The global forex market boasts over $4 trillion in average daily trading volume, making it the largest financial market in the world. Forex's popularity entices traders of all levels, from greenhorns just learning about the financial markets to well-seasoned professionals. Because it is so easy to trade forex - with round-the-clock sessions, access to significant leverage and relatively low costs - it is also very easy to lose money trading forex. This article will take a look at 10 ways that traders can avoid losing money in the competitive forex market. (There are no specifically forex focused programs, but there are still some advanced education alternatives for forex traders. Check out 5 Forex Designations.)
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Do Your Homework – Learn Before You Burn
Just because forex is easy to get into doesn't mean that due diligence can be avoided. Learning about forex is integral to a trader's success in the forex markets. While the majority of learning comes from live trading and experience, a trader should learn everything possible about the forex markets, including the geopolitical and economic factors that affect a trader's preferred currencies. Homework is an ongoing effort as traders need to be prepared to adapt to changing market conditions, regulations and world events. Part of this research process involves developing a trading plan. (For more, check out 10 Steps To Building A Winning Trading Plan.)
Take the Time to Find a Reputable Broker
The forex industry has much less oversight than other markets, so it is possible to end up doing business with a less-than-reputable forex broker. Due to concerns about the safety of deposits and the overall integrity of a broker, forex traders should only open an account with a firm that is a member of the National Futures Association (NFA) and that is registered with the U.S. Commodity Futures Trading Commission (CFTC) as a futures commission merchant. Each country outside of the United States has its own regulatory body with which legitimate forex brokers should be registered.
Traders should also research each broker's account offerings, including leverage amounts, commissions and spreads, initial deposits, and account funding and withdrawal policies. A helpful customer service representative should have all this information and be able to answer any questions regarding the firm's services and policies. (Discover the best ways to find a broker who will help you succeed in the forex market. Refer to 5 Tips For Selecting A Forex Broker.)
Few things are as damaging to a trading account (and a trader's confidence) as pushing the wrong button when opening or exiting a position. It is not uncommon, for example, for a new trader to accidentally add to a losing position instead of closing the trade. Multiple errors in order entry can lead to large, unprotected losing trades. Aside from the devastating financial implications, this situation is incredibly stressful. Practice makes perfect: experiment with order entries before placing real money on the line.
Any analysis technique that is not regularly used to enhance trading performance should be removed from the chart. In addition to the tools that are applied to the chart, the overall look of the workspace should be considered. The chosen colors, fonts and types of price bars (line, candle bar, range bar, etc) should create an easy-to-read and interpret chart, allowing the trader to more effectively respond to changing market conditions.
Part of this is knowing when to accept your losses and move on. Always using a protective stop loss is an effective way to make sure that losses remain reasonable. Traders can also consider using a maximum daily loss amount beyond which all positions would be closed and no new trades initiated until the next trading session. While traders should have plans to limit losses, it is equally essential to protect profits. Money management techniques, such as utilizing trailing stops, can help preserve winnings while still giving a trade room to grow.
Factors like emotions and slippage cannot be fully understood and accounted for until trading live. Additionally, a trading plan that performed like champ in backtesting results or practice trading could, in reality, fail miserably when applied to a live market. By starting small, a trader can evaluate his or her trading plan and emotions, and gain more practice in executing precise order entries – without risking the entire trading account in the process.
Use Reasonable Leverage
Forex trading is unique in the amount of leverage that is afforded to its participants. One of the reasons forex is so attractive is that traders have the opportunity to make potentially large profits with a very small investment – sometimes as little as $50. Properly used, leverage does provide potential for growth; however, leverage can just as easily amplify losses. A trader can control the amount of leverage used by basing position size on the account balance. For example, if a trader has $10,000 in a forex account, a $100,000 position (one standard lot) would utilize 10:1 leverage. While the trader could open a much larger position if he or she were to maximize leverage, a smaller position will limit risk. (For additional reading, see Adding Leverage To Your Forex Trading.)
Keep Good Records
A trading journal is an effective way to learn from both losses and successes in forex trading. Keeping a record of trading activity containing dates, instruments, profits, losses, and, perhaps most importantly, the trader's own performance and emotions can be incredibly beneficial to growing as a successful trader. When periodically reviewed, a trading journal provides important feedback that makes learning possible. Einstein once said that "insanity is doing the same thing over and over and expecting different results." Without a trading journal and good record keeping, traders are likely to continue making the same mistakes, minimizing their chances of become profitable and successful traders.
Understand Tax Implications and Treatment
It is important to understand the tax implications and treatment of forex trading activity in order to be prepared at tax time. Consulting with a qualified accountant or tax specialist can help avoid any surprises at tax time, and can help individuals take advantage of various tax laws, such as the marked-to-market accounting. Since tax laws change regularly, it is prudent to develop a relationship with a trusted and reliable professional that can guide and manage all tax-related matters.
Treat Trading As a Business
It is essential to treat forex trading as a business, and to remember that individual wins and losses don't matter in the short run; it is how the trading business performs over time that is important. As such, traders should try to avoid becoming overly emotional with either wins or losses, and treat each as just another day at the office. As with any business, forex trading incurs expenses, losses, taxes, risk and uncertainty. Also, just as small businesses rarely become successful overnight, neither do most forex traders. Planning, setting realistic goals, staying organized and learning from both successes and failures will help ensure a long, successful career as a forex trader.
The Bottom Line
The worldwide forex market is attractive to many traders because of its low account requirements, round-the-clock trading and access to high amounts of leverage. When approached as a business, forex trading can be profitable and rewarding. In summary, traders can avoid losing money in forex by:
Being well-prepared
Having the patience and discipline to study and research
Applying sound money management techniques
Approaching trading activity as a business
