It is a widely known fact that most people who trade Forex, or foreign exchange currencies, lose money in the long run. To put a specific number to it, 90% of traders, or even more, lose money and end up closing or abandoning their account. By understanding the root cause(s) of failure for the majority of traders, you can avoid these financially costly mistakes and make more informed trading decisions.
Most traders lose money due to the following main reasons:
- Low Startup Capital: this leads to overtrading and overleveraging to compensate for the low capital.
- Improper Risk Management: traders are unable to control risk and end up losing more money per trade than they can afford.
- Fear of missing out and greed are both huge psychological barriers to consistently profitable trading.
These are only a few of the many reasons why traders lose money. Read on further as we discuss more reasons for trader failure. We’ll also be talking about other related questions you might have regarding the diverse and intricate world of Forex trading.
Table of Contents
- 1 Failure in Forex Trading – The Causes and How to Beat Them
- 1.1 Low Startup Capital
- 1.2 Improper Risk Management
- 1.3 Poor Trading Psychology
- 1.4 Lack of Research When Finding a Broker
- 1.5 Lack of Forex Education and Demo Practice
- 1.6 Lack of Trading Journal and Accountability
- 2 Relevant Questions
Failure in Forex Trading – The Causes and How to Beat Them
Low Startup Capital
Novice traders often get too excited to jump into Forex, thinking they can become profitable overnight. But the reality of Forex trading is that you need money to make money. Too little capital and the trader ends up overleveraging and frequently trading to compensate for the nominal profits being generated. And while it is possible to start trading with $10 on your account, this should be taken by the trader as an opportunity to learn how the market works in real time rather than as a day job that can provide for you financially.
Improper Risk Management
Risk management may arguably be the top reason why traders lose money in Forex. Most novice, and even some experienced, traders lack the risk management rules to avoid devastating financial losses. This includes failure to have an exit strategy in the form of a reasonable stop loss, trading in highly volatile market conditions, and increasing frequency and size of trades.
Money management is key to protecting capital while growing it. A risk/reward ratio of at least 1:2 is recommended to be profitable over time. Risk/reward ratio pertains to how much you are prepared to risk for whatever amount you expect to gain. For instance, a 1:3 risk/reward ratio means you are willing to risk $1 to gain $3.
Part of good money management is the proper use of leverage, a facility that magnifies your trading position and consequently the potential profits or losses of that position. Brokers offer leverage of up to 1:500, meaning that every $1 you deposit into your account can buy $500 worth of currency. Leverage can quickly increase any potential upside on a trade, but can lead to huge losses if used carelessly.
Proper Leverage Use
Ideally, a Forex trader should use no more than 100:1 leverage. That means that with a $1,000 account, you should only be controlling $100,000 worth of currency, which is equivalent to one standard lot. Before you even start trading, determine how much of your account equity you are willing to risk on the position. If you are willing to lose 5% of your account equity on a $1,000 account, that’s $50. The percentage is what is referred to as a percentage risk.
Keep in mind that risk and leverage are two completely separate things. Most traders confuse the two as the same. What’s important is to choose the right risk percentage based on your account size and then translate that risk percentage into the appropriate lot size using the leverage that you have selected.
A good solution to improper risk management is to have a risk management plan that includes a predetermined leverage and risk percentage that is based on your account size and have a stop loss and target profit for every trade. By automating your entries and exits, you remove the possibility of large losses hitting your account.
Poor Trading Psychology
Psychology is another common barrier to trading success. Even with a high win-rate strategy and a rock-solid money management plan, poor trading psychology can force a trader to ignore and abandon all of the rules and trade haphazardly. This results in more losses, which eventually forces the trader to engage in further riskier investments made out of poor risk management and an unsteady mindset. This becomes a vicious loop until the trader ultimately blows his/her account.
Greed and fear of missing out are the two most common mindsets that force traders into taking unnecessary levels of risk. A trader’s greed can lead to trading too often and/or trading too big a position size to try and maximize profits. Fear of missing out also leads to frequent trading as people try to catch every up and down in the market.
Fixing trading psychology is a matter of internal self-evaluation and a constant practice of discipline and focus, which typically take traders time to form into lifelong habits. Here are some tips to help you form healthy trading habits.
- Set hours or a schedule for trading. Avoid checking the Forex market outside of those hours.
- Manually record your trades in a journal.
- Limit your trading to a few currency pairs. Familiarize yourself with those pairs before expanding to new ones.
- Set a positive risk/reward ratio and risk percentage before opening trades.
- Always set a stop loss and target profit for each trade.
These tips and any trading strategies or risk management plans that accompany them won’t matter if you are unable to follow them strictly and consistently. Find life hacks for staying disciplined, such as not depositing any new capital until you’ve reached certain milestones or at least broken even.
Lack of Research When Finding a Broker
The broker you use to execute trade orders will determine how fast/slow you get those orders filled, what spreads you have to pay per trade, what charting tools and technical features you have access to, and what educational resources you can use to make better trading decisions in the future. Here are some things to look for in a broker.
Fees and Spreads
A spread pertains to the difference between the buy and sell price of a currency pair. For instance, if NZD/USD has a buy price of 0.6490 and a sell price of 0.6500, then the spread of the pair is 10. This, however, does not necessarily equate to the dollar amount of $10. The dollar amount of a spread will depend on your trade/lot size. Opt for a broker that offers low spreads and no additional or hidden fees.
There are two main account types that are usually offered by a broker: standard and pro account. Standard accounts are charged with a spread per trade while a pro account will get charged a minimal raw spread in addition to a fixed commission. In exchange, pro accounts often have access to more currency pairs to trade, higher leverage, and more advanced charting tools.
The most common platform for trading Forex is MetaTrader 4. However, some brokers also have their own proprietary platforms for trading. A good broker will have at least two different platforms for you to choose from. Look for a broker that has a mobile version of its trading platform on the App Store and Android Market. Having the option to check and manage your account through your smartphone is priceless when it comes to trading.
If you are unable to sign in to your account, or if you are having issues using the platform, how quickly and easily can you reach the broker’s customer service team? You want to be able to keep your account online at all times to capitalize on trade opportunities in real time or to manage losing positions.
How stable is your broker? Can it handle major price moves that could wipe out leveraged trading accounts overnight? If your broker turns belly up without warning, your capital might be unavailable for withdrawal. A way to gauge whether or not a Forex broker is financially responsible and stable is to see if they are regulated by the NFA, ASIC, FCA, SVG or any other government regulator. Check our guide to learn how to assess a Broker properly.
When browsing for a reliable broker, you’ll likely stumble upon different Forex schemes. You’ll have brokers promising you extremely high leverage of up to 1:1000 or even offering to give you free startup capital to trade. These are all red flags that you should be wary of lest you risk your sensitive financial information being stolen and misused.
Lack of Forex Education and Demo Practice
Having no Forex education, formal or otherwise, leads to failure to identify market patterns and economic catalysts that move prices. Fortunately, there is an abundance of educational resources out there to supplement your learning. You can sign up for an intensive Forex course led and taught by a professional trader or peruse community-driven trading websites that have tons of contributions from like-minded individuals.
Many novice traders also get too impatient and skip the crucial step of practicing their trading mindset and strategies on a risk-free demo account. Practicing on a demo account may not yield real profits, but it does give you an idea of how trading will feel once you go live. You can also use demo accounts to forward-test your strategies in real-time market action. Think of a demo account as a Forex simulator, helping you gauge your strategy’s performance over time in different market cycles and chart patterns.
It is recommended for traders to begin by using a demo account for the first six months or until they have reached a favorable win rate on their trading strategy. Once you transition to a live trading account, only risk a nominal percentage of your capital.
Lack of Trading Journal and Accountability
Although complete freedom is one of the main upsides of a trading career, it can also work against you by removing accountability from the equation. You can easily shrug off any irresponsibly opened or closed trade without remorse.
Requiring yourself to keep a trading journal that lists each trade in detail gives you that sense of accountability. You are forced to use logic and reasoning as baselines for why you want to open a position in the market instead of submitting to your emotional impulses. A trading journal can also be a great resource to refer to for technical setups and to dissect emotional issues that are affecting your trading performance.
Are There Profitable Forex Traders?
Yes, there are. Hedge funds, such as George Soros’ Soros Fund Management, engage in currencies trading as part of their portfolio. And with an increasing number of hedge funds pointing their massive resources toward the Forex market, the industry expects more profitable traders in the future. That being said, it can be difficult to figure out the specific percentage or how profitable these successful traders since the data is often made private and inaccessible to the public.
Can You Trade Forex for a Living?
The answer depends on how much you have on your trading account and the percentage of it you are willing to risk per trade. Say you have $1,000 and you are only prepared to risk 5% per trade, which is $50. For the $50 risk, you have a potential reward of $150 as you’ve set your risk/reward ratio to be 1:3. Now, even if you can live off of $150 per day, you are not guaranteed to make $150 every day as some days prices might not move and simply consolidate.
How Difficult Is Forex?
The technical side of Forex is quite straightforward. It only starts to become complicated once you introduce technical tools and indicators as well as quantitative strategies to try and predict future price movement. A truly difficult bit in trading is keeping the right mindset when you’re losing money on a trade. Without a sound mindset, a novice trader can throw out the game plan and risk more than what he/she can afford.
How Long Does It Take to Learn Forex?
There is no linear learning curve for Forex traders. How fast you grasp the concepts is up to you. Forming the habits of patience, focus, and discipline will perhaps take longer than learning the technical side of trading. And even when you do nail down the fundamental concepts of trading, you can expect to learn new things over time as you discover new strategies and ways to manage risk and grow your portfolio.
There are different reasons why Forex traders lose money and blow out their accounts in a relatively short period of time. But what’s identical is what traders have to do in order to succeed. Keep in mind that self-awareness and acknowledging the presence of these issues is inadequate; you need to actively avoid them using the aforementioned tips.