Forex trading offers a key advantage over other trading environments: Leverage. This advantage can help you earn a lot of money — and help you lose your shirt. Most forex platforms allow you to leverage trades by putting $1 down as your “margin balance,” and that gives you the right to borrow $100 for investment purposes.
While leverage can amplify your gains, you must educate yourself about common forex pitfalls and mistakes when using any forex platform. That way, you can keep your gains and avoid devastating losses. Here are two forex blunders to avoid:
1. Betting on a Position in Advance of a News Event
Global news events can radically shift the trajectory of a foreign currency on the forex markets. This makes the news an important indicator that forex traders watch like a hawk. Take Brexit, for example. In the days leading up to the June 2016 “British Exit” vote, most forex traders assumed that a “yes” vote on Brexit would cause the British pound to plummet.
Indeed, that’s what happened. Look at the chart after the “yes” vote came through:
If you suspect that a news event will have a specific effect, be cautious. While every forex trader must watch and react to the news, it’s not always smart to position yourself before an event. Forex trading pairs don’t always do what you expect them to do in response to the news.
Yes, you can jump out of the position if the news event doesn’t pan out the way you thought. However, factors like follow-up news events, responses from key political and business players and central bank intervention can cause markets to act in a highly irrational way. Moreover, volatility can trick forex traders into believing that an erratic price movement is an actual trend.
Look at the Brexit price above. Do you see how it bounced significantly up and down after the news? Those fluctuations could fool a novice forex trader.
Long story short, positioning yourself before a news event could end up hurting you. The same goes for positioning after the news.
Remember: A major event could create dramatic volatility. Enter a news-related position only if (1) you’re using a proven trading strategy and (2) a clear trend has emerged.
2. Doubling the Stakes on a Losing Trade
We’ve all seen the cowboy movies with the men in 10-gallon hats around the table. One wins big and the loser says, “Double or nothing!” That’s what you’re doing when you “average down” on a forex trade. Most traders know they’re not supposed to do it, but forex plays psychological tricks on us, and it can be hard to resist the impulse to average down — especially when it’s “forex for beginners.”
Here’s why averaging down is a bad idea for new forex day-traders:
You have a losing trade on your hands and you’re keeping it against better judgment. Staying in a losing position (1) increases the risk of losing more on a trade that your strategy says to dump and (2) keeps your capital tied up when you could be entering another position with a higher chance of success.
Your loser trade must perform uncharacteristically well to break even. Imagine you lose 50 percent on the first trade. Doubling down on the position after a 50 percent loss means you’ll need a 100 percent gain to make your money back. That kind of gain isn’t very common — especially when the trade is already a loss.
You’ll probably trigger a margin call. By averaging down on a forex day-trade, you could end up chasing your original position into a dark margin hole. As you bet more on the trade, you’re likely to lose more money and trigger a margin call. That will require you to risk even more assets to meet the call, or you’ll have to exit the trade — which you should have done in the first place!
As a final caveat, averaging down might work in certain long-term trading circumstances.
That said, when you’re day-trading on forex as a beginner, you must have a solid exit strategy in place before you make the decision to enter a trade and you must have nerves of steel to stick with that strategy. This is easier said than done, especially when you get those “feelings” and “hunches” that you “know” have to be right.
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