I bet you’ve heard of people who have burned their fingers in forex trading. These people often refer to forex trading as extremely risky and unpredictable. I’ve even heard a guy say it’s a kind of gambling. Well, most (if not all) of these people had no idea about applying proper risk management. Those who knew something about risk management did not follow their own rules or only applied them for a short time. Of course, in addition to risk management, many other factors determine a trader’s success, but without proper risk management, the chances of failure are basically guaranteed.
He sees that trading in the forex market and other markets is a huge challenge for the average person. The emotional aspect of trade is probably the biggest challenge you have to face on the road to success. When waves of fear and greed beat the merchant ship violently, you must maintain a controlled and disciplined approach in order to survive the storms. Unfortunately, it takes a lot of journeys across dangerous oceans for the “average Joe” to learn how to control himself, his emotions, and his trade. Before you can master the markets, you have to master yourself.
Let’s take a look at the three deadliest traps to avoid when trading:
Snare # 1 – Too much leverage
When I first heard about leverage trading, I thought, “Wow! That’s beef good! ” And of course it’s scary, but extremely dangerous if you don’t know how to use it properly. You can see that the smallest position you can usually open when trading forex is a micro item that is 1000 currency pairs. Without leverage, you would need more than a thousand dollars to open a 1K position on the EUR / USD exchange rate. You will then need additional funds to maintain the trade in case you experience a drawdown. Of course, the moment you open a trade, it is immediately deducted for the spread.
In any case, with a leverage of, say, 1: 100, you need less than $ 11 to open EUR / USD trading. This makes FX trading much more viable for investors and traders with small accounts. Suppose you want to open a trade on the EUR / USD exchange rate with a 50 core stop loss and a 100 pip gain. The amount needed to open 1,000 items is about $ 11. Fifty pip is $ 5 if you trade with this lot size. So to keep your trading to the point where the stop loss reaches, it would take about $ 16, which is really a minute amount. Of course, a $ 16 account cannot be traded effectively, this is just a practical example to point out the difference between a leveraged account and an account without a “normal” leveraged account.
Here, inexperienced traders are captivated by excessive greed. They think about it, “I’m going to get a big return on my investment by going VERY! With my $ 500 account, I can easily open a 25,000 trade. If I hit a 100 pip target with EUR / USD 25,000, I will have an amazing profit of $ 250. I can make a 50 percent return on my investment in an instant. I can’t wait for the trade to take place. “The naive trader notices a setting in EUR / USD that seems like a very good option and pulls the trigger, trusting that he is only a few hours away from his huge 50 percent profit on his account. Does that sound familiar?
Suppose this inexperienced trader takes this trade with a 50 pip stop loss and a 100 pip profit and loses the trade. That would be a loss of no less than 25 percent on your entire bill. Of course, you could have won the trade, but we know that even the best trading opportunities can turn into loss-making trades.
Now suppose the same trader has taken the courage to make another trade, but this time a smaller 20K trade, with a 70 pip stop loss and 140 pip taking a profit, risking $ 140. If he lost the second trade as well, only $ 235 of the original $ 500 would remain. That’s a 53 percent loss in just two trades! Do you see how dangerous excessive leverage can be?
Now that we know we shouldn’t use too much leverage in our trading, how much leverage would have been appropriate with this trader’s $ 500 account? Well, no matter how big your account is, you shouldn’t risk more than about two percent of your equity in a single trade. I would recommend less experienced traders to risk one percent or less. Of course, traders with no experience should try a demo account first.
So for a $ 500 account, a 50 pip stop loss on 1K EUR / USD trading carries a $ 5 risk, which is 1 percent of total capital. Keep in mind that the minimum amount required to open and maintain a trade until a draw of 50 pips (1K lot size) is $ 11 + $ 5 = $ 16. Subtracting this, you get $ 484 out of $ 500. Divide $ 484 by $ 5 and you get 96.8. This is the amount of time you can lose one percent of a $ 500 account before you have enough money left to do another trade. Round this number to 96 (because 0.8 trades = no trades). Amazing, isn’t it?
Suppose you have a forex trading strategy with a 55% win ratio. Let’s be simple and work with a stop loss equal to the takeover gain. Now, if you risk 25% of your total account in a trade, you can obviously easily destroy your account. After all, it would only take four loss-making trades to clear the account (this may not make sense at first glance, but it is possible by setting the stop loss distance in check boxes to accommodate a smaller item size) it should match the reduced capital levels, the last one or two trades) .
With a strategy that results in a 55% win rate, you can easily lose four trades in a row. However, the same strategy rarely loses 20 times in a row, even less 40 or 50 times.
Statistically, based on a special bankruptcy formula, you have a 13% chance of blowing your entire account at a 55% payout rate if you risk 10% of your account on each successive trade. If you risk only 5% per trade, that number drops to 1.8%. But when you risk only 2% per trade, your chances of blowing your entire account are reduced to zero. These three examples show a 1: 1 benefit / risk ratio. Remember, we are talking about exactly the same win rate (55%). The only difference is the percentage of equity for each transaction. Of course, the results will change if you set the payout ratios and the reward / risk ratios, but for all the different inputs, the principle remains the same – risking a smaller amount of capital at once reduces the risk of failure (ROR) dramatically. Never use excessive leverage!
Snare 2 – Revenge Trade
This is one of the most dangerous games you can play with your money. Without a disciplined trading approach, you will make no money in the long run.
Many traders are unable to handle the loss, which ultimately causes many to take revenge on the trade. Sometimes they are able to handle one or two consecutive lossy deals, but when they lose too many times in a row, they get angry and try to recoup those losses with one trade.
The nature of the revenge trade
When these traders continue this ridiculous next trade, they are so overwhelmed with their own emotions that they do not base this trade on solid market analysis. Nor do they take proper account of the risks involved in trading. Most of the time, this trade is so leveraged that it exposes a huge portion of the trader’s equity. Now that this trade is often carried out impulsively and hastily, it is usually a very bad trade. The victory rate for typical revenge deals is really awful. Consequently, the vast majority of traders who are kidnapped in this style of trading blow their bills at one stage. You may get the one or two lucky revenge exchanges that get your lost money back but end up knocking.
Revenge is often nearing the end of the trader’s day. The reason for this is that traders have some expectations about how their trading day will turn out and of course everyone wants to sit down at the dining table, happy with the fair profit made for that day. If your wife asks what your trading was like, it’s very good to answer, “Honey, I’ve made a very good profit today.” And of course it’s a terrible feeling to say, “I filled the markets terribly and lost a lot of money.”
Pride and certain expectations can really be detrimental to trading. If you have followed your trading plan and suffered losses in a difficult day’s trading, you need to stay cool and wait for the next trading day. Any good trading strategy loses trading. You have to be tough enough to bridge these losses. After all, if you risk one or two percent of your equity per trade, you have nothing to worry about if you adopt a strategy that has proven to work in the long run. Not even a few consecutive losses should shake you.
Traders who risk small portions of their account during each trade are much less exposed to the vengeance virus. You see that losing most of your own wealth in one or two trades puts you in a position where your emotions are easily flooded. That’s when he starts making irrational decisions and loses himself and his trading account. When traders become really emotional, revenge trade can happen almost automatically.
Snare 3 – Stop Loss Trading
You’ve probably heard of this before, but you have to use stop loss when trading. I personally know at least two institutional traders who don’t use stop losses, but these guys trade millions of dollars and hardly, at all, use leverage. Although stop losses are not applied, meticulous risk management is performed for each transaction executed. You may be wondering how this is possible. Well, a really simple example: if you open a 1K buy trade at GBP / USD, most losses are £ 1,000 if the pound loses its full value, which is of course very unlikely. The current exchange rate is around $ 1,2800, which means that £ 1,000 is currently around $ 1,280. If you have a $ 128,000 trading account, then you can trade a 1K item with GBP / USD without a stop loss and only risk 1 percent of your total account on this trade. This is just a simple, impractical example to prove that you can actually trade without a stop-loss and continue to use excellent risk management.
However, for the average retailer, it is not practical and very risky to trade without a stop loss. In order to adhere to proper risk management principles, you need a stop loss to limit your losses according to pre-determined risk parameters, for example, you can risk up to one percent of your equity in a single trade. Stop losses provide excellent control over your trading activities and allow you to use an acceptable amount of leverage efficiently.
An important aspect of applying stop loss is not to move further from the current market price when trading goes against you. Inexperienced traders tend to move their stop losses in this way and end up suffering much larger losses than was necessary. Shifting the stop loss in the wrong direction can be the same as trading without a stop loss.
Keep in mind that risk management is probably the most important aspect of trading. If you don’t understand well, it greatly limits your chances of success. Don’t use excessive leverage, don’t get revenge, and don’t forget to always use stop loss!