Every day thousands of trader’s flock to the Forex and Futures markets in hopes of making it big. And for good reason, there is certainly alot of money that can be made trading these markets.
But just like everything else in life, you must be at the top of your game in order to succeed. In this article, we will discuss some common mistakes and pitfalls that new traders should be aware during their trading journey, so that they can take the necessary steps to overcome them.
Lack of Preparation
If you want to know why many newbie forex traders fail, one of the most common reasons is the lack of preparation. Trading is one of the toughest professions out there. It’s extremely competitive and difficult to maintain an edge in the market even when you are well prepared. So, you can imagine what likely happens to those that do not take the necessary time to prepare for the trading day. But being ill equipped to face the market is exactly what a lot of beginners do.
They feel as though they can just wing it and as a result do not have any type of routine prior to the trading session. As a matter of analogy, one would never expect an amateur, untrained high school tennis player to face the likes of Roger Federer on the tennis court and have any reasonable expectation of winning. That seems almost too obvious. But when it comes to trading, new traders often forget this.
You have to understand that you are competing with major institutions, hedge funds, CTAs, and other market professionals who are very well prepared and for you to compete on the same playing field, you must at the very least do your homework each day about the markets you plan on trading.
Whether you are a fundamental trader or technical trader, you should have a daily routine that you follow, so that when your desired setup occurs, you just act on executing it in a flawless manner and without reservation.
Not Using a Stop Loss
As traders, our primary role is that of a Risk Manager. We must manage risk above all else. And one of the best ways to manage risk is by using a Stop loss order on every trade. I would go as far as saying that not only should you use a stop loss on every single trade, but you should also put in a hard stop the moment you enter a position.
But many novice traders either prefer to use a “mental stop”, wherein they have a predetermined level where they will plan to exit for a loss or worse they will refuse to use a stop loss altogether as they are so sure about a position that they just don’t think they need one. Both of these arguments are flawed.
As for the first argument for using a mental stop instead of a hard stop, I believe it’s just an excuse for a trader to give themselves more time to stay in the trade. If they have already determined the invalidation point for the trade, then no additional time should be given on the trade, and hence a hard stop should have been the preferred risk control mechanism used.
Now for the second argument for not using stop losses – not feeling that you need one because you are sure the market will go your way. To that I can only say the following:
“The only Certainty in the market is Uncertainty”.
Large unexpected losses resulting from not using stop losses is a newbie trading mistake that is completely avoidable.
Trading with Poor Risk to Reward
Many beginning traders mistakenly believe that the best trading systems are those with the highest win rates. As a result, they routinely gravitate towards strategies that have a 70%, 80%, or even 90% win rate. But these strategies often have a high risk of ruin because they typically have very low reward to risk ratios associated with them.
Let’s take a look at two examples below. One of which is a high win rate strategy and the other is a moderate win rate strategy:
Strategy A wins 70% of the time and the average Win to Loss is .50 : 1, meaning that the amount per winning trade is half the amount per losing trade.
Strategy B wins 40% of the time and the average Win to Loss is 2 : 1, meaning that the amount per winning trade is 2 times the amount per losing trade.
Which of these two strategies do you think is more profitable?
If you answered Strategy B, then you would be correct. Even though this strategy has a much lower win rate, its higher
Avg Win: Avg Loss ratio makes it a more profitable trading strategy.
Let’s take a look and see why this is the case:
The Trade Expectancy for Strategy A is calculated as follows: (assuming $ 500 Avg Win)
(Win % x Average Win Size) – (Loss % x Average Loss Size)
(.70 x 250) – (.30 x 500) = $ 25 per trade
The Trade Expectancy for Strategy B is calculated as follows (assuming $ 500 Avg Win)
(Win % x Average Win Size) – (Loss % x Average Loss Size)
(.40 x 500 ) – (.60 x 250) = $ 50 per trade
Traders should not believe the forex trading myth that higher win rate systems are better than lower win rate systems. Traders should focus not only on Win rates but also take into consideration the Risk Reward profile for each trade.
Getting Impatient and Over Trading
The very thing that attracts many new traders to the world of forex trading is often the thing that leads to their financial failure in the markets. What I am referring to is the lure of fast money and 24/5 action.
Novice traders think that in order to make money in the markets, they have to be trading all the time, around the clock. This could not be further from the truth. In fact, I would argue the exact opposite. Instead of trading the fast paced 3 minute or 5 minute timeframe, you would be much better off financially and emotionally by trading higher timeframes such as the 120 minute or 240 minute chart.
Aside from the fact that these higher timeframes offer better quality setups, they also have the advantage of reduced transaction costs due to less frequent trade turnover.
However, this is one of those forex trading mistakes that new traders are reminded of but rarely take heed of until they blow up an account or two and begin to study what went wrong. Eventually, if they’re lucky, they will come to the self-realization that it’s not how often you trade that matters at the end of the day, but rather how well you trade that really matters. Remember as traders, we are not getting paid by the hour, so take a step back and start concentrating on taking the best trades not the most trades.
Not Applying Proper Position Sizing
Professional traders know that position sizing is critical to success in the markets. In fact, it is often the difference between trading success and failure. They typically have very strict parameters for position sizing and often use a fixed fractional model, a fixed ratio model, a fixed contract per account size model, or something else.
But the point is that they have a detailed position sizing strategy that will let them know exactly how many lots or contracts they will allocate on a trade. No guesswork, or gut feelings are involved in the process.
For example, a professional trader, based on his trading plan, may allocate 2% of capital on any trade. This would be considered a 2% fixed fractional model. So, if the trader has a $ 50,000 account, then the maximum allowable risk would be $ 1,000. And if the trader has decided based on their chart analysis that the most logical stop level is $ 450 from the entry, then they would be allowed to allocate a maximum of 2 lots on that particular trade.
Beginning and amateur traders typically allocate risk based on their how they feel about their recent string of trades instead of relying on a preplanned position sizing model. They tend to trade way too big after a recent string of winners and often get caught on the wrong side of the market when they are most aggressive, which in turn leads to large losses. These amateaur trading mistakes related to position sizing should be dealt swiftly if you want to stay in the game for any reasonable amount of time.
Trade management is possibly one of the hardest aspects of trading. And the reason for this is that the moment that you enter a trade, all of your objectively will go out the window. You will become biased and begin to see what you want to see and your subconscious mind will filter out things that are not in line with your trade bias. This may seem hard to believe for some, but it is a matter of fact.
When you are in a trade, it feels uncomfortable to do nothing. But many times, doing nothing is the best thing to do. We have a desire to constantly monitor, adjust, and micro mange the position to the point where it becomes counterproductive.
You have to try to overcome these trade management mistakes. And one of the best ways of doing that is by using a Set and Forget type of trade management policy. Within this trade management style, you do all your analysis prior to execution, when you are the most unbiased. You determine and set your stop loss and profit target in the market the very moment that you enter the position. And then you let the market do its thing. There is nothing more you can or should do about that open position. Instead take your dog for a walk, go to the Gym, or look for the next trade setup.
Have a Shiny Object Syndrome
One of the things that we all value in our professional and personal life is the ability to have choices. Having choices is a wonderful thing in most parts of our lives, but in trading, it can sometimes hold us back from realizing our full potential.
What do I mean by that? Well quite simply, having the freedom of choice in terms of trading strategies and systems can often lead us down an endless path for perfection.
You know what I mean, the search for that holy grail trading system that will make us rich beyond our wildest expectations. If you have been around this game for any length of time, you know that there is no Holy Grail trading system out there. Goldman Sachs doesn’t have it, J.P. Morgan doesn’t have it, and as retail traders we will certainly will never have it. The sooner that novice traders realize this, the faster they can get to the business of trading.
Successful traders have a defined edge and they apply that edge in the market whenever the opportunity arises. They know that they will make mistakes in trading, and that there will be losing trades, even a string of them, but that does not deter them from sticking to their strategy.
Beginning traders should also focus on picking a methodology that suits their own personality and learn everything about it. Then they should apply the strategy in the market, and give it enough time for the odds to play out. Only once they have given the particular trade methodology an honest go, should they consider pulling the plug and moving on to some other strategy.
Not Keeping Good Records
Any successful business owner will tell you that keeping and maintaining good records is essential. Not only is it required for tax purposes, but just as importantly, good record keeping allows a business owner to know where revenue and expenses are coming from. They can use that information to cut unnecessary expenses and increase customer value to attain a healthier bottom line.
Trading is not too much different if you think about it. As a trader, our revenues are profits from winning trades, and our primary expenses are our losses from losing trades. If we do not have a detailed journal of our thought process and events surrounding our trades, how can we ever expect to boost our results? In short, we cannot.
Therefore, it is essential that traders keep a trading diary, and review it on a regular basis. This is probably one of the best beginner trading tips that I can offer. Take a look at what is working and do more of that. At the same time, review what is not working and try to cut that out of your trading plan.
If you are serious about trading and are treating it as a real business and not just some side hobby, you have to start by committing to having a personal trading journal. It’s not that sexy, but it will do wonders for your trading. And if you find yourself leading astray from this routine, remember the adage – What gets measured, gets improved.
Averaging Losing Trades
Averaging losing trades has to be the biggest cardinal sin of them all, but it is one that almost every trader has made at some point in their careers.
Murphy’s law tends to be especially cruel to traders that average their losing trades, as it is usually when you are the most aggressive in a position that you tend to lose the most amount of money.
Many traders are enticed by averaging losers, because on the surface it almost seems like a sure bet. Let’s look at it from the perspective Roulette for a moment. You have close to a 50% chance of winning or losing by placing a bet on Red or Black.
You decide that you will double your bet size every time you lose, and as a result you should come out ahead. So, you begin with $ 100 dollars, and double your bet every time you lose. Here is what that scenario would look like after 8 consecutive losses, which is common both in roulette and trading:
1st loss : $ 100
2nd loss : $ 200
3rd loss: $ 400
4th loss: $ 800
5th loss : $ 1,600
6th loss: $ 3,200
7th loss: $ 6,400
8th loss: $ 12,800
Though this is a rather simplified example, it should serve to show you that averaging losers is a horrible strategy in roulette and an even worse strategy in the markets. Eventually, sooner or later, you are asking to get your account blown up. Averaging losing trades and trading too much size is without a doubt the biggest reasons why many newbies fail at trading.
Tendency to Internalize Losses
One of the most common mistakes that beginning traders make is that tend to equate losses with failure. And this is especially true for those that are accomplished in their own profession such as Doctors, Lawyers, Engineers and other highly successful individuals. They are used to getting things right and achieving their goals. And so, they bring this mentality to the markets and it tends to cause havoc on their psyche.
First and foremost, anyone that is entering the trading world, should realize losses are a natural part of trading. They must accept this and believe this in their core being in order truly overcome the negative emotions associated with losing trades.
Professional traders, on the other hand, have come to realize that trading is a game of probabilities and that no single trade or even a string of trades has much meaning in the whole scheme of things. So, a winning trade or a losing trade does not affect their emotional makeup.
Amateur traders are much more effected by recency bias, meaning their mood and actions in the market are heavily influenced by their most recent trade performance. These traders should take necessary steps to train their brains to view losses as a necessary cost of doing business rather than a reflection on their intelligence or judgement.
In this lesson, we have discussed the top trading mistakes that new traders make. The first step in fixing your mistakes is to acknowledge them. Take some time to go over each of these common trading mistakes and see which ones are the most relevant to you.
You should make a concerted effort to work on improving each area of weakness. Keep in mind that there is no final destination when it comes to trading. We must all be improving all the time. Even the 30 or 40 year veteran in the trading business will tell you that they are still learning something new all the time, and constantly looking for ways to increase their trade efficiency.
If you put in the necessary time for self-reflection and an honest effort at making incremental improvements, then you have a chance at success in the markets. Anything short of that, you are doing yourself a disservice and not giving yourself a fair shot to compete successfully in the market.