Talking Points:
- Traders fail by risking too much per trade
- Traders fail by not adapting to market conditions
- Traders fail by using a negative Risk:Reward ratio
Many people from all walks of life give Forex a shot, but most people that attempt it lose money. Have you ever wondered why that is? At DailyFX, it is our job to assist people in reaching their goals and make them the best traders they can be. So in today's article, we are going to look at some of the top reasons why most Forex traders fail, and how we can improve our chances of profitability.
Trading Too Big
One of the major selling points of the Forex market is the large amount of leverage that is available. In the United States, traders can trade up to 50:1 leverage. In the UK, traders can trade up to 200:1 leverage. And in some parts of the world, traders can use as high as 400:1 leverage! Talk about risky... But many traders cannot help themselves and want to trade big. The problem is using high amounts of leverage reduces the chance that we will be profitable in the long run.
In my previous article, 3 Things I Wish I Knew When I Started Trading Forex, I explain how leverage can actually cause an otherwise profitable strategy to lose money. This occurs because some traders risk their entire account on 1 or 2 trades where a stroke of bad luck can completely wipe them out. The solution is to try to use less than 10x effective leverage, and try not to risk more than 2% of you account on any individual trade. That way, if your strategy has an edge, you should see a profit in your account in the long run without a blow up.
Not Adapting to Market Conditions
Often overlooked, market conditions play a huge role as to whether or not our strategies will be successful. Many traders might find a strategy that makes money some of the time but then loses money the rest of the time. A lot of times these changes in our "luck" has to do with how the market conditions has changed.
It's important for us to Change Strategies When Market Conditions Change. So during times of low volatility when a currency pair is moving sideways, it would make sense to trade a range strategy. If we tried to apply a trend based strategy during that same low-volatility period of time, it'd probably produce poor results. But if we used that same trend strategy when volatility was higher and a currency pair was consistently moving upward or downward, our results would likely be much better.
Learn Forex: Volatility Decreasing Over Time, Great for Range Strategies
The chart above shows volatility over the last year and a half. Because volatility has been dropping, I've seen trend trading systems become less profitable and range bound systems perform much better.
Risking More Than We Can Earn Per Trade
The 3rd reason why many Forex traders fail is that they use a negative Risk:Reward ratio. Meaning, they (on average) risk more money per trade than they attempt to earn. This point is actually one of my potential tweaks that can Improve Your Trading Strategy in Two Minutes or Less.
When traders set their stop losses far away and set their profit targets close, they put a lot of pressure on their strategy's win rate to turn a profit. For example, if I always set my stop at 30 pips and my limit at 10 pips, I will need to have at least a 75% win rate to break even. Imagine winning 3 out of every 4 trades and still not making any money.
But if we set a positive Risk:Reward ratio, we can flip these percentages around. Let's say we use a strategy that has a 30 pip limit and a 15 pip stop. With this ratio, we only need a 33% win rate to break even. If our win rate turns out to be higher than 33%, we will be turning a profit.
Understand that the closer our stop loss is in relation to our profit target, our win rate will go down. But our win rate does not need to be near as high to make money.
In Conclusion
Hopefully these three examples of why many Forex traders fail will help you not become just another statistic. With the right tools, knowledge, and mindset, anything is possible. If you would like to test some of these tips risk-free, download a Free Forex Demo account today with free charts and real-time pricing data.
Good trading!
---Written by Rob Pasche
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