Markets are unpredictable. Many new traders charge full throttle into the markets with big ideas and high-profit expectations, but soon find out that making money consistently is not as easy as they expected. If you’re at the start of your trading journey, this guide will take you through a few top tips to get you started. If you are already familiar with trading, you will notice some of the biggest and most common trading mistakes, and hopefully how to avoid them!
Make a trading plan
It’s important to have a proper “plan of action” in place before you trade. Know your entry and exit price levels for every position, before you place the trade. How much capital are you willing to risk for each trade? Have you put a stop order in place, or perhaps a profit target? What is your exit strategy? A trading plan defines what is meant to be done, when, why and how. These tools and methods will serve as your line in the sand. For many newbie traders, keeping your emotions in check is tricky business, and a trader with no predetermined trading plan is a recipe for disaster. Making a trading plan and setting risk management rules will help limit trading mistakes and minimise your losses.
Be disciplined
We’ve established the importance of a trading plan, now the important part is sticking to it! A trading diary is a good idea. If you record every time you enter a trade and the reasons behind it, it will help you analyse each trade, whether it was profitable or loss-making. It will help you understand what did or did not work and the surrounding circumstances. This in turn will help you learn from your trading mistakes. Containing your emotions and maintaining discipline are two fundamental characteristics of a good, successful trader.
Use protective stops
Most disciplined traders use stop-loss orders, but it is surprising how many new traders either don’t incorporate them into their trading strategy at all or are not quite sure how to set them correctly.
Stop loss and take profit orders are both orders placed in the market to close an open position at a predefined level, although they serve different purposes. A stop-loss is set to potentially limit your losses when a trade goes against you, while a take profit order works to lock in your profits and close the position if the take profit level has been reached. Make sure your stop loss isn’t too close to the current price that you end up getting stopped out of your trade before any real price movement has occurred. Once you have set your stops, honour them. Shifting the goalposts is usually not a good idea.
It is important to remember, that in certain circumstances it is possible for you not to be filled at the particular market price you set your stop level at. This may be because of ‘slippage’ which is based on two factors, liquidity and volatility, as slippage can occur in fast-changing market conditions or in markets where there is a lack of liquidity.
Gap risk is also a potential factor, which can occur when holding positions open during closed market periods. You can read more about ‘gap risk’ and non-guaranteed stop losses in our guide: Risks of trading CFDs.
Apply good money management
Discipline in money management is key if you are setting out for long-term success. Good money management incorporates factors such as setting a sensible risk-to-reward ratio, realistic profit expectations and being prepared for whatever the market might throw your way.
The key questions traders should ask themselves are: how much do I risk to get the reward I am looking for? If I open this trade, do I have enough money to trade additional positions? This is exactly why setting unrealistic profit expectations is a bad idea, chasing the profit without any real thought about the impact of your trading decisions. Essentially money management is another form of risk management in your trading strategy. Therefore, applying good money management rules to your trades can help minimise your risk.
A few golden rules should always apply:
- The money used to fund your trading account should be capital you can afford to lose
- Never risk too much capital at one time
- Try determining a “worst case scenario” for each trade to help allocate sufficient capital
Set your risk-reward ratio
What is the best risk-reward ratio? Unfortunately, it is not a straightforward answer. The optimal risk-reward ratio depends heavily on how much an individual feels comfortable risking on a single trade, as well as their trading style or strategy.
The concept of the risk-reward ratio, however, is simple. Risk is the amount of money that you may lose in a trade. The lower the risk-reward ratio, the smaller the risk is relative to the potential reward. For example, you might risk 1% of a 100k equity account ($1,000) but aim for a 2% gain on the upside of ($2,000). This will be a 1:2 (risk: reward) ratio where you aim to take a profit twice as big as the loss you’re willing to accept on the same trade.
As a rule of thumb, you should always calculate your risk-reward ratio of a trade, before you enter into the position. A low risk-reward ratio is advisable for new traders, as this will help minimise potential losses. More experienced traders, on the other hand, often take on more risk in pursuit of potential bigger profits. To avoid big losses, another common money management rule is not to risk more than 1% of your total account value on a single trade.
Understand the markets
Never enter a trade blindly. It’s best practice to allocate time to analyse the markets, study and review your performance, which will help tweak your overall trading strategy.
Keep an eye on what moves the markets. Global financial news events, major economic data releases, and political instability, all have the ability to change market sentiment which in turn will have a significant impact on the price of major currencies. For example, make a note of upcoming key dates on and off the economic calendar which could affect the markets in which you trade. Do your homework!
Diversify wisely
There are definitely benefits to diversifying your trading portfolio, however trading too many markets merely for the sake of diversification can be just as detrimental.
Don’t leap into trading markets you neither understand nor are familiar with. If you are new to trading, don’t try to spread yourself too thin by trading too many different markets at once, especially in the beginning. Doing this will just make it harder for you to make good and informed decisions. Limit yourself to one or two markets. Analyse those markets and familiarise yourself with how those markets react to certain factors. As you become more experienced, it will become easier to diversify your trading portfolio further and trade a wider range of markets.
Keep your emotions under control
There are many common emotions associated with trading, whether you are new to trading or an experienced trader – fear, greed, stress, happiness, anger, frustration. Most traders have felt them all. However, it is important to keep your emotions in check.
Knowing when to stop and admit defeat when a trade has not gone the way you had hoped, is an important skill to develop. When you make a mistake, you need to know when to call time and continue to the next trade, rather than holding out and hoping that the market will turn in your favour. Cut your losses and move on. This also works the other way around. When a trade goes in your favour and you have already made a good profit, it’s important to establish how far to let them run and when to take that profit and get out. Greed is one of the biggest mistakes some traders make.
Many traders get so emotionally involved in their trade, that if the trade goes against them and they are wrong about their position, they react badly. The same applies to a winning trade. A lack of patience and overreacting to wins are two bad trading characteristics you should learn to shift. Don’t let big profit wins cloud your better judgement on future trades. Your trading strategy should not adjust because of a few winning trades. Make sure you stand by your risk and money management rules and don’t get overconfident. Keeping your emotions in check is a very important trading discipline to grasp. Emotional trades can be costly and very counterproductive. Don’t let your emotions get in the way of making good judgement calls and sensible trading decisions. Remember, you are more likely to make informed and educated trading decisions when you are calm and clear-headed.
Choose a trading style to suit you
Your trading style should match your lifestyle, which in turn depends solely on how much time you can dedicate to your trading strategy, analysing the markets and placing trades. Are you a full-time worker or do you have sufficient, flexible free time? The answer you give will dictate what trading strategies and methods you will be able to adopt.
There are four main types of forex trading strategies: scalping, day trading, swing trading and position trading. Scalping is the most short-term form of trading, with position trading (long-term trading) on the other end of the spectrum. As you will learn, some trading strategies take up more time analysing the markets on a daily basis, than others. It’s up to you to decide which one suits your lifestyle.
Deciding what type of trader you are is something we look at in more detail in our article Different types of trading strategies.
