Updated from its original posting on 26-04-2010
Jack is a professional trader.
He makes all his money trading the Forex market. He has been trading for five years.
He is patient, disciplined and, in his trading, he is fearless.
Tom is a newbie.
He barely manages to break-even with his trading. He has been trading for six months.
Tom takes unnecessary risks as he is undisciplined, and he panics when he takes a trade.
Let’s imagine we have a super profitable system. On paper, traded mechanically, this system has an average of seven wins from ten trades. Now, let’s imagine we give both Jack and Tom this method and they trade it.
What do you think will happen?
Jack will take the system, take the trades, and make a lot of pips. In fact, Jack will probably improve the efficiency of the system and bump it up to eight winners out of ten.
Tom will take the system, take the trades, and pretty much screw it all up. As I said, trading it mechanically will give Tom an average of seven out of ten winners. However, Tom will be lucky to get five out of ten winners.
Why does it work this way?
It all comes down to two things: psychology and experience.
There isn’t much you can do about experience. So let’s take a look at some of the dangerous psychological pitfalls. Hopefully, after reading this, you will be able to see them coming and stop them, before they destroy your account.
1. The Desire to be Rich
The desire to be rich manifests itself in many ways. The main ways are fear and greed and they inevitably lead to other problems. If you think about it the majority of the issues newbie’s have stem from the desire to be rich. Things such as:
Forex will not make you rich in the short term. It will likely take years before you’re trading well enough to leave your day job. Forex is a career and in the long run, if you’re successful, it can give you a very relaxed life. However, if you started trading last week and you plan to quit your job in six months, because you anticipate being rich enough to buy a Ferrari, you are delusional.
This is a career, not a get rich quick scheme. If you want to be rich quick hit the casinos. You have a better chance of winning there.
2. Fear of Losing
From a young age, we are taught that money is important. That without money you have no real value. We are conditioned into believing, that to be successful when we grow up, we must have lots of money. This in turn causes people to be afraid of losing money. This is because the reverse is also true. If you lost money then you are a failure as it is the opposite of making money. This in turn leads to some newbie traders being afraid to pull the trigger and actually taking a trade.
Some newbie’s trade demo accounts for two years, never summoning the courage to open a live account. Some newbie traders with live accounts panic whenever they enter a trade and, in turn, make rash decisions.
Take a look at people like Richard Branson, Donald Trump, Alan Sugar and Warren Buffet. These guys are all billionaires (or close enough to it) and each of them has failed many times. Richard Branson has spearheaded many failed ventures. Did those failures set him back though? Hell no! The man is going to start flying people to space at $200k per head, next year, with Virgin Galactic.
I think losing some money to the markets is actually beneficial. It teaches you some very important lessons. What is damaging is the fear of losing money. The fact that you think about it puts you at much greater risk of it actually happening. You have to trade with a positive attitude. So get rid of those fears and worries, they will not do you any good.
The truth is you are going to lose money to the markets, it’s unavoidable. Every professional trader has lost money. Not every trade will be profitable. The market simply doesn’t always work in your favour, and there are times, especially as a newbie, that you will be stung. If you end up blowing your first live account… so be it. As long as you pick yourself up and try again, you will be a better trader for it. I blew two accounts before I started trading profitably.
3. The Need to be Right
This is a good one. Tom opens his platform and enters a dumb, baseless, long trade. He targets 100 pips and has a 50 pip stop loss. The trade goes against him immediately.
It goes down, first ten pips, then twenty pips, and then thirty pips. When it reaches forty pips, Tom decides he doesn’t want to lose another trade and moves his stop loss down.
The price keeps falling and Tom continues to move his stop.
Eventually Tom closes out his trade and he has lost a huge portion of his account.
Tom was not able to accept that he has taken a losing trade. He kept pushing the stop down in the hope that it would eventually turn around. The need to be right is an account killer.
4. Being Undisciplined
I saved this one for last because, even though it is one of the most common and dangerous pitfalls, it is rarely discussed. A trader who lacks discipline can never make it in this business. Many traders are guilty of lacking discipline for many different reasons.
The main culprits are what I like to call ‘System Jumpers’. These are traders that are constantly tweaking and changing their trading methods. These traders do not realize that learning to trade a system efficiently takes time.
System Jumpers are traders who lack the discipline to stick to, and learn how to trade, a system. They try it for a week and when it doesn’t work they jump to the next system or method.
Another common action of an undisciplined trader is abandoning a perfectly good trading method. Every trading method has periods in which it performs below average. No matter how versatile a method is it cannot perform, at peak efficiency in all market conditions. A true trader has the discipline to stick it out through the hard times.