10 Ways to Avoid Trouble in the Markets

02/11/2014 6:00 am EST

Focus: TRADING

John Forman

Senior Forex Analyst, Thomson Reuters IFR Markets

Trading can be an exciting and lucrative career, but just like any other endeavor, there are pitfalls along the way, which John Forman of The Essentials of Trading hopes to help you navigate successfully with his tips below.

So you want to trade, eh? Or have you already started? What drew you to it? Was it the huge profit potential? Maybe it was the excitement. Or perhaps you’re like me and love the challenge of solving a big, multi-dimensional puzzle. Whatever the case, there’s certainly a number of things that make trading the financial markets worthwhile. At the same time, however, there are some huge obstacles along the path to profits and success. In this article I will give you ten ways to avoid trouble in the markets. They will help protect your capital and increase your chances of success. Ready? Let’s jump right in!

#1 Avoid Errors in Order Entry!
The quickest way to lose money in the markets is to make mistakes when you place your orders. Fortunately, this is something very easy to fix. PAY ATTENTION! It’s as simple as that. Every trade entry system you could use has some kind of order confirmation mechanism. Take the extra two seconds and check to make sure everything is correct. I can assure you this will save you money, not to mention a little stress and high blood pressure.

#2 Use Only Risk Capital!
New traders often get so caught up in the excitement and anticipation of trading that they let common sense go on holiday and trade with money they have no business putting at risk. Any money you put in to the markets must be risk capital, money you can afford to lose and not impact your basic financial situation. It’s hard enough to be successful as a fledgling trader. You do not want the added pressure of having to make money and/or not being able to afford losing it.

#3 Start With Enough Capital!
It takes money to make money. You’ve heard that often enough. Accounts that are too small can be a major hindrance to trading success. They suffer from transactions costs that are proportionally higher than is the case for larger accounts, which hinders returns. They also restrict the number of positions you can have at one time, which means you cannot always take good trades that come along and you may not be able to diversify as you should.

#4 Trade Small!
When in doubt, put less money at risk. There is no more swift way to lose huge chunks of money than to trade too big. Your trading size should be determined by your account size based on the risk being taken. If you are risking an amount of your account that potentially puts your long-term ability to keep trading in question, your position is too big. If this means you cannot trade certain instruments, find something else.

#5 Avoid Trading Too Often!
Trading can be fun, exciting, and profitable. It is also an intermittent reward system, like gambling. That means it’s easy to get hooked and in a dangerous cycle. The feeling you have after a winning trade will make you want to do it again. This can lead to sloppy trading. I personally try not to make any additional trades the same day as I close out a position when trading short-term. That helps me get some time and space to ensure I am making good decisions based on my system, not my emotions. Do whatever you must to ensure you always trade in control.

NEXT PAGE: 5 More Ways to Avoid Trouble

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#6 Have a System!
You will not be a successful trader if you do not have a system. They come in all different shapes and styles, but there are a couple of common elements. A system has both entry and exit determinants. A system can also be described. If you cannot verbalize your system, it’s not a system. If you don’t have rules for both entry and exit, it is not a system.

#7 Take the Time to Learn!
Many, many dollars can be saved by new traders if they take the time to learn and practice. There are so many resources so readily available today that there is no excuse for not entering the markets prepared to do battle. Demo accounts can be found for all major markets. That means you can practice your order execution, and you can paper/demo trade your system to confirm its viability before putting a single dollar at risk. To do otherwise is foolish.

#8 Trade in the Right Time Frame!
You have a life beyond trading. May be you have a job or go to school. You have family and social commitments. All of these things combine to determine the time frame you can use. It does not make sense, for example, to try day trading when you cannot monitor the markets almost continuously. In my own trading, there are times when I can day trade or swing trade (one-three-day position durations), but there are others when I know I won’t be able to dedicate as much time to the markets and therefore have to take longer-term positions. You must find a trading time frame that fits your lifestyle.

#9 Trade the Right Market(s)!
What often happens with new traders is that they get into trading because of some experience they had which introduced them to the thrill of the game. That experience probably also got them in to a certain specific market, like stocks or foreign exchange. An emotional attachment is established. Needless to say, this isn’t the best way to pick the market you should be trading. The various markets have different trading profiles. Some are more volatile than others. Some are good for trading intraday, while others are better for longer-term action. The process of deciding to begin trading should include a hard look at what market(s) you should trade based on your account size, trading time frame, personal knowledge and interests, and risk tolerance.

#10 Understand the Risks!
Every market has different risk factors. In fact, each trade has its own distinct risk profile. You need to be aware of what they are. You may have a general awareness that the market may not go the way you thought. That is certainly true, and that is why stop loss orders are advocated. It is how the market can go against you, though, that is important. In the major markets, things like economic releases, earnings reports, and statements by government officials can influence prices. Some cannot be avoided, like a natural disaster, but others can be by simply being aware of the calendar and taking measures to guard against an adverse data release or speech by someone like the Fed Chairman.

As a new trader, you will make mistakes. If you take the advice of this article you can avoid some of the bigger potential pitfalls. That could both save your money in avoidable losses, and potentially lead to more profits.

By John Forman, Author, The Essentials of Trading

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