
“Because we had to move our little $1300 account to an ECN and there was an adverse strong move last night we got margin calls. The signal provider went from 409% gain to 426% gain with almost all winning positions but yet we lost 35% of our account. So I’m pretty bummed about that right now. The only thing I can do now to keep trading is to open a demo account to pull signals to and then use your trade copier to convert the trades to micro lot sizes for our account which can’t stay ECN any longer.”
And this wasn’t the end of the story. My friend shared with me this updated account report after another large drawdown. This was his main trading account starting with about $1300 at the beginning of the month of June. Can you imagine how hard of a lesson this is when it is someone’s main account and they do not have any money to be able to replenish the account. This trader was running into margin calls on his account all throughout these drawdowns.
This seems to be a pretty nasty event. However, this happens in real life, especially in the Forex trading world. The lesson you can glean from this experience is to test Forex signals to make sure your account can actually handle them. It is best to test them in real-time with small lot sizes.
There is another important lesson here and that is to be even more cautious than you think you should be when copying trades from an outside source. This is the account and signal provider (probably not available anymore) that he chose to follow for $20 per month. In the beginning everything seemed to be going great. Take a look at the amazingly steady performance of the system on a live account. Yes, there were drawdowns in the past, but they were manageable.
And this is what happened just days after he started subscribing to the provider. It completely destroyed his account, losing more than 85% and more than $1100 in just a few days. No one could have seen this coming and the signal provider surely did their best. But this is the nature of the type of grid style trading that they employed.
Leverage and Drawdowns:
There are a lot of real-world experiences which showcases mistakes humans usually make in Forex. One such mistake that even hedge funds make is not taking leverage and drawdowns into account. Leverage allows you to borrow funds from your Forex broker. For example, you have a $1000 with a 400:1 leverage. This means you can trade about $400,000 worth of currency positions. Leverage can maximize your potential profits AND your potential losses. The higher the leverage, the higher potential of betting higher amounts of money. As they call it, leverage is a double-edged sword. On the other hand, a drawdown is referred to as the decline after a peak of a particular capital (or amount of money). Drawdown is usually shown as a percentage between the peak and the decline’s trough.
A Simple Forex Mistake:
Here’s another example of a real-life Forex mistake:
“I bought EUR/USD for about 1 standard lot size and was waiting for it to go up. I had all the fundamentals right and the technical analysis right. Everything in the chart I was looking at was falling in the right place. I went away for 2 minutes or so in order to go to the bathroom. When I went back, EURUSD fell down by 15 points… That’s about $150… A big amount for my meager $2,000 account! Then, it hit me, I had to buy AUD/USD and not EUR/USD! I bought the wrong currency! Good Lord! That’s a real lesson for me.”
The lesson we can glean from this message boils down to mindfulness when it comes to trading, especially real-live accounts. Simple mistakes such as putting in the wrong position size, trading the wrong currency pair, and clicking buy instead of sell, can put a huge strain on your trading account. What if you had to buy EURUSD at 1 standard lot and you clicked sell with 10 standard lots? That would be a really huge loss for you.
The Almost Mythical Case of Bucket Shops
Bucket shops are brokers who take clients’ money but do not allow clients to trade with live market charts. Instead, they generate the charts manipulating them in ways that the client keeps losing money that goes in the broker’s pockets. The practices of these brokers have been frowned upon by almost anyone but the regulators of these financial institutions claim that there is nothing illegal about a bucket shop. They have no direct relations with the Forex market, and do not execute real transactions on the real market. All they do is create an illusion of trading operations whereas, in reality, they only make mutual bets around rate changes between a client-trader and themselves. Owing to the large rate of computer literacy and a variety of Forex brokers, the problem of bucket shops has greatly been reduced. But it is still important to pay attention to every detail when picking a broker to avoid getting played.
Other Reasons For Failing in Foreign Exchange Trading:
A lot of traders fail in the business and they don’t even get to stay for a year. But why do so many traders lose their hard-earned capital even before they beat the learning curve and stay profitable? Below is a list of the reasons why traders bite their tongue at a loss in Forex:
- Thinking In Terms of Gains Instead of Losses
Most traders get into a trading position thinking about how much they want to gain. But the truth is, in order to stay in the game longer you have to calculate how much you are willing to lose before taking a trading position.
In order to make this clear, let’s take an example. For example, you have a $10,000 and you are willing to risk 2%–which equals to $200—of your capital. You want to buy EURUSD at 1.1100 after the 20-day moving average crossed above the 100-day moving average. Note that this is for illustration purposes only, assuming that you have at least a 1:1 risk reward ratio.
- Indicate at which price point/ indicator signal you are going to close the position which goes against your favor.
o Taking the example in point, let’s say you will close the position if the moving average crossover takes an opposite position or if the price reaches 1.1090.
- Subtract this opposite price point from your trading position’s desired starting point. This indicates the number of pips you are willing to lose.
o So, subtract 1.1090 from 1.1100. This tells us that we are willing to lose 10 pips.
- If 1 point is equal to $10 for a standard lot size, calculate the appropriate lot size for your position.
o $200/ $10 = 20 points
o 20 points/10 points = 2
o Therefore, you are allowed 2 standard lot sizes for this trade.
You might just want to take a minute and re-read all of that to really take it in… I understand that this might sound complicated, especially for new Forex traders, but it’s actually becomes really simple with a 1-click trading tool like Trader On Chart.
- Not Watching The Market
If you are a short-term trader, you may have probably done this. You took a coffee break or you went to the restroom and the next thing you see in the monitor is a grueling loss of your account. Not taking a second-by-second view of your Forex trading position, especially if you’re fast, short-term trader can sweep up your trading account. Of course, this doesn’t happen with long-term traders. Medium-term and long-term traders have more time in their table as they hop in for longer-term trends instead of scalping for short-term gains.
- Inconsistency in Trading
Inconsistency can come in many forms. You can be inconsistent with your trading strategy and you can be inconsistent with your schedule for the business itself. Why is inconsistency a mistake for traders? Inconsistency in trading can be referred to as jumps in your schedule. For example, you can trade every single day for a whole week, stop for two weeks, and trade again for a whole week.
Inconsistency is mostly caused by a trader’s failure to make the profits he/she once projected or was hoping to have made by this time, the trader then slips into a time when he/she begins to lose faith in the forex market and begins to shift sight to other ventures failing to realize that every beginning is always harsh.
First of all, if you are inconsistently trading, you are not perfecting your craft and testing your craft in every single type of market condition you can possibly encounter when you trade daily in a demo or real account. Remember, habits can be developed and lost. This is the same as your skill in trading. Consistently practicing both your trading strategy and your trading discipline will help you develop the two.
- Using Your Emotions Instead Of Your Head
This is actually the mother of all reasons why traders fail. Successful traders tell you not to use emotions. You might read it in a book or two; however, you won’t realize it until you experience it in a live account (with real money in stake, of course).
For example, you might win in 3 consecutive rows. So, you get excited and you increased your lot size by 10 times. Then, you experienced a loss–large enough to sweep up your profits and a portion of your capital. Ouch! Then, you get mad. You try to get back at the market and make more trades. These trades are usually less informed as you get scrambling to gain what you have lost. And there goes your capital!
This is just an example. However, mind you, it really happens in real life. That’s why successful traders always want you to manage yourself and your emotions first before you start trading.
- Missing The Fundamentals
A good example can be seen below:
“I was trading GBP/USD and was scalping for 1-pip to 3-pip profits. This was my strategy ever since. All indicators including the ADX and the moving average ribbons were indicating a good short move. I was very into my monitor… I had to make sure I enter in the right price using the 1-minute charts. I started a short and then the trade move towards me by 2 pips. Now, my trade was breakeven…. Commission cost was now covered… I was waiting for a few seconds and then GBP/USD spiked up! Surprised, I scrambled to exit my position for a loss. Little did I know, the Non-Farm Payrolls data just released during the same minute.”
Most of the time, fundamental data thwart technical data. This is true in the world of Forex. If you are a short-term trader, you should still watch fundamental data, especially economic news that are up for release during the trading day. It is best to unload positions on currency pairs 2 hours before economic news are released. However, if you are into event trading you can rake up some profits before, during, and after the said economic news.
- Trading With No Strategy
This factor accounts for more than 80% of all the losses in the Forex market today. It is the failure to create a working risk management strategy that will keep you from losing too much by telling when a trade is too risky to enter and when a loss is too expensive for your capital. The rate of fluctuations in the pricing of currency pairs has always proven itself to be very risky. So, to keep you from being confused when it’s time to either open or close a position, a strategy is needed.
The forex market always rewards the patient trader. Trends take days and even weeks to develop. After some initial moments of slow movements, it tends to pick up pace and either fall or rise substantially. To catch these formations in their earliest moments, patience is the only trait a trader needs. A trader must not be quick to dismiss signals as false out of the fear of being wrong. History has shown that trading analysis are right more than 80% of the time, but the inability of a trader to wait out the motions that discourage his/her entry into the market has accounted for the failure to profit from their analysis; most traders enter a position and exit when he/ she starts to feel wrong about it because the numbers are not going the way they hoped–only for them to check the charts later and discover that they were right about the analysis but not patient enough to let the trend form.
- No Currency Pair Favorites
When trading the forex market it is important to have a few currency pairs you have the most familiarity with and when making a choice of currency pairs to trade, only practical reasons that affect the trader personally should be taken into consideration. It is quite surprising the way some traders choose a currency pair for making a trade based on patriotic, geographical and sentimental reasons. I have noticed that many traders from America, for example, trade the USD against EUR or GBP. Japanese, Canadians, British, Swiss and traders from many other parts of the world often make the same mistake of opting to trade their national currencies too. They trade it against other currencies even when these other currencies appear stronger and have a history of being the dominant currency, even against the currencies of specific neighbouring countries of any given geographical region.
The most basic purpose of participation in this business is not to show our patriotic feelings or support our country’s economy. The basic purpose of the business is to make profits. From the point of view of a speculative trader, the patriotically geographical approach to a choice of currency pairs for speculative operations on FOREX is neither rational nor justified. Choosing a currency pair for the following speculative transaction must be carried out with full attention given to certain laid down parameters, so patriotism and residence should never be seen as a determinant factor as trades based on emotions are just another recipe for failure.
Forex traders are prone to seek adventure. After all, if we wanted slow and steady capital appreciation on our money we would likely buy some CDs, government bonds or Treasury Bills. We wouldn’t go after the potential of making 100% per year on our money (and from a tool, like forex, that can lose 100% of your money in a year or even a day).
There is always a balance between potential gain and potential loss. Nothing is guaranteed in this business but perhaps the best tool that we have for getting past risk is a conservative approach to testing and then trading itself. Trade the smallest sizes possible if you’re going into something new. And of course, always keep to the oldest advice in the trading business, the disclaimer you see on almost every product you buy: “Trading forex is risky. Never trade with money you cannot afford to lose.” Yes, be willing to take risks, but the true pros in this business will take the most calculated risks possible.
So is it wrong to experiment with new things? Is it a bad idea to take a risk and try a signal provider that has excellent reviews? In so many ways it depends on how aggressively you trade it based upon your account size/equity. Margin can be a good thing in forex trading and allow for some nice gains, but it is also a very sharp double-edged sword when things start going against you.
Is this going to help you with your future forex endeavors?
Have you been trading too aggressively or been taking unnecessary risks with your trading account?
Post your comments below and share your experiences.