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Be Less Dumb- Avoiding Trading Traps Part 1
The irony of the trading life is that we spend 99% of our time trying to figure out how to win instead of making sure that we don’t lose. The fact of the matter is that most traders will benefit far more from learning how to avoid the common traps in the market than from refining yet another derivative of a derivative of a derivative strategy.
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There are three common traps in FX in my opinion and each is destructive in its own way not because of the intrinsic damage that it does, but because of what we do NEXT. Namely, every time we fall into one of these traps we lose our psychological equilibrium and do massive damage to the account as we deviate from our business plan ( see my column last week).
This week I will address personal traps that ensnare us all.
The easiest quickest and most certain way to lose money in FX is to overlever your account and have a margin call automatically stop you out. In order to properly manage your leverage you need to understand the concept of capacity -- that is the maximum notional amount of all open trades that you may carry in the market at any given time. If you strategy calls for possible 5 opens trades at once you cannot have each trade at 10:1 lever factor because you will run out of usable margin. This is the easiest mistake to correct and yet the most common one that we all make. Generally the rule of thumb for US based traders where max leverage is 50:1 is that your capacity should not exceed 20:1. That means that if you are going to have up to 5 trades open at once -- each trade cannot exceed 4:1.
Order entry mistakes
We all hit sell when we mean buy and then nurse the trade hoping that it will become profitable. Deadly mistake. Hit the wrong button? Get the F-out!. Don’t think, do. The 5 or 10 pips that you will lose will be a pittance compared to the money you will lose by holding on to a trade.
But perhaps the worst mistake we make is to forget to attach a stop to every order. It is IMPERATIVE that you check all your floating trades and make sure that each has a stop behind it.
Orders over the weekend
If you are a long term trader who holds positions with 300-500 point stops then this trap is not for you. But if you primarily day trade then holding positions over the week-end can be like stepping on landmine. All you need is just a couple of weekends during the year to wide gap open against you and your account will feel the pain. Bottom line if you daytrade. Get flat for the weekend.
As one of my traders in our chat room said today -- the motto for success in our business is Be Less Dumb.
The key to making money from the markets does not lie in a newfangled system. It is much dependent on avoiding the common traps.
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