“Oh, you trade? I would never trade, it’s TOO risky!”
“You could lose all your money trading”
“I blew up an account try to learn how to trade!”
These phrases and sentiments are quite common when the topic of forex trading is discussed. Any time that I hear one of those phrases, I promptly agree. It IS a risky endeavor.
However, I quickly add that where there is risk, there is reward! IF you can identify your risk, you can plan for it and even control it.
IDENTIFYING RISK
Let’s identify the risk in the trading world, because if we can identify it, we can manage it. It’s quite simple really. In order to make money in the markets, you need to risk money. So, one of the risks in trading is losing money! You could lose money! Fortunately, there are so many strategies and courses that can teach you how to make money in forex trading, It’s important to learn how to keep what you’ve made.
In trading forex, it is best to understand what can prevent you from making and keeping money. These are some of the biggest risks that traders need to identify:
A. Improper position sizing
B. Overtrading or “revenge” trading
C. Underestimate and mismanagement of emotions in trading
Improper Position sizing: It’s difficult to lose money even if one has it in abundance, the risk of losing money can be the biggest obstacle to overcome for traders who do not have a lot of it. When one has a small amount of money wanting to make larger amounts quickly, the temptation is to use large position sizes. This is the natural tendency, to go fast and strong and all in. But it’s one of the biggest risks in forex trading. Because while one large position only needs a small move to make a lot of money, the same large position only needs a small move to lose that same amount. A large position on a small account balance is a risky proposition.
Overtrading or Revenge Trading: Typically, when a trader makes a mistake, they want to fix that mistake right away. Often, trying to fix a trade immediately does not fit within their trading strategy and that can cause making another mistake. This can cause a cascade effect and quickly lead to overtrading. When a trader overtrades, they are placing many more trades than their trade plan or skill level allows. Overtrading is sometimes called “revenge trading” because a trader is trying to quickly fix a bad outcome or quickly get a better outcome without any looking to their process or following sensible risk rules. Succumbing to revenge trading is one of the biggest risks to trading forex.
Underestimation and mismanagement of emotions in trading: In my opinion, this is the biggest risk to trading forex. Both of the previous risks of improper position sizing and of revenge trading are tied to emotion. The emotions of greed and fear are the most common emotions, which all other emotions in trading stem from. When traders over position size, it is typically because they want to make more money more quickly. Greed. When traders overtrade to fix mistakes, it’s because they are afraid of being wrong or having a bad result. Fear. The trader that fails to identify and recognize these emotions that cause risky behaviors, will inevitably underestimate and mismanage their emotions while they trade.
I like to share a story about the first trade I took in my live account. I had paper-traded for a year and had done really well so I thought that trading would just be easy and smooth sailing. After I scrounged up around $11,000, I placed my first trade. Can you guess what happened? No, I didn’t blow up the account (that’s most traders’ first guess), I lost $200. Less than 2% of my account.
Not bad, very reasonable loss, right?
Well, not to me. I bawled like a baby on the drive home. But why?
I had no idea the emotional impact losing real money would have had on me. I had lost trades plenty of times in my demo account, but losing REAL money, that was not something I was prepared for. I underestimated the impact of emotions in live trading.
Luckily, because I had identified the first two risks of trading, I was able to follow the basic risk rules of proper position sizing, to refrain from overtrading. Doing so helped mitigate some of the trading risk that comes from the emotions! You want to be able to recognize and identify how much a losing trade affects you emotionally in order to better plan for it.
Next post on Planning Risk. Stay tuned!