Top Reasons Forex Traders Fail

The forex market is the largest and most accessible financial market in the world, but although there are many forex investors, few are truly successful ones. Many traders fail for the same reasons that investors fail in other asset classes. In addition, the extreme amount of leverage - the use of borrowed capital to increase the potential return of investments - provided by the market, and the relatively small amounts of margin required when trading currencies, deny traders the opportunity to make numerous low-risk mistakes. Factors specific to trading currencies can cause some traders to expect greater investment returns than the market can consistently offer, or to take more risk than they would when trading in other markets.

Forex Market Trading Hazards

Certain mistakes can keep traders from achieving their investment goals. Following are some of the common pitfalls that can plague forex traders:

• Not Maintaining Trading Discipline

The largest mistake any trader can make is to let emotions control trading decisions. Becoming a successful forex trader means achieving a few big wins while suffering many smaller losses. Experiencing many consecutive losses is difficult to handle emotionally and can test a trader's patience and confidence. Trying to beat the market or giving in to fear and greed can lead to cutting winners short and letting losing trades run out of control. Conquering emotion is achieved by trading within a well-constructed trading plan that assists in maintaining trading discipline.

• Trading Without a Plan

Whether one trades forex or any other asset class, the first step in achieving success is to create and follow a trading plan. "Failing to plan is planning to fail" is an adage that holds true for any type of trading. The successful trader works within a documented plan that includes risk management rules and specifies the expected return on investment (ROI). Adhering to a strategic trading plan can help investors evade some of the most common trading pitfalls; if you don't have a plan, you're selling yourself short in what you can accomplish in the forex market.

• Failing to Adapt to the Market

Before the market even opens, you should create a plan for every trade. Conducting scenario analysis and planning the moves and countermoves for every potential market situation can significantly reduce the risk of large, unexpected losses. As the market changes, it presents new opportunities and risks. No panacea or foolproof "system" can persistently prevail over the long term. The most successful traders adapt to market changes and modify their strategies to conform to them. Successful traders plan for low probability events and are rarely surprised if they occur. Through an education and adaptation process, they stay ahead of the pack and continuously find new and creative ways to profit from the evolving market.

• Learning Through Trial and Error

Without a doubt, the most expensive way to learn to trade the currency markets is through trial and error. Discovering the appropriate trading strategies by learning from your mistakes is not an efficient way to trade any market. Since forex is considerably different from the equity market, the probability of new traders sustaining account-crippling losses is high. The most efficient way to become a successful currency trader is to access the experience of successful traders. This can be done through a formal trading education or through a mentor relationship with someone who has a notable track record. One of the best ways to perfect your skills is to shadow a successful trader, especially when you add hours of practice on your own.

• Having Unrealistic Expectations

No matter what anyone says, trading forex is not a get-rich-quick scheme. Becoming proficient enough to accumulate profits is not a sprint - it's a marathon. Success requires recurrent efforts to master the strategies involved. Swinging for the fences or trying to force the market to provide abnormal returns usually results in traders risking more capital than warranted by the potential profits. Foregoing trade discipline to gamble on unrealistic gains means abandoning risk and money management rules that are designed to prevent market remorse.

• Poor Risk and Money Management

Traders should put as much focus on risk management as they do on developing strategy. Some naive individuals will trade without protection and abstain from using stop losses and similar tactics in fear of being stopped out too early. At any given time, successful traders know exactly how much of their investment capital is at risk and are satisfied that it is appropriate in relation to the projected benefits. As the trading account becomes larger, capital preservation becomes more important. Diversification among trading strategies and currency pairs, in concert with the appropriate position sizing, can insulate a trading account from unfixable losses. Superior traders will segment their accounts into separate risk/return tranches, where only a small portion of their account is used for high-risk trades and the balance is traded conservatively. This type of asset allocation strategy will also ensure that low-probability events and broken trades cannot devastate one's trading account.

Managing Leverage

Although these mistakes can afflict all types of traders and investors, issues inherent in the forex market can significantly increase trading risks. The significant amount of financial leverage afforded forex traders presents additional risk that must be managed.

Leverage provides traders with an opportunity to enhance returns. But leverage and the commensurate financial risk is a double-edged sword that amplifies the downside as much as it adds to potential gains. The forex market allows traders to leverage their accounts as much as 400:1, which can lead to massive trading gains in some cases - and account for crippling losses in others. The market allows traders to use vast amounts of financial risk, but in many cases it is in a trader's best interest to limit the amount of leverage used.

Most professional traders use about 2:1 leverage by trading one standard lot ($100,000) for every $50,000 in their trading accounts. This coincides with one mini lot ($10,000) for every $5,000 and one micro lot ($1,000) for every $500 of account value. The amount of leverage available comes from the amount of margin that brokers require for each trade. Margin is simply a good faith deposit that you make to insulate the broker from potential losses on a trade. The bank pools the margin deposits into one very large margin deposit that it uses to make trades with the interbank market. Anyone that has ever had a trade go horribly wrong knows about the dreadful margin call, where brokers demand additional cash deposits; if they don't get them, they will sell the position at a loss to mitigate further losses or recoup their capital.

Many forex brokers require various amounts of margin, which translates into the following popular leverage ratios:

The reason many forex traders fail is that they are undercapitalized in relation to the size of the trades they make. It is either greed or the prospect of controlling vast amounts of money with only a small amount of capital that coerces forex traders to take on such huge and fragile financial risk. For example, at a 100:1 leverage (a rather common leverage ratio), it only takes a -1% change in price to result in a 100% loss. And every loss, even the small ones taken by being stopped out of a trade early, only exacerbates the problem by reducing the overall account balance and further increasing the leverage ratio.

Not only does leverage magnify losses, but it also increases transaction costs as a percent of account value. For example, if a trader with a mini account of $500 uses 100:1 leverage by buying five mini lots ($10,000) of a currency pair with a five-pip spread, the trader also incurs $25 in transaction costs [(1/pip x 5 pip spread) x 5 lots]. Before the trade even begins, he or she has to catch up, since the $25 in transaction costs represents 5% of the account value. The higher the leverage, the higher the transaction costs as a percentage of account value, and these costs increase as the account value drops.

While the forex market is expected to be less volatile in the long term than the equity market, it is obvious that the inability to withstand periodic losses and the negative effect of those periodic losses through high leverage levels are a disaster waiting to happen. These issues are compounded by the fact that the forex market contains a significant level of macroeconomic and political risks that can create short-term pricing inefficiencies and play havoc with the value of certain currency pairs.

Conclusion

Many of the factors that cause forex traders to fail are similar to those that plague investors in other asset classes. The simplest way to avoid some of these pitfalls is to build a relationship with other successful forex traders who can teach you the trading disciplines required by the asset class, including the risk and money management rules required to trade the forex market. Only then will you be able to plan appropriately and trade with the return expectations that keep you from taking excessive risk for the potential benefits.

While understanding the macroeconomic, technical and fundamental analysis necessary for trading forex is as important as the requisite trading psychology, one of the largest factors that separates success from failure is a trader's ability to manage a trading account. The keys to account management include making sure to be sufficiently capitalized, using appropriate trade sizing and limiting financial risk by using smart leverage levels.

Commodities and a Futures Contract – How Are They Different?

A commodity is a physical product that you can touch or feel, such as corn, gold or crude oil.

A futures contract is a commodity that trades on a futures exchange in a standard contract size for delivery at a future date.

The concept of “future” is what throws most people off. It really means that some entity wants to buy or sell the commodity at some time in the future at a price agreed upon today. Remember, futures contracts were created for those with a commercial interest – not speculators like you and me.

How Does a Futures Contract Work?

A buyer and seller create a futures contract. It will consist of a standardized contract of a commodity established by a futures exchange. It will consist of:

• The commodity
• Date to deliver the commodity
• Amount of commodity
• Price of the commodity

For example, Gold Mining, Inc. wants to sell 100 ounces of gold they will have mined by August. XYZ Jewelry Makers wants to buy 100 ounces of gold to make gold rings that they will start manufacturing in September. Since it is currently just March, there is plenty of time where the price of gold could move much higher or lower.

If Gold Mining waits until August to sell their 100 ounces of gold, they run the risk of the price dropping – thus hurt their profits. Oppositely, if XYZ Jewelry Makers waits to buy their needed gold, they run the risk of paying a higher price-thus hurting their profit margins.

This is why both parties create a futures contract – to hedge their risk on the price of gold and to ensure a sale or delivery of gold. One of the most attractive features is that they can close a contract anytime they want during market hours. In fact, less than 5% of futures contracts are held until delivery.

Here is how a futures contract would work in this situation.

Gold Mining sells 1 August Gold futures contract at $625 per ounce. XYZ Jewelry Makers buys 1 August Gold futures contract at $625 per ounce.

The futures contracts are traded on the New York Mercantile Exchange (NYMEX) and consist of 100 ounces of gold. Delivery of the 100 ounces is to be made in August. These two parties are not necessarily making a futures contract with each other. Some other entity could be on the other side of the trade.

If either party decides they no longer need the futures contract for their business needs, they will buy or sell in the open market to close their position and either a speculator or a commercial will take the other side of the trade. If XYZ bought their contract at $625 and sold at $640 two month later, they would make $15 per ounce or $1,500 on their futures contract.

If they both hold until the contract expires in August, XYZ will take delivery of 100 ounces of gold and pay $625 per ounce, while Gold Mining delivers 100 ounces of gold and gets paid $625 per ounce.

So, in this example, gold is the commodity and the futures contract is the means by which gold is traded.

Advanced Forex Trading Techniques

Forex trading can be as simple or as complicated as you want it to be. In the beginning forex trading seems like it is simple. It seems like your only job as a trader is to pick what direction a currency pair is going to go and collect your profit. Or, maybe you are thinking of trying to find a 100 percent accurate forex trading system on the internet. If only it were that simple.

Hedging

Hedging is a way to reduce risk by taking both sides of a trade at once. If your broker allows it, a simple way to hedge is just to initiate a long and a short position on the same pair. Advanced traders sometimes use two different pairs to make one hedge, but that can get very complicated. For example, say you decide that you want to go short on the USD/CHF, because you see it sitting at the top of a recent price range. You decide to initiate your short. After setting up your short, you start thinking that the USD/CHF is looking a little strong and you think that it might break upward and make your short an expensive one. To do an advanced balancing act, you start looking at other USD pairs. You find that the EUR/USD tends to move inversely to the USD/CHF. To complete your hedge, you go short on EUR/USD. The USD ends up breaking resistance and moves strongly against the CHF. Your short EUR trade becomes a winner and your USD/CHF trade is a loser, but your risk is limited because they almost even out.

Position Trading

Position Trading is trading based on your overall exposure to a currency pair. Your position is your average price for a currency pair. For Example, you might make a short trade on EUR/USD at 1.40. If the pair is ultimately trending lower, but happens to retrace up, and you take another short at say 1.42, your average position would be 1.41. Once the EUR/USD drops back below 1.41, you will be back in overall profit.

Forex Options

A forex option is the agreement to purchase a currency pair at a predetermined price at a specified time. For example, say you are long the EUR/USD at 1.40 and you feel that there is a chance that it will fall to 1.38 in overnight trading. Not wanting to risk a deeper reaction, you decide to put a stop at 1.3750, setting up a potential loss of 250 pips. 250 pips sounds really painful, so you decide to use a forex option to lessen the pain. You purchase an option for the overnight hours with a strike price of 1.3750. If the EUR/USD goes up and never touches 1.3750 overnight, you would lose the premium that you paid for your currency option. If the EUR/USD falls and touches your option and your stop loss, you would receive the profit from your option, depending on how much of a premium you paid, and you would realize the loss of your long trade on the EUR/USD. The option profit would make up for some of that loss on your currency trade.

Scalping

Scalping is making a very short term trade for a few pips usually using high leverage. Scalping typically is best done in conjunction with a news release and supportive technical conditions. The trade can last anywhere from a few seconds to a few hours. Many beginning forex traders start with scalping, but it doesn’t take long to figure out how much you can lose if you don’t have any idea what you are doing. In general, scalping is a risky strategy that does not pay well in comparison it's risk. If you are going to make scalping trades, it is best to do them in conjunction with your overall trading position, not as a primary method of trading.

Advanced forex trading is about seeing all your options when you make a trade. Aside from using masterful risk management and extreme caution, advanced trading can be an alternate way to make profits and control losses. Advanced trading techniques are just about using the markets behavior to your advantage. Learning to use advanced techniques properly is what will give you the edge that will make you stand apart from the average trader.

New Trading Strategys Profitability

When a trader finds a new strategy using a new indicator, what does he do with it? Does he just observe it for a few weeks and see if he can get a feel for it? Or just straight out trade it in real time and see how verify its profitability by seeing if the equity is better than it was before trading it?

In automated trading, a programmer can code and give straight forward signals based on the indicator where to enter and exit and have it tested against historical data. Unlike auto trading, discretionary traders have a harder task of having to be as objective in observing and identifying where the entry or exit signals take place, then writing it down and later calculating the overall performance of the testing.

The testing of the strategy in a conventional and even unscientific way can be extremely arduous and time-consuming task. It is especially frustrating when there are so many indicators and strategies available to go and verify each for its potential in making profits that it's disheartening to go through the testing one by one. Just that thought would entice the trader to take the shortcut.

One way to do this is testing it by demo/paper trading. For a couple of weeks with a twenty-something or thirty-something trades, he would have a good idea how it works, how much it makes or loss. If he thinks it's ready for real trading, he can start. The only problem is that the strategy has only seen a current market condition, it may work in the next few months, but when a new market condition emerges, such as from an uptrend to a consolidation stage, this may cause a period of losses, which may lead to big drawdowns. Only using the demo stock trading may not be enough. Plus the sampling size is so small to have adequate judgment on the validity of the performance results.

Going the opposite direction, a trader may decide to backtest with historical data and review the possible profitability of the strategy. This might be a great way since the historical data provide more than adequate periods of time, normally in years. The sampling size may be in the hundreds of trades, with it in many different types of market conditions. With this type and enormity of research, this would be more than sufficient to decide that there can be no doubt profitable once it's put into real trading right? Wrong, historical data in charts do not completely represent what and how it looks like in real time trading, no matter how accurate the data is. There are many elements where the data was "cleaned" or "corrected." It only happens after the fact. But the biggest hidden factor is the indicator: indicators are in constant motion in real time. In backtesting, the indicators are already resting in place so this eyeballing old data with that indicator with historical data is like "shooting fish in a barrel," and not shooting fish in the ocean. It is well known that indicators lag so when the data is already shown and known, the indicators would show what it would have been like look like in real time. But that is not the case when the real data is still unfinished. This is one reason why many online trading systems tested against historical data fail in real time, automated or discretionary.

In order to make sure that the strategy works well with real money, it needs to be tested with historical data as well as in paper trading. These two tests then need to be compared to carefully find if there are discrepancies not only in performance results, but also the signals for entries and exits. If there differences do exists, historical data testing need to be revised, retested and corrected.

Taking shortcuts may prove a doer to be a clever person in the real world, but in the trading world, it can be a costly lesson. In fact, there are no shortcuts in trading; it's a long, winding hard road filled with potholes, in conditions with little visibility, with many toll booths along the way. Do it right and the road will be more enjoyable and profitable. Click here to view more forex chart.

Forex Trading, or The Stock Market?

24-hour market

The foreign exchange is open for business 24 hours a day, seven days a week. This is a big advantage for small investors who are just starting out and trading in their spare time. You don't have to juggle your schedule to make time for trading opportunities. Rather, you can trade whenever it's convenient for you, including at one o'clock in the morning if you choose.

Low transaction costs

Rather than being paid traditional commission-based fees, forex brokers don't charge hidden fees as a rule. Instead, the broker's fee is included in the trade within the bid/ask spread. (The spread is the difference between what you buy a currency for and what you sell it for, with the spread expressed in "pips.")

Leverage and margin

Because forex traders can trade on margin, they can have significant leverage in their trading. They can make extraordinary profits with reasonably small investments. For example, if your broker allows you a margin of 100:1, you can purchase $100,000 in currency with just a $1000 deposit. Of course, you have to use leverage carefully because it can hurt as well as help you, and you can incur large losses as well as large profits.

High liquidity and fast trade execution

When you trade in currencies, you trade in cash. Because no investment is more liquid than cash, trades are executed almost instantaneously. You don't sit around and wait for your trade to execute.

Not easily influenced

Because the foreign exchange market is so large, no individual, fund or bank, or government entity, for that matter, will influence it for very long. This is in opposition to the stock market, where one negative appraisal by an analyst could significantly hurt investors.

Relatively small sample to keep track of

With forex trading, you only have seven major currencies to follow, rather than thousands of stocks and companies as with traditional stock market trading. Therefore, you can focus a lot on just those currencies you trade in. Many successful traders don't even trade in all seven but focus on three or four. In this way, you can narrow their focus even further. If done right, this can increase your success markedly.

No bear or bull markets

Because you can trade short or long in forex trading, you can make money regardless of whether prices go up or down, as long as you guess correctly. Because of this, you have more control than you do in the stock market, where the market has a "mind of its own" in a lot of cases.