Like dieting and working out, money management is something that most traders pay lip service to, but few practice in real life. The reason is simple: just like eating healthy and staying fit, money management can seem like a burdensome, unpleasant activity. It forces traders to constantly monitor their positions and to take necessary losses, and few people like to do that.
1. Lock Of A Game Plan
Numerous traders do not have a game or trading plan. They do not know what to do because they do not have defined strategy or profit goal. A large floating profit will often turn into a large loss because they did not know when to get out. Always be sure to have a TRADING PLAN.
2. Lock Of Money Management
Trading in the Forex market can be seen as a matter of odds. The more times you are right about a trade over a certain period of time, the more likely you will be profitable over that certain period of time. Of course, if your losing trades are significantly larger than your gaining trades, simply having more gaining trades will not cause you to profit over a certain period of time. You must always take into consideration your starting capital, the margin levels you are using, and also, you must make sure that you do not overtrade your account. Not overtrading your account is essential to money management and will help you avoid common pitfalls and errors.
3. Failure To Use Stop Loss Orders
This is related to the first 2 rules: Lack of game plan and lack of money management. Failure to utilize stop loss or limit orders reflects the absence of goals and objectives. Mental stops do not prevent against irrationality, arising when individuals operate on fear and hope.
4. Talking Small Profits And Letting Your Losses Run
A very common mistake among traders is taking small profits and letting losses run. Again, this is often the result of not having a game plan. Neither having a game plan nor avoiding common mistakes ensures that you will profit in spot forex. However, having more control over your trading strategy usually results in better anticipation of profits and losses before you ever enter a trade. Thus, when you take small profits and let your losses run, you demonstrate that you have failed to set up stop losses and take profit positions, and thus, have not planned your trades appropriately. Do not trade unless you have pre-set levels for these stop loss and take profit positions for each trade. Avoiding this common pitfall should give you more control of your trading and learn more from your losses and gains.
5. Overstaying Your Position
Another common mistake of trading is overstaying your position, or simply failing to take profits at a pre-determined level. There seems to be a natural law that the market is only going to allow one individual so much money before it starts to take it back. Yet, it is when you have these profits, especially paper profits that you often try to get the last nickel out of the trade. If your price objective is met and you are still in the market without a stop loss order, you are overstaying your position.
6. Averaging A Loss
This is usually a holdover from trading stocks. In the Forex, with one to five percent margin, averaging a loss can be disastrous. A typical approach is that after you have bought a currency and it drops lower, you figure that since it was a good buy then, it is a better buy now. You can also left averaging down by figuring you will have a lower average entry price which requires a smaller move to break even. Unfortunately, you will lose twice as much if the market continues against you.
7. Meeting Margin Calls
Most often, meeting a margin call will only increase your loss. A margin call means that you were wrong, and that your position should be closed out. Because people hope the market will eventually go in a favorable direction, they meet those margin calls and continue to hold the losing position.
8. Increasing Your Commitment With Success
One of the most dangerous mistakes you can make in trading is to increase your exposure as you become more successful. You will risk more dollars per trade because you have more money. But, because you have more money (and confidence) when successful, you are also likely to take larger percentage risks. Not surprisingly, this ruins more traders than a series of small losses.
9. Overtrading Your Account
Overtrading your account or risking too large of a percentage of equity on any single trade; either by trading too many contracts for any single trade or by trading too many currencies. This often happens after a period of success when you "know" that the market is going to do something. To prevent this mistake from occurring you must have a hard and fast rule that you can risk no more than a certain percentage of your equity on any trade regardless of how good the trade looks.