Why Forex Traders Lose Money
There is no precise information about the percentage of Forex traders who lose money in the market. However, a majority of the unverified sources in the Internet indicate that more than 90% of currency traders end up on the losing side. Still, it is not uncommon to come across statements saying “trading is not rocket science.” So, if it is easy to profit from the market, why do so many traders fail? Let us try to analyze the reason behind the poor performance of most of the FX traders.
Lack of a tested strategy
All Forex traders know the importance of a well tested strategy. However, only a few of them have the patience to test a strategy for a considerable period. A currency pair can be in an uptrend or a downtrend for several weeks. Thus, a simple trend following strategy will certainly generate high returns. However, when the same currency pair starts consolidating within a range, the strategy may create whipsaws, leading to a huge loss. Thus, a strategy should be tested both during periods of volatility and calmness in a currency pair. Backtesting is not the final step in strategy testing, but a process to identify whether a strategy has the potential to be used in the market or not. It should be followed by optimization and forward testing (paper or simulation trading). FX traders who do not have enough patience to follow these steps generally end up losing money.
Low risk-to-reward ratio
There will be always some trading opportunity in the foreign exchange market. At least one or two of the major currencies will be trending. Still, a trade should not be executed without taking the risk-to-reward ratio into account. If a currency pair is trading beneath a major resistance level, then it would wise to enter after the resistance is broken. Opening a trade anticipating a breakout could lead to losses most of the time as the major support level will be far below the entry point. In such a scenario, the risk-to-reward ratio will not suggest taking a trade. Traders who do not give importance to proper risk-to-reward ratio have higher chances of ending up in the red.
Both professional and beginner traders know the importance of stop-loss. However, applying stop-loss practically while trading in the market is a difficult thing to do from the psychological point of view. It is not uncommon to see traders complaining that their stop-loss order is often taken by a spike. That is how smart money operates in the market. Only practice can teach a trader to identify a proper stop-loss level. However, it should never be avoided. A Forex trader who avoids stop-loss will more likely get the account balance to zero.
Misuse of leverage
Forex brokers offer leverage primarily to boost their trading volumes. However, it should be used wisely. Trading one full lot of EUR/USD with a capital of $500 is risky because a 50-pip movement against the position will trigger a stop-out. However, using the same 1:200 leverage to open several one-lot trades with an account size of $10,000 is safe. Therefore, we can say that currency traders should size their positions appropriately without misusing high leverage. Otherwise they will end up in a loss.
A trader should close an open position as soon as he realizes that the trend is not in his favor. However, it requires certain determination to close a loss-making trade without giving a second thought. Greed gives false hope to a trader, making him wait endlessly. As the trend is against the trader, the losses will keep increasing steadily. Before the trader recoups himself, there would be a margin call and subsequent liquidation of positions. Likewise, a greedy trader will find it hard to close a profit-making position at the right time. Even after the currency pair reaches a major resistance level, a greedy trader will hesitate to book the profit. At last, the trader would end up realizing the profit at a lower level or even exit without any profit in case of a quick trend reversal. Thus, greediness is another trait that makes Forex traders fail.
Once a position is open, a trader should allow either the take-profit or stop-loss level to be hit. Instead, beginners tend to change their take-profit and stop-loss orders out of fear. If the market starts moving against the open position, then beginner traders generally shift their stop-loss orders and vice versa. Warren Buffett, arguably the greatest investor of all times, once said: "Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market." The same rules apply to Forex trading. A trader driven by fear is doomed.
Failing to keep up-to-date with economic developments
A lot of homework is necessary before taking a long or short position in a currency pair. Both the fundamental and technical aspects of currencies need to be studied before arriving at a trading decision. Neglecting major economic data and political developments will result in an irrevocable loss.
Currency trades should be never taken purely based on the recommendation of people whose reputation is unknown. In case a blind trade leads to a loss, the Forex trader will find it difficult to assess the reason for this loss. Therefore, Forex traders entering into trades recommended by unqualified people will continue on the road of ignorance.
The most important reasons for a Forex trader to lose money are discussed above. Of course, there may be other reasons for a trader to lose money. Those can be identified only by a detailed study of their loss-making trades. Even the most seasoned traders do incur losses. However, good traders not repeat their mistakes. This trait makes them successful.