It is a fact that most independent self-funded traders are unprofitable. For example, Forex brokers required to report on client losses under EU law usually report that between 60% and 85% of their clients are losing money.
After experiencing personal success as a trader and seeing other traders be successful, I passionately believe that even though most traders lose money, this is not inevitable.
With such a high failure rate in the industry, it’s worth examining the root causes of why so many Forex traders lose money – read on to learn how you can prevent it happening to you.
How to Avoid Losing Money in Forex
In this article, I will cover some trading topics such as risk management and leverage, and other areas concerning managing the process, such as record keeping.
There are three key parts to trading, and success or failure is usually determined by one of these areas:
- Trading strategy (entry, stop loss and take-profit rules).
- Money management & risk control.
- Trading psychology—ability to maintain discipline and adhere to your rules.
Treat trading like a business.
I want to paint a picture of trading as a business. Treat it like a business, not a hobby. Many new traders underestimate the level of commitment needed to succeed.
So, let’s dig in and look at the key components of preventing trading losses.
Look for a Reputable Broker
Forex / CFD brokers decide pricing and trade fills without a central exchange.
Forex and CFDs are over the counter (OTC) markets. These have no central exchanges to provide pricing and fill trades. Instead, brokers provide liquidity, quote prices, and fill orders.
Forex brokers automate most of these processes, and ECN accounts provide customers with direct access to liquidity providers without going through a broker’s internal dealing desk. Yet because Forex and CFDs are OTC markets, prices and order fills will vary from broker to broker.
When you trade Forex or CFDs, you rely on the broker for quality of execution. The choice of broker in Forex and CFDs is much more critical than in markets with centralized exchanges, such as equities or futures.
Understand how Forex brokers fill trades before deciding which broker to use.
Without centralized exchanges in Forex, each broker is regulated differently depending on their region. Some regulators are more effective at protecting customer assets, for example, insisting that brokers segregate client funds and provide fair and transparent pricing. I recommend choosing a broker covered by one of the stronger regulators, e.g., FCA (UK), ASIC (Australia), or the NFA (US).
Use a Demo Account
What’s demo trading? Instead of trading with real money, anyone can open a demo account. All Forex platforms, e.g., MetaTrader 4 or 5, have a demo function.
Demo trading is an excellent way to evaluate your progress when learning how to trade or assess a new strategy or signal service. There’s no risk, and I can make as many mistakes as I need to without losing money.
Set parameters to demo trade, for example, try 50 demo trades on two Forex pairs, to prove profitability before trading a live account. A time limit can also work well, for example profitability over a 6-month period.
Starting small allows me to not worry about the dollar impact of my decisions and instead focus on the quality of my decision-making. There will still be an emotional component to trading with real cash, even on a small account. However, the emotions will be smaller, and I will also get the opportunity to learn how to manage my emotions and trading losses on a smaller account.
The beginning of a trading journey should be about learning and refining my skillset. One of my favourite trading quotes is, “The goal of a successful trader is to make the best trades. Money is secondary,” by Alexander Elder.
The foundation of money management is to trade only with money you can afford to lose, in other words, “risk capital.”
This rule is so important that regulators require brokers to state it on their sites.
A good experiment to know if I am trading with money that I can’t afford to lose is to imagine losing it all. Is there anything I can’t do in my life afterwards? Can I take that loss and still meet my obligations?
Leverage is necessary to trade Forex because the actual price movements between currencies are typically small. However, leverage amplifies risk as well as reward. Unfortunately, the often-high available leverage in Forex has made it notorious for attracting individuals that use excessive leverage and take on too much risk.
Use a maximum % risk per trade.
The best way to control leverage is to have a rule of a maximum percentage risk per trade on your account. This has the huge advantage of knowing that a single trade cannot ruin your trading account.
A common percentage traders use is 2%. For example, if I have a $10,000 account and a maximum risk percentage is 2%, a trade should not cost my account more than $200 if it hits the stop loss. I will adjust my position size, accordingly, automatically taking care of my margin and leverage.
Control Trading Risks
A strong trading strategy with solid risk control is a winning combination. There are three elements to controlling risk:
- Use a stop loss for every trade.
- Take trades with anticipated positive reward to risk ratios.
- Position size to a maximum percentage risk per trade on the account.
All three steps will give any trader a comprehensive risk management plan.
Forex pair correlations.
There are other things you may want to consider, such as currency correlations. For example, if I go short EUR/USD and GBP/USD at the same time, I will have two positions that are long USD. If the value of the USD increases in one, it will probably increase in the other too. That means I could be stopped out of both trades. Maybe I should take just one of those trades, or cut the position sizes on both trades?
Know Tax implications
Tax rules for traders in some countries are unclear. I have lived in the UK and Canada, and both countries’ tax rules for traders can be vague and subjective, although there are some tax guidelines UK traders can use. For example, in one country I may have to pay income tax or capital gains tax depending on the frequency of trading and how much “effort” I put in, neither of which are precisely defined in the statutes. You may have a similar unclear situation in your country of tax residence.
Either way, knowing the basics of the tax rules which apply to you is advisable. It may be worthwhile looking for an accountant specializing in independent traders if you are trading in meaningful size.
Adapt to Market Conditions
A trading strategy cannot be expected to work well in every market condition. Some are better for trending markets, others for ranges; many purely technical analysis strategies should avoid entering new trades around big news announcements.
Know why a strategy works and don’t blindly follow it. For example, if the strategy uses indicators, understand the formulae behind the indicators. The only way I know if market conditions are not optimal for my strategy is by understanding the strategy. Then when I see poor market conditions, I can step away, adjust my risk, or look at different pairs or timeframes.
Periods of uncertain sentiment.
The impact of many news announcements is easy to interpret, e.g., a stronger-than-expected GDP number usually strengthens a currency. Yet there are some news events, e.g., the outbreak of wars, where market participants are unsure how those events will feed into the price. There’s no clear sentiment, and I find those times the most hazardous to trade, and the best course of action is to not trade until the market becomes clearer.
Follow a Trading Plan
Develop a trading plan that contains all the necessary decision-making details. I divide up my trading plan into these key areas:
- Entry rules.
- Stop-loss rules.
- Take profit rules.
- Money management rules:
- Maximum risk percentage per trade on my account
- Minimum reward/risk ratio
I don’t leave anything out. My rules include timeframes, assets to trade, times of day to trade, news announcements to avoid, and other factors.
From that, I construct a checklist for entering and exiting trades. Having a trading plan and following it keeps me in tested waters and away from unchartered territory where my edge is unclear.
Trading is not the same as gambling. When I trade, there is an underlying asset or security, and I do not have the probabilities stacked against me as I would in a casino game of roulette. However, trading can elicit the same type of addictive behaviours as gambling. It’s difficult to recognize but be wary of trading for an emotional fix or dopamine hit.
A trading journal is one of the most effective tools against emotional or addictive trading. Write down the reason for every trade, and then review the journal periodically. I ask myself: am I trading according to my plan? Or is there something else going on here?
The most basic form of overtrading is taking trades that are not part of your strategy. The urge to overtrade is often borne from good intentions - to place more trades, to make more money. Yet the relationship between more trades and profitability is not always a positive relationship. After a certain point, we experience the law of diminishing returns, where adding more trades means making marginally less money or even losing money with more trades.
The biggest issue with taking trades outside of my strategy is that I have not tested the ideas, and I do not know if I have an edge in the markets with those trades. Maybe some of them will be profitable, but it’s not a sustainable way to grow my account.
Overtrading happens for various reasons: chasing the market after a big price move, fear of missing out by not trading volatile conditions or getting bored or anxious during quiet times.
To combat overtrading, keep a journal to record each trade and the reasons for taking them. Then it’s easy to see if there are trades not part of the plan and if they are damaging the account.
Trading only when you have a good reason to trade is a very, very important factor in not being a losing trader.
The reasons why more than 65% of retail Forex / CFD traders lose money are quite clear:
- Use of poor trading strategies
- Lack of understanding of the Forex market
- Lack of a good or adequate money management strategy
- An over-optimistic approach and other psychological issues
If you want to be in the minority of retail traders who become profitable Forex / CFD traders, it is important that you develop a trading strategy which has a proven edge over many historical years of data, and that you consistently apply a money management size to determine how much you risk per trade which is based upon the equity in your account.
Your trading strategy should always include a technical element, even one as simple as entering on breakouts and using a trailing stop to determine trade exits. There is nothing wrong with using fundamental analysis as a trade entry filter or to determine some variation in position sizing.
The final element for success is mostly psychological – you need to be mentally strong enough to stick to your plan, but to also be flexible where appropriate. If you make note of your mistakes, you should be able to learn from bad experiences where you are responsible for some extra losses, and stop making them, to become an even better trader.
Why do I keep losing in Forex?
There are two big reasons for losing consistently in Forex: a poor trading strategy and poor risk control. Examine both to find the root cause behind trading losses.
How do Forex traders deal with losses?
There will always be some losses in trading. Start small or with a demo account to get used to taking losses as a normal part of trading.
Can you lose in trading Forex?
Yes. There is always a risk of trading losses in Forex and any other market. That’s why it’s essential to have risk management as part of a trading plan. Most retail Forex traders lose money.
What is the maximum loss in Forex?
The maximum loss will be the size of your trading account if your broker or broker’s regulator mandates negative balance protection. In the few rare cases where negative balance protection does not exist, it is possible to be liable for even more than your deposit, if you are trading with leverage, especially where the market makes an unusually large and sudden move, as it did in the 2015 Swiss Franc crisis.
When should you quit Forex?
If you are experiencing continuing losses, it’s best to stop and re-examine your Forex strategy and trading methods.
Do most Forex traders lose money?
Statistically, most Forex traders do lose money. Many new traders underestimate the level of commitment needed to be successful.