Despite of what you may believe, 90% of traders fail in the foreign currency exchange market. The numbers of successful traders are small compared with the majority of losers. The reasons traders are defeated by the market is lack of knowledge.
Once you understand how the foreign exchange works, you must understand your own emotions as well as other people’s emotions. You must have the ability to identify high probability trade setups and be able to manage your money effectively.
As human beings, rather than logical thinking, we base most of our decisions by our emotions. Our minds can play tricks on us; emotions can seduce us into unfavorable trading situations. The mindset of the trader is the most important component for success. To be successful as a trader, you have to be self-motivated, have a solid plan of attack, and not be afraid to fail.
Successful currency exchange traders invest a huge amount of time, money and effort to attain consistent success. Consider learning the basics of foreign exchange, going to seminars or investing in trading software. Mistakes are inevitable, do not dwell on your losses, and know that there will be other opportunities to profit.
The Two Main Drivers of the Forex Market
The main drivers of fluctuation in foreign exchange rates are fear and greed. These emotions can also affect our state of mind in any trading transaction. Fear and greed are the unseen forces that tilt the scales of value in the supply and demand of currencies. Traders become consumed by great expectations that a currency will appreciate in value against another currency when they feel optimistic about a country’s money. Then they are driven by greed to buy the currency pair now and sell it for profit in the future.
As traders continue to buy, greed turns into excitement, driving currency prices to higher levels. When one currency in a pair goes up, the other goes down, fear is an equally strong emotion which drives currency price movements. When traders buy a currency with great hope, they sell the other with great fear. The problem comes when you allow emotions to influence your logic when making trading decisions, as the majority of these decisions will not be sound.
Everyone has emotions of fear and greed, they cannot be avoided the best thing to do is to control them, instead of letting them control your thoughts and actions. Recognize the fear you are experiencing and learn to manage that emotional obstacle so that you can become a better trader.
The Fear of Missing Out
The fear of missing out is a strong emotion that is invoked in people which develops from any kind of a buying craze. This specific kind of fear is a form of greed because people obsess at the prospect of a too-good-to-pass-up, opportunity.
This fear manifests itself specifically during a sharp upsurge or decline of a currency pair. The fear of missing out is so powerful that it compels you into obsessively placing buy orders; despite doubts at the back of your mind. Losses will occur, no matter how precise a trading system may be. Losses can even happen successively, specifically during unstable market conditions or when you don’t have your emotions under control.
The Fear of Losing Money
The fear of losing is most predominant in inexperienced traders as they lack adequate trading skills and understanding to evaluate trading opportunities with confidence. This leads to trading paralysis, as traders become afraid of losing money when entering or exiting trades.
The Fear of Being Wrong
To be a successful trader the ability to predict the market is not necessary. The foreign exchange market is not based certainty but on probability. No one person or computer system can accurately predict the market.
Traders should not be fixated on a single trade or the results of a few trades. The objective is to be profitable over a period of time. By putting less significance on being correct on a trade, the fear of making mistakes will cease making it possible to make better trading decisions. Keep in mind that there will be times of gains and times of losses which is why it is wise to enter only trades which yield the best probability of success.
The Disciplinary Aspect of Trading Forex
A good trading system alone is insufficient to be consistently profitable trading forex; equally important is discipline. In the foreign currency exchange there are two types of discipline, money management and emotional management.
There are 10 simple but very important money management rules that a Forex trader must follow in order to be consistently profitable.
- The money in your trading account should be considered “Risk Capital”. Even if this money is lost in a trade it will not adversely affect your lifestyle. Use only money that you can afford to lose.
- Do not leverage your money higher than 200:1 ratio. Higher the leverage leads to a higher the risk.
- In Forex trading the priorities are 1.) Money preservation 2.) Minimizing losses and 3.) Maximizing profits.
- When opening a trade position always ensure that a stop loss is in place.
- Do not ever risk more than 5 percent of the balance margin in any trade.
- The recommended risk-reward ratio is 1:3 (33%) which ensures a monthly profit even if half of the trades are losers.
- When the market is unfavorable in your open position do not open a similar position as this would be compounding your losses.
- Do not have excessive open positions which your net margin balance is not able support in the event the market is against you. This is known as over-trading.
- Only trade when the risk is minimal and only when the profit justifies the risk. Do not trade unnecessarily; Forex trading is about risk management.
- Do not leave too much funds with your broker account in other words, accumulate too much profit in the trading. Leaving too much capital with a broker is always risk.
In the same manner as money management, there are 7 simple but very important emotional management rules that a Forex trader must follow in order to be consistently profitable.
- You must have a passion for trading, if the objective is only for profit, it is not likely to provide sufficient motivation for success.
- The trading style or method you choose should be suited to your personality.
- Instead of stressing, view challenges as learning experiences.
- Stay away from adding high-risk trades to your open positions; patiently wait for trades with the highest risk to reward probability.
- Do not be emotionally attached to any position be prepared to close a position even at a loss. A loss does not make one a loser; the objective is to be profitable over a period of time. Do not dwell on gains or losses focus only on your system and follow it with discipline.
- Open and close trade positions based on logic do not allow fear to distort your thinking. Have patience, do not fear of missing out, there is always another profitable trade coming your way. A healthy diet with regular exercise will help cope with stress and other negative emotions.
- Adopt the mindset of a professional trader. More than 95% of retail forex traders lose their money to institutional traders. Why not adopt the mindset of these traders so that we can use it against them. Without a change in mindset, it doesn’t matter what trading system you use, you will lose your money to institutional traders, eventually.