Dangerous Misconceptions On Forex Trading

Dangerous Misconceptions Of Forex Trading

Today’s lesson is all about laying to rest some widespread misconceptions that are circulated around the Forex trading world and that get lodged into many traders minds. Through talking with hundreds of traders every week, I have a front-row seat to some of the most prevalent misconceptions that traders have about trading and what it takes to succeed at it. A lot of these inaccurate and ineffective ideas are really more than just ideas, for many traders they are patterns of thinking that trap them in a cycle of bad trading habits and that cause them to lose money in the markets. What’s even worse is that many of the self-defeating beliefs that traders have are found on popular trading websites and other media sources, so they seem legit. So, today I am going to give you guys my point of view on 6 of the most erroneous trading beliefs that many traders possess, and hopefully you’ll begin thinking a little differently about trading after reading this lesson.

Misconception 1: It’s harder to make money on higher time frames and it takes longer 

I get a lot of emails from traders who say that they think trading the daily charts will cause them to take on more risk per trade since the stop loss distances might be a little wider than lower time frames. I also get emails from traders saying they are afraid there won’t be enough “opportunities” if they trade the daily charts. Here’s my response to both of these success-inhibiting beliefs:

            A) To say that you have to take on more risk when trading higher time frames like the 4 hour or daily charts simply shows a lack of understanding of position sizing. If you need to put a wider stop loss on a trade setup because you’re trading a higher time frame than you’re used to, you simply need to adjust your position size down so that your dollar risk amount stays the same.

For example, if you typically risk $100 per trade on the EURUSD and you had a 25 pip stop loss on your previous 30 minute chart trade but now you’re looking at a 50 pip stop distance on the 4 hour chart, you don’t take on more risk, you just drop your position size down. So, if you would have traded 4 mini-lots with your 25 pip stop loss ($4 per pip multiplied by 25 = $100), then on the 4 hour trade you will only risk 2 mini-lots instead of 4, that way your risk stays at $100 ($2 per pip times 50 = $100). Thus, you adjusted your position size down to meet the same dollar risk tolerance, but you have not taken on more risk. If you want to know more about position sizing please read my article on risk reward and position sizing.

            B) The second misconception about higher time frame trading that I want to address is that there are “not enough setups on the higher time frames”. This belief is simply irrelevant, as well as untrue. First off, the way that I trade and teach my members to trade is that quality of trades is far more important than quantity of trades. Indeed, most traders lose money primarily because they trade way too much, simply scaling-back the amount of trades you take per month will very likely build your trading account faster. For any given trading edge, there simply are not a lot of high-probability setups per month or per week or per day that are worth risking your hard-earned money on. But, thanks to our intense desire to make money fast and with little effort, many people tend to trade when there’s no high-probability opportunity presenting itself and no good chance of making a profit. Thus, whilst you might not be used to trading just 4 or 8 times a month, rather than 48…it does not mean your chances of success are diminished. I don’t think I need to do too much more convincing about the perils of over-trading as I have written a lot about it before, if you want to learn more than please read my article about why over-trading is a trader’s biggest mistake.

The idea that there are less trading opportunities the further up in time frame you go, is simply inaccurate. Many traders have a very broad definition of what they consider “opportunities”, and you have to consider that whilst there might be more setups that fit the definition of your trading edge on low time frame charts, they are low-probability setups. So, sure you might find more pin bars or other setups on a 30 minute chart over a daily chart, but you have to consider the probability of the setup and what it means, not just that “it’s there”. A daily chart signal carries much more weight and meaning than a 5 minute or 15 minute chart. So, don’t mistake a higher quantity of setups on low time frames as “more opportunity”, there is a big difference between seeing your setup on a 5 minute chart and a high-probability instance of your setup…they are not always the same thing, and in fact rarely are.

Misconception 2: You should always let your winners run 

We all hear the old saying “cut your losers short and let your winners run” when we are learning to trade, indeed this saying can be found on almost any trading website you stumble across. But, what exactly does it mean? How is it done?

Often, traders get the idea that they should ALWAYS try to let their winners run as much as possible, and this results in them actually making less money over time. When you get in the mindset of trying to let every trade run or setting huge profit targets, you end up simply never taking profits, or taking small profits. It’s a very funny thing that it’s psychologically harder to close a trade out when it’s well in your favor than when it’s coming crashing back against you. But, many traders who are trading emotionally and with little or no forex money management plan end up waiting to take profits until their trades are moving rapidly against them back towards their entry. The reason this happens is the same reason people go into a casino, make a little money early on and then continue to play with that money until they’ve lost it all and then some, turning what was a profitable trip to the casino into a losing one; because when you are up money it FEELS really good…so it’s hard for most people to make a conscious decision to take their profits and cut off that good feeling.

As traders, we often tend to feel “warm and fuzzy” when our trades are cruising in our favor, forgetting that the inevitable retrace is coming. Typically, many traders end up not taking profits when they are up a lot of money, it’s only when the market reverses and they see their profit quickly evaporating that they decide to exit emotionally, usually for a much smaller profit than they were up, or for a loss. This is why I am a big fan of simply taking a 1:2 or 1:3 risk reward profit on most of my trades; it often allows me to exit when the market is in my favor rather than when it’s crashing back against me. I don’t always take a rigid 1:2 profit, but no matter what, I always have a plan of action on how I will manage my exit before I enter.

Misconception 3: You should risk 2% of your account per trade

The “2% rule” as it is commonly known, can be a very limiting way to manage your money as a trader. I suggest people risk a “comfortable” dollar amount per trade, I don’t believe in the percent of account concept for many different reasons. The primary reason is that percentages are all relative to your trading capital, but a dollar amount is concrete. For example, a trader might say he made “10%” on his account last month but that might only be 100 dollars, whereas another trader could say he also made “10%” last month but that could be 10,000 dollars. So, as you can see, dollars risked versus dollars gained tell the most relevant and honest picture of a trader’s performance and thus it’s the best way to manage your trading money.

Account size is irrelevant for many people; essentially it’s just a margin holding account. For example, your actual available trading capital may be 100 times what you have in a Forex account. But you might choose to keep most of your capital in an account that yields a slower more consistent return; because you can trade off high margin in your Forex account there’s no need to hold all your money in your trading account. This is of course for traders with a decent amount of risk capital; someone with 5 or 10k to trade with will probably want to have the whole amount in their trading account. The point I am making is that calculating the percent of your trading account you want to risk per trade is not always the best route to take. In my opinion, and in the opinion of other pro traders I know, the actual dollar amount you risk per trade is what really matters and it is something you have to work out your own. I get a lot of emails from traders asking me how much they should risk per trade and my response is usually something along the lines of;

No one knows the dollar figure you are comfortable with potentially losing per trade better than you, because you know your own risk profile, trading ability and overall financial situation better than anyone.

Here’s one tip for you to help determine the dollar amount you should risk per trade, besides the fact that you need to be emotionally “comfortable” with it:

You should be able to handle 10 to 20 losses in a row as a worst case scenario. It’s unlikely this would happen if you’re trading like a sniper, but it’s possible. So, make sure you could lose the amount you want to risk per trade 10 to 20 times in a row and still be “OK”.

As I said, for some, the account size is arbitrary and not as relevant. So the % risk model is really pointless. I use fixed $ risk per trade given the size of my trades. I have a plan and follow it precisely. I am not trying to compound account balances. I withdraw profits often and save or spend the money.

Misconception 4: Brokers are trying to scam you

This is a biggie that I get emails about almost every day. It seems as though many traders think brokers are the enemy, constantly trying to scam them and “run their stops”. Whilst I am not denying that there are some less-than-scrupulous Forex brokers out there, the really bad ones usually don’t stay in business too long and most brokers are reputable and safe. A brokerage has a financial self-interest to provide its clients good service and support, and the broker industry has a lot of competition, especially in Forex. So, it really doesn’t make sense that brokers would constantly be trying to cheat or scam their own clients…and most don’t.

I am not trying to defend all brokers, but let’s face it; they are a really easy target and often times they get unfairly blamed because a trader didn’t understand that the spread might widen during volatile price movement or for other similar reasons. Also, reviews that you read on various Forex forums are typically full of inaccurate statements, exaggerations, slander and lies, so there’s really no point in paying attention to most of them. Some traders will even go onto a public forum and post a bad review of a broker after losing on a trade from something that was their fault, not the broker’s. Many traders don’t want to own up to the fact that they alone are responsible for losing money in the markets and brokers make very easy targets (scapegoats). Still, it doesn’t hurt to make sure the broker you want to use is reputable and regulated by the regulatory agency of the country it’s based in, for more information on the brokers we use for trading execution and charting analysis.

Misconception 5: Economic news is extremely important 

With all the economic news that floods the airways and internet each day it’s almost impossible not to assume it’s really important. This causes traders to pay way too much attention to it and lose time and money as a result. Over-analyzing forex news variables and other economic variables is one of the biggest reasons why traders second-guess themselves and become frustrated and confused. I believe that all economic variables are reflected in a market’s price action, so I pay little to no attention to news reports and I couldn’t be happier about it.

Misconception 6: Trading systems and strategies are the most important aspect of trading

If you go to any bookstore and look at the finance section you will find a lot of books on technical analysis but far less on trader psychology and money management. Same thing if you do a Google search for something like “forex trading system”…you’re going to find Forex trading software, robots, signal services, etc. You have to be a little cleverer and do more digging to find solid education on trader psychology and money management…why? It’s primarily because most traders just want to learn what they think is a “magic-bullet” trading strategy and start trading as soon as possible. Money management and trader psychology often seem like secondary things that they can learn later.

The truth is that trading is not very difficult from a technical chart analysis stand point, but trading systems and strategies are what people like to learn about the most because they think “after I learn XYZ trading system I’ll start making money”. In reality, it’s a combination of trading method, proper trader psychology and money management skills that make a professional trader and you really have to have all three if you want to make consistent money in the markets. These three “pillars” of trading success as I will call them, are closely connected with each other and if you have one pillar missing or weak, the other two will crumble eventually.

Wishing you best in trading.

t4josy