Day trading in forex
10 Forex Day Trading Mistakes That Will Cost You
The forex market has very low barriers to entry, making it one of the most accessible day trading markets in the world. If you have a computer, an internet connection, and several hundred dollars, you can theoretically start day trading. Just because it is easy to start trading doesn't mean it is easy to make a profit, though. There are tons of pitfalls new forex day traders face. Here are 10 common mistakes you want to avoid, as these are the main reasons many new traders fail.
There are two trading statistics that you want to keep an especially close eye on. Your win-rate and risk/reward ratio.
Your win-rate is how many trades you win, expressed as a percentage. For example, if you win 60 trades out of 100, your win-rate is 60%. As a day trader, you will typically want to keep your win rate above 50%.
Your reward/risk ratio is how much you win relative to how much you lose on an average trade. If your average losing trades are $50 and your winning trades are $75, your reward/risk ratio is $75/$50=1.5. As a day trader you want to keep your reward/risk above 1, and ideally above 1.25.
If you keep your win-rate above 50% and your reward/risk above 1.25, you are a profitable trader. You can still be profitable if your win-rate is a bit lower and your reward/risk is a bit higher, or your if your reward/risk is a bit lower but your win-rate a bit higher. Try to keep it simple though, and utilize strategies that win more than 50% of the time, and offer a better than 1.25 reward/risk ratio.
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Have a stop loss order for every single forex day trade you make. A stop loss is an offsetting order that gets you out of a trade if the price moves against you by a specific amount. Having a stop loss assures that you get out of a losing trade. The price didn't move how you expected, so there is no reason to say in the losing trade. Take the loss and move on to the next trade.
A stop loss is placed at a location that shouldn't be touched if you are right about the direction the price will move in the short-term. A stop loss order should be placed at the same time a day trade is taken, not after. You want that stop loss to be active as soon as you enter a trade. If you haven't placed a stop loss, it can't control your risk.
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Placing a stop loss on each trade helps control risk, and also helps to avoid a common problem called "averaging down." Averaging down is when you make additional trades, adding to your position, as the price moves against you. Adding to a losing trade is a dangerous practice since the price can move against you for much longer than you expect.
Not only are you not exiting a trade that is losing you money, but you are making that position larger, which means the loss gets exponentially bigger the more the price moves against you and the more you add to the position.
Never add to a losing day trade. Take a trade with the proper position size and set a stop loss on the trade. If the price hits the stop loss the trade will be closed at a loss. There is no reason to risk more than that on a trade that is not doing what you expect. Small losses are much easier to recover from than large losses.
Position size was mentioned above. Proper position sizing is part of the risk management strategy that all forex day traders should have.
The first part of your risk management strategy is to establish how much of your capital you are willing to risk on each trade. Day traders should ideally risk 1% or less of their capital on any single trade. That means that a stop loss order closes out a trade if it results in more than a 1% loss of trading capital.
Only risking 1% per trade is ideal because even if you lose multiple trades in a row only a small amount of capital will be lost. At the same time, if you make 2% or 3% per winning trade (discussed in the risk/reward section above), losses are easily recouped and thus it is actually possible to make great day trading returns even though risk is kept relatively low.
Another part of risk management is controlling daily losses. Even with risking only 1% per trade, if you take a lot of losing trades in a day you could lose a substantial amount of your capital. For that reason have a daily stop loss. For example, you may choose to have a daily stop loss of 3%. If you lose 3% of your capital in one day, you stop day trading for the day.
Don't only control your risk on each trade, but control your risk each day.
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Risk management was just discussed, but it's important to bring up "going all in". Even if you have a risk management strategy in place, there will be times you are tempted to ignore your risk management rules and take a much larger trade than you normally do. Reasons for this may include:
- You have had several losing trades in a row, and you want to make back all the losses (and maybe some profit as well) all on one trade.
- You are trading very well lately, and feel you can't lose, so taking a larger position than usual isn't that bad.
- You feel very confident that you can't lose on this particular trade, so you are willing to risk almost everything on it.
Stick to your 1% risk rule per trade, and your 3% risk rule per day (or whatever small percentages you personally decide to risk). These figures do not change based on your emotions or how you feel about a trade.
Never risk more than a couple percent on a single trade, because if you start risking 5%, 10% or more of your account, you can start losing substantial sums of money very quickly.
If you risk too much you are already making a trading mistake, and mistakes tend to compound. If this big losing trade starts moving against you, you may feel regret which can lead to canceling your stop loss order in the hopes the price will turn around and you can avoid the loss. Worse yet, you may add to the position, hoping that if it turns around you can make an even larger profit. Avoid such situations in the first place. Stick to your risk management strategy, and avoid going "all in," no matter what the reason.
High impact scheduled economic news releases cause pairs affected by the news to rise or fall sharply. Anticipating the direction the pair will move, and taking a position before the news comes out seems like an easy way to make a windfall profit. It isn't.
Often the price will move in both directions, sharply and quickly, before picking a more sustained direction. That means you will likely be in a big losing trade within seconds of the news release.
Now you may be thinking "Great, with all that volatility the price is likely to swing back in my favor and I can take a profit!" Maybe it will, maybe it won't. But there is another problem. In those initial moments, the spread between the bid and ask price is usually much bigger than usual, which means you may not even be able to find liquidity to get out of your position at the price you want.
Instead of anticipating the direction news will take the market, have a strategy that gets you into a trade after the news. This approach still allows you to profit from the volatility, but without all the unknown risks. The non-farm payrolls forex strategy is an example of this approach.
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Depositing money with your forex broker is the biggest trade you will make. You are trusting them with all your money. If they are a trading scam, poorly managed or in financial trouble, you could lose all your money, regardless of how well you trade.
Take time in choosing your broker. There is a five-step process you should go through when deciding on which broker to use. That process is outlined in 5 Tips for Finding a Great Forex Broker.
You may have heard that diversification is good. Well, even that is arguable, (Warren Buffett said that "Diversification is protection against ignorance. It makes little sense if you know what you are doing.") but assuming you believe it you may be inclined to take multiple day trades at the same time instead of just one, thinking you are spreading out your risk. Chances are you are actually increasing your risk.
If you see a similar trade setup in multiple forex pairs, there is a good chance those pairs are correlated. that is why you are seeing the same setup in each one. When pairs are correlated, they move together, which means you will probably win or lose on all those trades. If you risk 1% on each, and take five trades, if you lose on one you will probably lose on all 5, resulting in a 5% loss. not 1%! By taking correlated trades, you have inadvertently increased your risk.
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It is easy to get caught up in the news of the day or form a bias based on an article or video you saw that says economic conditions are good/bad for a country/currency.
The long-term fundamental outlook doesn't matter when you are day trading. Your only goal is to implement your strategy, no matter which direction it tells you to trade. "Bad" investments can go up temporarily, and good investments can go down in the short-term.
Fundamentals have absolutely nothing to do with short-term price movements. so don't even bother looking at fundamental analysis while day trading. It will not serve you well, and any long-term biases could cause you to deviate from your trading plan (discussed next). Your trading plan--and the strategies it contains--give you an edge in the market and prevent you from gambling.
Everything discussed so far should be included in a trading plan. A trading plan is a written document that outlines exactly how, what and when you will day trade.
Your goal is to follow your trading plan precisely. Your trading plan should also be precise so it is easy to follow.
Your plan should include what markets you will trade, at what time and what time frame(s) you will use for analyzing and making trades.
Your plan should outline your risk management rules, discussed above.
Your plan should also outline exactly how you will enter and exit trades, for both winners and losers.
If you don't have a trading plan, you are gambling. Create a trading plan and test it for profitability in a demo account before utilizing it with real money.