The Black Hole of Trading Part 2 of 6

You may think you know what a CFD, a currency pair, or an option is, but you probably don’t know anywhere near as much as you should. For example, trading a CFD and an option using the same outlay can result in two completely different scenarios; the CFD can take out your initial outlay, your entire capital, and you you’ll get a margin call (if you know what one of these are).

An option on the other hand can only ever go to zero; in other words, you can only lose your initial outlay, but with options there is a thing called time decay, which simply means, the longer you hold an option, (all else being equal), the less valuable your option becomes. CFD’s don’t have time decay, but they do incur interest when bought.

So if you decide you think the little green bar is going to keep going up, what do you buy an option, CFD or just the stock? Then there are market makers and brokers, regulators, and laws which differ greatly between just these two derivatives markets.

Then you have forex, which unlike all other markets has two opposing forces at play. By buying the EUR/USD, you are in fact buying the Euro currency with US Dollars, and if you live outside the US, then you’ve got to factor in the currency exchange rate between the US dollar and your own currency, otherwise you have no idea what you’re risking.

2. You don’t know how your particular choice of market behaves

This is a big one in recent times when it comes to the novice short term forex market trader. For a measly $100 nowadays you can open an online forex brokerage account and start trading forex.

This is such an attraction to many, however a soon as you place a trade you notice your trade goes wildly against you, your stop doesn’t get filled (if you know how to place your stop properly), and all of a sudden you’ve got nothing left in your account. What you didn’t realize was that just 5 minutes after you placed your trade a major news announcement came out, an announcement that the experienced trader knows creates the biggest volatility of the month (barring an unforeseen catastrophe) and causes temporary widening of the spreads, up to ten times the norm.

Maybe you’ve opened a futures account and decide to buy some grain or some soy beans. What you may not know is that commodities can have limit days where if a certain price is reached during the market session all trading ceases. A bit scary if it then gaps down below your stop the following day (if you know what gapping means).

3. You really don’t know what it is you want from trading

It’s not enough to say I want to leave my job and trade full time. What does that mean in terms of money, time, figures and accounting? If you can’t put a figure on what it is you want, either in time or money, then every trade you undertake means absolutely nothing.

If you place a trade and it makes you $100 or $10000, then so what. What are you going to do with that money? Maybe you think you’ll start with $10,000 and try and get your account up to $20,000, but in what time?, a month, a year, 10 years; and if you did pick a time, why? Why would it be important for you to double your money in a certain amount of time?

Let’s say you did set out to double your money in a year, how many hours per week are you willing to sacrifice to reach this goal, and once again, the question remains, why? There is nothing wrong with saying you want to trade because you’re plain sick of your job, but give your trading business what it deserves, some specific goals including time, financial and personal, and a plan to get you there.

4. Your expectations are beyond your knowledge, skills or emotional levels

Of course, if you didn’t even consider point 3 above, then this one will certainly get you where it hurts. Of course knowledge starts with the basics, which were touched on in 1 and 2, but it doesn’t end there. Knowledge means understanding how the brokerage side of things works and how your trading platform works, your legal requirements, your method of analysis and process for trading and much more.

Then there is skill level. If you’re hopeless at fixing a computer, what are you going to do if it crashes right at the point where you’ve placed a trade but haven’t put your stop loss in yet?

What about your math skills? Can you quickly determine the exchange rate between your own currency and the currency the asset you want to trade is in, and determine the effect this will have on your own account?

Do you know how to calculate percentages for risk management (do you even know what that is)?

What about your emotional level? Are you quick tempered or do you beat yourself up easily? Maybe you’re strong and resilient or have you come from a disciplined background. Either way, these emotions all have their place in the scheme of things.

Having a poor emotional habit (such as being impatient), doesn’t mean you wont succeed at trading, but it does need to be addressed, however you must also look for your strengths, as these are pillars to your success.