The most common mistakes traders on Forex
A huge number of traders constantly fall into the same traps. It turns out that avoiding them is not so difficult if we use the simple rules that the author of this article offers us, who himself constantly adheres to them in any trade: from day trading to positional.
Every loser and almost anyone starting to trade on the market makes almost the same mistakes. The first category is subject to them, because otherwise it simply can not behave. The second – as a result of his inexperience. But in any case, the basis here is one – everyone thinks in a stereotyped way, in strict accordance with the psychological manifestations inherent in the behavior of the crowd. If we discard all illusions about our own “I”, we are all imperfect people, and simply – they are stupid when it comes to making the right decisions in the financial markets. But in general, no matter how wrong we are, it is peculiar to us as a crowd to turn out to be wise, so the only person who does not make mistakes is the market itself. We will not go into the causes of this, expounding on the effectiveness of the market and its perspicacity, but we will turn to the main mistakes of investors and traders, which are most clearly manifested and can be avoided, which can provide a sharp increase in the profitability of trade.
Mistake # 1: Buy on top
A huge number of traders enter the market at a time when it’s time to get out of it, regardless of the scale in which they trade. In terms of Elliott’s wave theory, this usually happens at the end of the 3rd wave or the 5th. Although in each case there is still a chance to take profits from further market growth, but the probability of a decline in these moments is usually already very high. As a result, the trader takes a little time to enjoy the profitability of the transaction, but very soon sees how the decline in quotes leads to a loss.
If this happens at the end of the 3 rd rising wave, then the trader is doomed to torment, because the price starts to move according to the laws of the 4th wave, where intricate movements in the side or slightly downward price corridor throw it in the heat, then in the cold: position constantly changing, moving then into profit, then at a loss. When this bothers, the trader leaves with a loss or with a small gain, after which he is amazed to see how the price goes to new heights, and his deal could give a good profit.
If the trading position is created at the end of the 5th ascending wave, then the business is even worse: the price trend can change at any time and in the foreseeable future does not return to the entry point. Perhaps this option is the worst of all existing, although sobering comes quickly, but the price of the lesson is often very high. Nevertheless, it is in this scenario that events develop with all the losers and a huge number of novice traders
Why is that? There are several explanations for this.
The first is the firm opinion that market movement should be accompanied by volume. There is a certain amount of truth in this. Indeed, if price growth is not supported by volume, this means reluctance on the part of new traders to enter the market, therefore, trade occurs mainly between its current participants and a certain number of new arrivals and departures. With good reasoning, one can quickly realize that the growth of volume is a double-edged sword: if someone buys, then someone must sell it. And then a mature idea arises: but can not the growth of volume in the growing market be a sign of reaching the top? After all, volume is a leading indicator for estimating the future price dynamics. But it’s one thing when the volume grows when the market breaks through a serious level of resistance, and quite another – at the time of finding the prices at the top of the chart, where nothing prevents moving prices in any direction. In the first case, the volume is really the friend of the buyer, and in the second case, he is, rather, his enemy.
The second explanation lies in the tendency of people to forget all sound reasoning when they see an active rise in prices. They think that they will not make it and will be in the tail of luck, already smiling at many who bought shares. Such traders are rushing to the market, and naturally – they are soon losing money. It is this category of investors that often provides the growing volume that we constantly observe at peak prices.
In fact, both explanations are to some extent equivalent. But how to be? Let’s talk a little bit. What is the volume? This is an indicator indicating to us the number of traded shares or futures for a particular period. But it’s one thing if the price has changed by 0.5%, and quite another, when it has moved by 5%. Apparently, a net change in volume is not such a benign indicator, as it may seem at first. The only way out of this situation is to use graphs that exclude volume from consideration and focus on price shifts adjusted by volume. A good example of this approach is the EQUIEMEA charts presented in the Metastock program.
So how to avoid such a common mistake – buying on top?
The answer is contained in a few simple rules:
1. Never buy with a growing volume if the prices are at the top of the market and there are no valid reasons for further price increases.
2. Buy in a growing market, supported by volume, only if you see a break through the resistance level.
3. Always remember: against your purchase is selling, where a trader leaves a long transaction or enters a short position.
Mistake # 2. Sale at the bottom
In the “sell at the bottom” trap, there are at least as many traders as compared to the “buy on top” situation. Strangely enough, but this case is mirrored with the one analyzed above: the same increased volume combined with the heavily falling prices. Again, if we succumb to the temptation to rely on the dogma of the volume supporting the trend or we are exposed to the impulse of greed, seeing how others earn on the fall of the market, we will certainly lose.
Of course, the increased volume can be interpreted as the inflow of shrewd and knowledgeable traders, confident in further downgrade of the market. Maybe it’s true, but it’s unlikely that you will be able to withstand a short position correction top-directed market movement that can be very intense without leaving it at a loss, and then watching a new drop in prices. In addition, do not forget, many of these traders hedge their positions with options or intermarket spreads, and therefore can withstand tangible market movements in both directions without any fear of receiving losses.
As for the mainstream trading public (ordinary investors, traders and some managers of investment funds), not burdened with knowledge of the tools available on the market, it is subject to emotions and feeds the panic market. As a rule, it has a pointed depression, like the letter “V”, supported by a volume. Sellers in this situation, occupying short positions on the trend, will very soon face a price reversal, and will be shivering in their hands with averaging or closing at a loss. Those who sell, getting rid of long positions, almost immediately will regret their actions, watching the rapid recovery of the market.
How to avoid such an error? On this account, there are rules similar to those previously stated:
1. Never sell at a growing volume if prices are at the bottom of the market, especially when all support levels are passed, and there is no valid reason for further price drops.
2. Sell in a declining market, supported by volume, only if you see a break through the level of support.
3. Always remember: against your sale is a purchase, where a trader leaves a short trade or enters a long position.
Mistake # 3. Selling growth leaders
Very often a trader takes a short position if he sees that the subject of his attention, share or futures, showed an intensive rise in prices, after which they made a reverse pullback. A huge number of players in the market make the assumption: this is a signal about the impending attack of bears. To their great disappointment, after some period of calm and movement in the price range, prices sooner easily rush higher, bringing disappointment to the short traders.
Yes, trading on correction is a good strategy, often bringing good incomes to traders who accurately determined the possible behavior of the market. But it must never be forgotten, the trade is conducted against the existing trend. Hence the conclusion: taking a position in the calculation for a downward correction is a prospective occupation only for the option of a good price return and on condition that the trade is conducted from an accurately calibrated resistance level that has shown its stability.
In reality, the leaders of growth, stopping their price move, do this with the sole purpose of “settling down” to go higher. Their correction may occur not as a result of price movement down, but “work out” due to the lateral trend. On the chart, it looks like a bunch of price bars, located in a relatively small range, which arose after an impulsive and rapid price movement. Yes, reversals of growth leaders also happen, but stopping their course is not so easy, so you should use these rules:
1. Do not take short positions on the leaders of growth, hoping for a strong correction – most likely it will not be so significant.
2. Trade with strategies designed to break through.
3. The longer the lateral trend lasts after a strong price spike, the greater the chances of the market to go higher up, breaking through the resistance at the top edge of the rence.
Mistake # 4: Buying growth leaders
Buy the recent growth leaders – the same oversight as the sale of them. It seems absurd, but in reality everything is exactly the way it is. Why? The answer is in deciphering the behavior of the growth leaders most often observed in the market. Common sense suggests that prices can not grow forever, but there is almost no limit to this, so the only thing they need before continuing to move up is to “settle.” But the problem is that this period can be quite long, stretching for weeks, so the effect of taking a long position will not be very great, even if the purchase was successful and the trade is always in the profitable zone.
The rule to avoid Mistake No. 4 is as simple as ever:
1. Never rush to take a position on the leader of growth in the direction of the trend, if you see a slowdown and a rollback.
2. Use stop orders, designed for execution after breaking through the resistance levels.
3. Buy with a limit order not earlier than the third strike on the support that has developed to the current moment, which simultaneously is consistent with the hacked rence and the previous impulse growth.
Mistake # 5: Buy Leaders Fall
Purchasing leaders of the fall is mirrored in its nature by selling growth leaders. What can you expect from a stock or futures that is in a downtrend? Nothing but minor correction. Often, it turns into a sideways trend, after which prices continue to move down. Again, in order to be successful in trading on correction, one must buy on good support, and at the same time accurately guess that here is the basis, albeit local.
Therefore, the rules are as follows:
1. Do not take long positions on the leaders of the fall, hoping for a strong correction – it is unlikely to be significant.
2. Trade with strategies designed to break through.
3. The longer the lateral trend lasts after a strong price fall, the more likely the market will go lower, breaking through the support at the bottom edge of the range.
Mistake # 6. Selling drop leaders
Again, this error is mirrored by mistake No. 4. The leaders of the fall are not so easy to stop: the market definitely has inertia, and even if it has reached its objective bottom, the residual downside force of the downward trend is able to “squeeze” prices even lower. The infidelity of the solution here lies in the simple inefficiency of the use of capital. The lateral rank can last a long time, for days and weeks, then go towards the previous downward trend. The most critical point is the third blow to the ground.
So for the situation under consideration the rules are:
1. Never rush to take a position on the leader of a fall in the direction of the trend, if you see a slowdown and a recovery in prices.
2. Use stop orders, designed to take a short position after breaking through the support levels.
3. Sell with a limit order not earlier than the third strike on the resistance that has developed to the current moment, the consistent trading value and the previous impulse drop.
Mistake # 7. Purchase of past growth leaders, recently fallen
This error is a consequence of the greed of the novice trader. It’s not a secret, he often comes to the market, after hearing about the excess profits received from the phenomenal growth of Internet companies. After acquainting himself with the graphical analysis, such a trader is fascinated by such actions as YHOO, AMZN, AMCC, JNPR, WCOM, LU, QCOM. Mentally, he sees what he would have if he bought these papers in 98, 99 or even in 2000. Therefore it is no wonder that he sees the same movements to the transcendental heights, where superprofits will be taken. These feelings support the persistent myth that “prices always come back.” But it is unlikely that now such a rule operates with the same force.
At present, we are dealing with quite a different market: the world has changed, it has been swept by high technologies, it is often impossible to evaluate correctly. Therefore, rules that are true for General Electric (GE) can not be true for Yahoo. Definitely, the more “civilized” market in this respect is the commodity market – on it we have a lot more chances that the price of the commodity will not fall much below its multi-year historical lows. In the stock market, you should always remember: if the price for some reason fell strongly after a strong growth, then there were good reasons for this. And they can have such consequences, which will lead our investment in the purchase of shares to a complete depreciation, namely, to zero. If you think that this is a rarity, then you are mistaken. Any business has its beginning and end, and in our ultra-fast age everything is speeding up, so it is foolish to count on the rapid restoration of the positions of companies that have lost their position.
Throwing aside the fundamental view, we can formulate a basic position for stocks that have fallen dramatically in value after a phenomenal rise: the price should move and show its “liveliness,” and not be in a stagnating state. In the case of “liveliness” of behavior, we can still hope for a good move upward, but with obvious stagnation it is hardly possible – there is not enough momentum and much needed strength of movement. Of course, the stock is able to grow by 30 and 50 percent at short intervals, but the danger of losing positions is extremely high. But in general, such papers are likely to pass through a long period of being in the stage of depression that can last months or even years before they start moving upwards, if at all, ever happen.
In this regard, the rules to avoid the error number 7, are as follows:
1. Never rush to buy shares that were previously in favor, but now fell heavily to the prices from where they started to grow.
2. When buying such shares, consider them only as a short-term trade.
3. Buy with a limit order after overcoming the nearest resistance and fixing prices above it, but when you roll back to it.
And of course, one always has to remember about the stop-warrant that closes the deal in case of failure, unless other instruments providing risk management are used. I will note from myself: we need to use them more widely, there are plenty of such mechanisms on the market, among which, in my opinion, the most productive options are. Fortunately, for almost all securities under the sights of active traders, they are available in abundance and are not badly discarded.