It seems forex brokers only ever tell us half the story. For example, we’re more likely to hear them talk about the forex market as a world full of “constant trading opportunities” than we are to be warned that “the largest losing trade tends to be five or six times larger than the largest winning trade.”
Yet, what's worse is that, even if they had told us, our brains would probably have ignored the warning - the bit we don’t want to hear. Extensive studies, examining our reception of information, have shown that our brains are extremely biased in their selection of what information to receive.
What’s more, investors often suffer from overconfidence. Research by Ola Svenson of Stockholm University into risk analysis and decision-making, showed that most of us are over-confident. In a survey of drivers, he found that 80 per cent of participants rated themselves among the top 30 per cent of all drivers. That's reflected in the observations of Andrey Dirgin, head researcher at the Forex Club, who says thousands of people jump into the world of trading currencies as soon as “they’ve picked up the basics of buy and sell”. However, most don’t have much of a clue what’s actually going on.
Analysing the performance of new traders on the Forex Club meta-trading platform, Mr Dirgin has come up with tips to help novice traders avoid making common mistakes. His main piece of advice is to use self-analysis. “Self-analysis and reviewing your performance are key elements of becoming a successful trader,” he says.
Yet self-analysis is not an easy task. Most of us, on the few occasions when we bother to sit down and do it, do it wrong. We tend to misuse hindsight and evaluate our decision-making at the time in relation to the eventual outcome. Instead, we should review our decision-making process in relation to how much we knew and could have foreseen at the time.
We also tend to find a pattern in randomness. For example, when reviewing our decision making we might consider a decision we made as ‘good’, because its outcome was good. In fact, the decision may have been a very bad one, but luck saved us.
Here are Mr. Dirgin’s top tips for successful trading:
1.Make a Plan ... And stick to it.
“The trader plans his/her trades and trades the plan with no deviation.”
Having a well thought-through strategy is the first step to avoiding serious losses. Every time you enter a position, be clear about when you're going to pull out. If you’ve made a good plan, there’s no reason it should go drastically wrong. Expect problems though if you don’t stick to it or try to change it.
Research by Dylan Grice at Societe Generale revealed how focusing on the outcome rather than the process leads to more losses. The paper (The tyranny of targets: process, outcome and the complexity of it all) shows how imposing an outcome, for example a two per cent maximum loss, can distort the process and lead to unwanted outcomes.
2. You have to be prepared to lose.
“Most trades lose whilst winning trades are rare.”
The successful trader understands that losses are part of the game. It’s natural to be upset when you make a loss, especially when you’re not expecting it (and judging by our over-optimism and over-confidence we’re not likely to be expecting it at all!). Having been disappointed, it’s even more natural to get carried away by our emotions and this often means it's hard to resist the temptation to stake increasing amounts of capital to win back what we lost.
This is revenge trading. And, because of these emotions, our revenge strategy is normally not as well-thought through as our original one. In fact, typically, the loss from a revenge trade is two to three times larger than the previous one.
3. Loss aversion
Some traders avoids stop-loss orders and allow trades to run heavily into loss while hoping for the market to turn around in their favour. But the danger is you'll get used to losing. If it appears your strategy is no longer working or is still not working, be prepared to drop it.
‘Loss aversion’ is a dangerous emotion that makes us want to keep our losers.
4. Patience
In the same way that we tend to keep our losers, we also tend to sell our winners. The temptation is to close the trade early for a quick profit. But this is greed, not good risk management.
5. Understanding trading
Before entering a trade, it’s important to understand fully what you are doing. Or at least as much as possible. “Traders… tend to have a poor understanding of risk management and its importance," sasy Mr Dirgin. The fact that thousands of people take up trading every month with only a basic grasp of the market explains why so many encounter big losses within the first few weeks. Ideally, recommends Mr Dirgin, novice traders should take their time to learn and understand the market.
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