The world of finance and investing is filled with opinions, news, jargon, and sometimes pure nonsense. It is only the people who actually make trades, who will be able to tell the truth from the lies.
After all, an opinion has no consequence. People can quip about what they think is true, if there is no money on the table. However, when you’re trading with your own money, you’re forced to confront the reality of things. I, for one, am no stranger to taking risks, but I only take calculated risks with a high payoff. That is what trading is all about.
Without further ado, here are 3 dangerous myths that could be wrecking havoc on your trading account:
MYTH #1: TRADING WITH LEVERAGE INCREASES YOUR RISK
(Reality: Trading with leverage reduces capital required, but risk can be kept the same.)
Let’s tackle the myth first; the media handles the idea of leverage very poorly, because it often sensationalizes the trader who over-leverages and blows everything.
The idea is simple: I have $100, and I leverage so that I can trade $500 or $1000 of stock/forex. I make one bad trade, and I’m wiped out.
This is true for the person without proper risk-management. After all, the temptation of leverage is to dump all your money into one trade, max out the leverage, and hopefully you make 500% on one trade and can call it a day. The truth is, these lucky trades do happen in reality. Eventually, the trader with his newfound wealth (and greed), piles his money into another trade, and loses everything.
Leverage kills the person who abuses it. It’s like fire; it can cook food for people, or it can kill people.
Leverage, in practice, actually keeps you disciplined. In forex trading, maximizing leverage is actually a wise way to start trading. When you leverage, you are actually committing less margin to a trade, and you can get comfortable with trading by committing as little margin as possible. Here’s what I mean:
For example, suppose you have a stop loss of -$10 and a target profit of +$30, and you make a trade of unknown size X.
1:100 leverage – Margin committed for X lots = $102.50 (I’m making this up)
1:500 leverage – Margin committed for X lots = $20.50 (five times smaller)
In the case of higher leverage, you stay comfortable because even though the stop loss is -$10, you see that the margin committed on your account is only $20.50. This allows you to not have to see the wild fluctuations in margin requirement, and keep you trading small and trading often.
There are several benefits to leverage that most people don’t know about.
Also, trading with higher leverage allows you to take multiple positions with little capital. This is great for beginning traders who want to experiment and take multiple trades with a small account. With as little as $500, you can take 3-5 forex positions with leverage, risking anywhere from $5 to $20 or so for each trade. This is a great way to start for aspiring forex traders.
MYTH #2: BROKERS ARE OUT TO HIT YOUR STOP LOSSES
(Reality: You get stopped out because of the market, not because of the broker.)
Many people who have been trading for some time get convinced that the broker wants them to be stopped out of their positions. I’ve heard of this and seen it happen; the trade hits your stop loss, then immediately goes in your favour and flies in the direction you want, and then you beat yourself up and say “I was supposed to make $XYZ on this trade but I got stopped out because of the stupid broker!”
The truth is, the broker has better things to do than to keep hunting the stoploss on your account.
At least, this is for brokers who want to remain in business over the long-term. How do brokers make money? They make money if you keep trading. Why would any broker want you to stop trading? They would actually want you to be profitable, because for every trade you make, they get a small cut from the spread (also known as the bid-ask spread). Essentially, they want you to love trading and trade so much and so often that they get large revenues from spreads.
Why in the world would the broker want to stop you out? The reason why we get stopped out, is because we are bad traders.
Professionals are buying or selling exactly where your stop loss is placed, because they know that the average investor would place their stop loss there.
The solution to not getting stopped out, is to first acknowledge that trading involves some positions getting stopped out. Being right 40-50% of the time is already sufficient for you to be profitable, so don’t be surprised if half your positions get stopped out.
One example is a sideways market. Beginners love to enter on sideways markets because it presents many signals in both directions. However, professionals are buying and selling at the extremes of the sideways markets, causing beginners to get stopped out repeatedly, while professionals make money repeatedly. Remember that there is another trader on the other side who is filling your order; if you are losing money, it is because someone else is taking money from your account, and putting it in their account.
MYTH #3: FOREX IS MORE RISKY THAN STOCKS
(Reality: Risk is independent on the product, and forex actually requires less capital.)
In a previous blog post, I mentioned this: If you have $500 to invest, it actually makes more sense to trade forex.
In the Forex market, you can ‘get a feel of the game’ by risking a few dollars per trade. By trading the smallest lot size (0.01 lots), you can learn to make a few dollars here, lose a few dollars there, and rack up trading experience and learn to trade ‘live’ without incurring hefty losses. By learning to make many decisions and experiencing all the different conditions of the market, you would become seasoned enough to trade a bigger size, and fine-tune your own trading strategy to become profitable in the long-run.
Many traders discover they have certain characteristics about themselves that hinder success. In trading a ‘live’ account with a small sum of money, they are putting in some skin in the game, and getting used to the ups and downs of their account. The best part about forex is that there are no commission charges, making the ‘tuition’ fees a lot less than trading in stocks.
I’ve spoken about this at length in my previous blog posts. Besides the lower cost of trading forex, you actually lower your risk by getting better at trading. After all, the biggest risk is yourself. If you’ve got skin in the game, made a few hundred trades with real money, and got yourself a strategy that you can rely on, you are actually a lot less a risk to yourself.
24/7 market; choose when you want to trade.
The great thing about Forex is that you can decide when to trade based on your schedule. That helps people who have punishing schedules: trading in the middle of the night, or during lunch, on a daily basis, works out to a trading schedule that accommodates your lifestyle needs.
Stocks have bigger gaps between bars than Forex does.
Furthermore, with regards to stocks, stocks tend to see bigger gaps between days. Here’s what I mean:
Gaps make the analysis a little more complex, because you have to take into account the size of the gap along with the actual candlestick printed on the chart. Forex allows you to employ technical analysis more simply, and learn how to read price action without the distraction of having to figure out what the gap means. Of course, this isn’t a problem among more liquid stocks like the SPY, C, MCD, FB and other “famous” counters.
WHAT’S THE REAL RISK?
The real risk in trading lies with the trader. The moment you stop improving, stop learning, stop growing, or stop challenging yourself, you’ll start to see your profits suffer. I encourage all of you aspiring traders to seek the truth, and rely less on opinions in your trading journey. After all, you can only find out the truth when you’ve got some money on the table, and actually start to make trades.