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It is today easier than ever before for traders to take a position across thousands of financial markets. But some things never change, and new traders can be prone to making common trading mistakes.
So what are the three most common mistakes and how can you avoid making them?
Miscalculating the balance between risk and reward
Studies show that the number one mistake that losing traders make is not getting the balance right between risk and reward. Many let a losing trade continue in the hope that the market will reverse and turn that loss into a profit. The reverse approach is applied to profits too. A lot of traders are only too eager to quickly take a profit as they are worried it will otherwise disappear.
This is of course completely opposite to that well-worn market advice 'let your profits run and take losses quickly.' The maths here is simple enough: if you are, for example, losing £100 on trades that go wrong, and only making £50 on trades that go well, your trading account is probably only going to head in one direction: down.
Before you place a trade, you should weigh up the potential profit versus the risk you are willing to take (risk: reward ratio). As a general rule of thumb, you would factor in double the potential profit amount (if not more) you expect to make versus the amount you stand to lose if the price moves in an unexpected direction.
If the trade does not fit those requirements, then the sensible approach is to pass on the trade and wait for a better opportunity to come up where the balance is more in your favor. This takes discipline of course – sadly, another trait that many traders just don’t have.
Patience is another useful trait in trading, but one that many of us will not have in the beginning. With constant access to markets and breaking news and changing prices, there can be a feeling that you need to act at the speed of light. But how many times have you opened a trade and then been disappointed that the market has not immediately taken off in the direction you were expecting?
The reality is that just because you have decided the market needs to move in a certain direction, it rarely means it will start going that way as soon as you place your trade. The market has not been waiting patiently for you to click buy or sell before going on its merry way!
Trades need time to develop, so if you have seen what you think is a good opportunity in the market then place your trade and give the market a chance to prove you right. Stop losses are very important in trading, to help protect against trades that don’t go your way, but don’t place them so close to where you entered that you will be taken out of the trade on just a normal fluctuation in price.
Risking too much capital in a single trade
The third most common mistake is in relation to the financial amount at risk. The sad truth is that most people risk too much on any one trading idea.
If you have, for example, £1000 in an account, then risking £200 on whether the euro is going to bounce is a foolhardy approach by most professional traders' standards. If losing on one trade means a serious percentage of your account will disappear, chances are that the account will not last long.
As conservative as it sounds, most professional traders would advocate only risking around 1-3% of the financial value of your account on any one trading idea. In other words, start conservatively, even though this might be going somewhat against the nature of many aspiring traders.
Source: CMC Markets UK
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