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Knowing When to Cut Your Losses in Forex Trading

By   /   January 8, 2013  /   No Comments

Any Forex trader will tell you that losses are inevitable. The most common problem among novice, and even experienced traders, is using the wrong approach of cutting profits early and letting losses run, vainly hoping for a miraculous turn-around that will recover the losses and turn them to profits. To grow your Forex capital, one should adopt the approach of “cutting losses and letting profitable trades run”.

There are two essential things that a Forex trader should learn very early in their trading life.

How to Detect a Bad Trade

The most important thing for any business to flourish is to avoid losing capital. In Forex trade, the trader should learn how to detect a bad trade early on before the losses run into big, unmanageable amounts. There are a few pointers a trader can use to detect a bad trade.

  1. Is the trade placed too close to a potential reversal point? Check whether a long order is placed at a resistance level or a short order is placed very close to a support level.
  2. Reversal candlesticks: Check whether there are bullish reversal candlesticks during a short trade or bearish reversal candlesticks during long trades.
  3. Fundamental analysis: Some news items and government policy decisions act to totally change price action on currency pairs and this may result in price actions that run contrary to the expected open position.
  4. General behaviour of a currency: If the currency you are trading on a currency pair is losing, check the performance of the traded currency in other currency pairs. If that currency is losing in other pairs, then that is definitely a bad trade.

Exiting a Bad Trade

After recognizing a bad trade, the first emotion that comes to most traders is denial. They end up hoping against all odds that the tide will turn, and the price action will move in the earlier expected direction and the trade will end up in a nice profit. Unfortunately, this is often not the case. Most times, the losses will run and will end up in unmanageably high amounts that the trader was not prepared to absorb.

Therefore, a successful trader must learn to curb all emotion and be practical when assessing bad trades and exiting them. A prudent trader will exit a bad trade manually immediately s/he realizes it is a bad, losing trade. The trader will also avoid judgemental actions that may lead to further losses.

The golden rule is “Never try to immediately recover losses”. Give it time until your emotions give way to more practical thought. Preferably, wait until the next day before trading again. Take that time to assess the extent of the loss and the damage to your Forex capital base. Only attempt to regain your lost capital after ensuring that there are sure banker trade operations, and not before.

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