The
global forex market does more than $5 trillion in average daily trading
volume, making it the largest financial market in the world. Forex’s
popularity entices foreign-exchange 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. Here are
10 ways traders can avoid losing money in the competitive forex market.
Key Takeaways
In order to avoid losing money in foreign exchange, do your homework and look for a reputable broker.
Use a practice account before you go live and be sure to keep analysis
techniques to a minimum in order for them to be effective.
It's important to use proper money management techniques and to start small when you go live.
Control the amount of leverage and keep a trading journal.
Be sure to understand the tax implications and treat your trading as a business.
Do Your Homework
Just
because forex is easy to get into, it doesn’t mean due diligence should
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 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—a systematic method for screening and evaluating
investments, determining the amount of risk that is or should be taken,
and formulating short- and long-term investment objectives.
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How Do You Make Money Trading Money?
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 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.
Use a Practice Account
Nearly
all trading platforms come with a practice account, sometimes called a
simulated account or demo account. These accounts allow traders to place
hypothetical trades without a funded account. Perhaps the most
important benefit of a practice account is that it allows a trader to
become adept at order-entry techniques.
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.
$5 trillion
The amount of average daily trading the global forex market does.
Keep Charts Clean
Once
a forex trader opens an account, it may be tempting to take advantage
of all the technical analysis tools offered by the trading platform.
While many of these indicators are well-suited to the forex markets, it
is important to remember to keep analysis techniques to a minimum in
order for them to be effective. Using multiples of the same types of
indicators, such as two volatility indicators or two oscillators, for
example, can become redundant and can even give opposing signals. This
should be avoided.
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, pay attention to the overall look of the
workspace. 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.
Protect Your Trading Account
While
there is much focus on making money in forex trading, it is important
to learn how to avoid losing money. Proper money management techniques
are an integral part of successful trading. Many veteran traders would
agree that one can enter a position at any price and still make
money—it’s how one gets out of the trade that matters.
Part
of this is knowing when to accept your losses and move on. Always using
a protective stop loss—a strategy designed to protect existing gains or
thwart further losses by means of a stop-loss order or limit order—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 (a stop order that can be set at a defined
percentage away from a security’s current market price) can help
preserve winnings while still giving a trade room to grow.
Start Small When Going Live
Once
a trader has done his or her homework, spent time with a practice
account and has a trading plan in place, it may be time to go live—that
is, start trading with real money at stake. No amount of practice
trading can exactly simulate real trading. As such, it is vital to start
small when going live.
Factors
like emotions and slippage (the difference between the expected price
of a trade and the price at which the trade is actually executed) cannot
be fully understood and accounted for until trading live. Additionally,
a trading plan that performed like a 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 the potential for growth. But 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.
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
important, 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 becoming profitable and
successful traders.
Know Tax Impact 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 and
can help individuals take advantage of various tax laws, such as
marked-to-market accounting (recording the value of an asset to reflect
its current market levels). Since tax laws change regularly, it is
prudent to develop a relationship with a trusted and reliable
professional who 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 about 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
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