While there are many investors in the forex market, the unfortunate truth is that relatively few are consistently successful – and many fail catastrophically. Although investing in forex has many of the same pitfalls as other types of asset trading, the high levels of leverage and unique dynamics of the forex market make it far less forgiving. For instance, a 1% decline in a stock price may result in a relatively modest loss for a stock trader, but a 1% drop in a currency price can wipe out a forex trader’s entire investment if they are too highly leveraged.
Given this, what common mistakes should you try to avoid when you invest in the forex market?
Trial and error strategy
First of all, if you are a novice investor, don’t just try things to see if they work. A trial and error approach is likely to lead to large losses very quickly, bringing an abrupt end to your forex trading career. Also, don’t just assume that strategies that worked for you in equity markets will transfer to the forex market. Instead, invest in formal education before you start out, or find a mentor who has a proven track record in the currency markets. Complement this with extensive practice – many forex brokers offer free demo accounts where you can hone your skills without risk.
Second, don’t fall victim to unwarranted expectations. While it is certainly possible to earn a good living and even become rich in the currency markets, forex trading is not a ticket to instant wealth. Good forex traders have a clear strategy and are happy to build up their profits slowly over time. Going for that single big win is more likely to result in major financial losses than significant gains. Investors who abandon prudent money and risk management practices to do this are almost certainly destined to fail.
In fact, well-defined money and risk management plans should be at the heart of any trader’s strategy. Make sure that all of your positions have appropriate stop losses in place, and that you are comfortable with how much of your capital is at risk given the returns that you are projecting in your plan. Diversify your portfolio across multiple currency pairs, and diversify your trading strategies as well. As your account balance grows, separate your capital into multiple pools, allocating a small proportion for high-risk/high-return investments while adopting more conservative strategies with the rest. This will increase the likelihood that even if a trade goes badly wrong, your losses will be sustainable.
Too much leverage
Finally, don’t be enticed by the high leverage levels that are available. While you may be offered leverage as high as 400:1, this level of risk may be unacceptable. Instead, consider keeping a leverage of around 2:1 for your trading. In other words, make sure that the value of your account is at least 50% of the total value of your positions. This is the ratio that most successful professional traders use – and for good reason.
A Guest Post by FXTM