Trading myths in forex and financial markets

When I first started trading, I discovered that there was so much information out there about the financial markets, forex and stock exchanges that it was difficult to say what was true. I spent a lot of time learning through trial and error in hopes of finding something that was truly useful and working. It's only after years of trading that I realize that simplicity is best and what may seem obvious may not actually be so.

I hope that by dismantling popular trading myths, I will help you avoid the unnecessary disappointments and failures that I once encountered. So, what are the most common trading myths?

I will succeed if I work hard

I know that everyone has watched films like: “Rocky”, “Never Back Down”, etc. and so on. Their plot is simple: the main character, through hard work, achieves his cherished goal and takes all the cream from the top of Olympus.

I have to disappoint you, in Forex trading everything is not so simple. You will not get good results by looking at charts 24/7 or studying hundreds of trading systems. The market doesn't just require hard work, it requires hard work with intelligence.

To become a good trader, you need to develop your skills and discipline. This means that you should work on the things that you can control. Start improving your trading by maintaining and analyzing a trading journal.

All I need is discipline

I won’t argue, discipline is one of the most important qualities required for trading in the market. But if you find yourself getting one losing trade after another, it may be worth reconsidering your trading system rather than working on your discipline.

Traders who have lost their deposits are not necessarily undisciplined. They may have put little effort and time into identifying the trading style that suits them best.

Emotions are the main enemy of a trader

Of course, emotions play an important role in trading, but for some traders they are limited to the phrase: “Let profits run and cut losses.”

Don't forget that profitable trading is a combination of skill, talent, passion, discipline, and not just your emotional state.

It is worth remembering that the more legs a chair has, the more stable it stands.

The entry point is most important

When I first started learning, I knew there was no holy grail in trading. But I was obsessed with finding the best entry point. I thought that if I had a good entry point, then the price would immediately go in my favor and I could make money.

However, there are many other factors in trading that are just as important to consider: position sizing, stop losses, trade management, etc. And a good entry point is just part of the equation for profitable trading.

Now the entry point for me just means the frequency of my trades. The more entry points I get, the more often I open new positions.

Did you know that even with random entry points, you can still remain profitable if you think about stop losses, position sizing, and trade management?

Fixed income

Trading is a marathon, not a sprint. We strive for constant profitability over a long period of time. But how can you determine your ongoing profitability?

Constant returns will differ for different traders on the selected timeframe. For scalpers, consistent returns mean making a profit every quarter. For traders who trade on daily charts, consistent returns will mean a year's worth of profits.

As you can see, consistency correlates with the time frames you trade on. The lower the time frame, the higher the frequency of your trading, with the law of large numbers working in your favor over a shorter period of time. Likewise for a trader who trades on higher time frames. He needs a longer period of time for the law of large numbers to start working in his favor.

You may be wondering what the consistent returns are for high frequency trading? If trades are completed in milliseconds, the law of large numbers can work even throughout the day. It is therefore not surprising that high frequency trading can generate profits every day.

Please note: before you want to determine consistent returns in your trading, you must first decide which time frame you will use.

Risk no more than 2% of your capital per trade

The 2% risk is the standard in trading that everyone talks about. In the long term, this level of risk helps protect your deposit from a complete loss of all funds. However, it does not take into account the trading timeframe, the profitability of the trading strategy, and your personal risk tolerance.

Managing risk using a fixed percentage of capital works if you are a day trader, swing trader or position trader. You will have enough time to calculate your stop losses and position size. But if you're a scalper who's been in the market for a few minutes, the 2% rule won't make much sense to you because you won't have enough time to calculate the position size every time you open a new trade without yet knowing where Your stop loss will be placed.

A return of 80% with a risk to reward ratio of 1 to 1 is very good for any trading strategy. The probability of making three losing trades in a row will be less than 1%. If you are risking 2% of your deposit on every trade, you are being too conservative and not making optimal use of all your options. Even if you risk 10%, your risk of ruin will be 0 after 1000 trades.

Each trader has his own risk tolerance. There are traders who set a loss limit for a certain period of time. Let's say you are willing to tolerate a 25% drawdown on your trading account, and you have a trading strategy that is profitable 50% of the time with a risk to reward ratio of 1 to 2. If you risk 2%, you will have a 0.56% chance of making 25 % drawdown to the trading account. If you risk 1% of your deposit, you will have zero chance of experiencing a 25% drawdown. In this case, a 2% risk may no longer be acceptable to you.

There is no universal amount of risk for every trader. You always need to consider your trading style, the effectiveness of your trading strategy, and your own risk management strategy.

Trading is a risk

Everything in life comes with some risk, and your job is to minimize all possible risks.

When you cross the road, you risk getting hit by a car. When you learn to drive, you risk the safety of others. When you enter a trade without a stop loss, you risk getting a margin call.

When you cross the road, you go to the green traffic light, look left and right. The chances of you getting hit by a car are greatly reduced.

After 30 driving lessons with an instructor, you are a much better driver. The risk of an accident is reduced.

Similarly, in trading, by learning how to trade properly and knowing your entry point, stop loss and risk level, you reduce the likelihood of losing your deposit.

Risk arises from lack of knowledge and practice. If you devote yourself to studying trading for a long time and adhere to the rules in your trading, your risks will be significantly reduced.

The greater the leverage, the greater the income

If you Google “forex trading” you will see promotions from hundreds of brokers who will offer you crazy leverage for your trading. Brokers will tell you that you can easily earn 100% of your deposit, but forget to mention that you can also quickly lose all your money.

Let's say you have a trading account of $1,000 and you buy 50 shares of Apple at a price of $20. The stock price then rises to $25. You make a profit of $250. But if Apple shares fall to $15 per share, you will lose $250.

Let's say the broker allows you to use 5 times the capital you have. This allows you to buy 250 shares of Apple for $1,000. If the stock price rises to $25 per share, you make a profit of $1,250. But if the stock price drops to $15, your loss will also be $1,250!

Always remember that leverage is a double-edged sword. It can magnify both your gains and your losses.

Risk to reward ratio

One of the most talked about topics in trading is none other than the risk to reward ratio. Often we see traders trying to maintain a risk to reward ratio of at least 1 to 2 before placing a trade, and that anything less than that would mean a bad trade. In short, the quality of trading depends entirely on the risk to reward ratio.

Risk-to-reward ratio is interpreted as risk (the pips you stand to lose) to reward (the pips you earn), which pretty much tells us nothing because it doesn't take into account the probability factor.

Instead, it would be more correct to use the following relationship:

Risk (number of points you can lose * probability of making a loss) / Profit (number of points you can earn * probability of making a profit).

Risk-to-reward ratio and probability of profit are two sides of the same coin. Thus, it is not worth talking separately about the risk-to-reward ratio without knowing the probability of a successful transaction.

Does correlation increase your chances of profit?

We can talk about correlation in trading when two or more technical analysis factors point to the same market direction, thereby increasing our chances of making a profitable trade. For example, a bullish engulfing pattern is placed at a support level equal to the 61.8% Fibonacci level.

However, there are two features of the correlation that are not mentioned anywhere.

Firstly, correlation has a lot to do with the number of patterns, setups and indicators you use in your trading. The more elements you use, the more correlations you will find. A trader using ten different patterns, setups and indicators should have more correlations in his trading compared to someone using just a few. Does this mean that a trader with 10 elements has a higher probability of trading profitably?

This cannot be proven statistically, because there are many different trading setups, patterns and indicators, as well as various combinations of them that can be used in trading.

Second, let's assume that correlation increases our chances of success, but by how much?

Let's assume that trading strategy A has a risk to reward ratio of 1 in 5 and is profitable 80% of the time. However, it requires the correlation of several elements, so this strategy only generates trading signals 5 times per year. Now take trading strategy B, which has a risk to reward ratio of 1 in 5 and is successful 50% of the time, generating 100 signals per year. Which trading system is more profitable?

With a risk of $100:

Trading strategy A would have (0.8 * 500) – (0.2 * 100) * 5 = $1900 after 1 year of trading.

Trading strategy B would have (0.5 * 200) – (0.5 * 100) * 100 = $5000 after 1 year of trading.

Although trading system A has a higher profitability than B, the low frequency of trades makes it less profitable.

Thus, if you are looking for trading opportunities on a chart with a high probability of profit, you may lose to a trader who takes advantage of less profitable but high-frequency trading opportunities.

You can make $100,000 out of $1000

Beginners are lured into trading with promises of quick riches and easy money. You see advertisements that promise 300% profits within a few months. But is this possible?

Let's take a long-term view of everything. On average, hedge funds will earn 20% annual returns. Let’s assume that you manage to earn 20% on an ongoing basis. It's easy to calculate that it will take you 26 years for $1,000 to turn into $100,000. If you have $20,000, then it will take you 9 years to turn that amount into $100,000.

In trading, you need to have a lot of money to earn a lot. If you have a small initial capital, then you will not be able to earn a million dollars in the near future.

You need to know exactly where the market is going

When I first started trading, I thought that those who make money always know where the market is going to go. In fact, this is not true.

If you think you need to know when you can make money in the market, then the casino needs to know if the next hand will win. But casinos make billions of dollars every year without knowing whether each hand will win or not.

Likewise, in trading, you don't need to know when the market will give you an opportunity to make money. In fact, you can still remain profitable if you are wrong most of the time. How is this possible?

Let's play a simple game according to the rules of which an incorrect prediction will cost you $100, and a correct one will cost you $300. You make a total of 20 predictions, of which 14 are wrong and 6 are correct. You lose $1400 for your incorrect predictions and earn $1800 for your correct ones. As a result, you earn $400.

This becomes possible if you lose little when you are wrong and win a lot when you are right.

Only new traders need to know where the market will go. Professionals use a trading strategy and trading plan, as well as competent risk management.

The broker is hunting our feet

Traders often complain when their stops are repeatedly triggered. It happens that the price hits the stop loss for several pips before moving in the opposite direction. And in this situation, brokers often seem to be to blame. But is your broker really hunting your stops?

My answer is no, and here's why:

If you consistently see a price from your broker that is different from other traders trading with the same broker, you can take a screenshot and post it on most trading forums. Because of this, the broker may lose its reputation and lose trust.

Forex brokers make money by taking the spread from their clients' trades. Therefore, it is in their best interest for traders to trade consistently over a long period of time. However, if they are trying to make money by taking out clients' stops just to earn a few extra pips, it is a matter of time before their clients find out about it and move on to more reputable brokers.

Conclusion

There is a wealth of information about trading in financial markets. Some of this is fact, but most of it is trading myths without concrete evidence. Be smart and don't fall for common misconceptions and mistakes.