The goal of a typical forex trader is to make a great profit from the market. However, this desire shouldn't lead to greed to make much more. Overtrading involves opening more positions than you can conveniently handle or leaving a position open longer than necessary.
Although there is no rule limiting retail traders from overtrading, such practice may affect your overall trading performance and lead to monumental loss.
What is overtrading?
Forex overtrading occurs when traders open several positions more than what is appropriate for them to handle or contrary to their trading plan. It may involve a high volume of trade while hoping to make more profit off the market. You can also be guilty of increasing your lot size significantly or leaving a position open more than necessary with the hope of favourable market movement.
Overtrading, also referred to as churning, is an unethical trading practice. Although there are no legal consequences for retail traders who indulge in such practice, forex brokers may be restrained by the investment and security regulations from helping investors overtrade in order to increase their commission.
As a beginner, you may want to indulge in overtrading for several reasons. It may be due to greed, excitement, or fear. You may open multiple positions because you believe you will get more profit from the cumulative gain from all the trades.
Traders can overtrade to recover their loss or revenge on the market after a series of losses. The excitement of a rapidly moving market can also tempt a trader to open excess positions.
Opening several trades at a time is not encouraged because you will have to divide your attention among each of the trades and it can negatively affect your performance in all the trades. It means you are prioritising quantity over quality. There will be less time to research and analyse each trade.
Maintaining a bigger lot size or leaving positions open for a longer period after initial profit is also not healthy because the market trend may reverse contrary to your prediction and lead to loss of all your investment. Overtrading also increases the commission payable to your brokers.
Overtrading vs undertrading
Undertrading is the opposite of overtrading. You are undertrading when you are not effectively maximising your trading opportunity. That is, you are trading lower than your potential or trading plan. If you constantly ignore potentially profitable trades or open a few trades you may be guilty of under-trading.
Other signs of undertrading include; creating smaller lot sizes, not using your funds for a longer period, having strict trade entry rules, or placing stop loss too close to the entry price such that a potentially profitable trade may be closed prematurely.
While overtrading may be a result of the need to make more profit or to recover lost capital. Undertrading is often due to the fear of losing money. Traders often use it as a preventive measure which may not be the best risk management approach. The best way to make maximum profit and control loss is to have a good plan and risk management strategy and follow them strictly.
How to avoid overtrading
Understand yourself
The first step to control excessive trading is to ascertain the problem. How will you know you are overtrading? Take time to analyse your trade, either monthly or quarterly depending on your trading style to discover overtrading patterns.
Signs of overtrading may include a progressive increase in the number of trades you have executed within a given period or a rapid increase in the amount you have invested over time.
Set up a trading limit
At the beginning of each trading week, determine the amount of trade you want to undertake. Set up a reasonable limit to also avoid undertrading. Once you hit your weekly trading limit, don't open additional positions until the following week regardless of the market circumstance.
Your trading limit will depend on your style. As a day trader, who opens and closes trading positions within 24 hours, you may want to stick to three to four trades per day every week.
If you choose to scalp, that means you open and close trades within a few minutes. Scalpers profit off multiple positions in a day. However, there has to be a limit so that all positions will not be in losses due to a lack of adequate attention.
Conversely, position traders hold on to a position for a longer period. They may execute just one trade in a week or two trades in two weeks. Setting weekly limits will force you to choose your positions carefully and focus on winning since you know you have limited trading opportunities.
Manage risk
You can separate emotions from trading by putting in place various risk management strategies. Risk management will also minimise the impact of inevitable losses. You should determine your risk and profit percentage ahead. Setting a stop loss and take a profit order at a reasonable point will help you prevent overtrading.
Determine your risk threshold per trade, it may be 1% or 5% per trade. Calculating this against your total trading capital can give you a sense of how many positions you should reasonably open in a day. If as a day trader, you decide to risk 5% on every trade, opening 10 positions on the same day means you are risking 50% of your capital.
To be on the safe side, you may want to reduce your number of trades and your risk percentage. Once you determine your risk percentage for each trade, set up a stop loss order to close your position when you reach the limit.
At the same time, determine the percentage of profit you expect per trade and the total gain you expect for the day. Set up a stop loss order that closes your position once you've made the percentage of profit on a trade. You can also stop opening more positions once you have made your predetermined level of profit.
To maximise this strategy, you can work out your risk: reward ratio by comparing the amount you are willing to risk to the profit you are expecting.
Trade with what you can afford
Greed is one of the emotions you need to throw out of the window if you want to make a profit and have peace of mind in the forex market. Although leverage allows you to increase your investment, do not overuse it.
Before you start trading, determine your risk threshold and how much you can afford to lose without having sleepless nights. Only trade with what you can afford and do not borrow excessively to multiply your position.
Final words
Overtrading does not assure more profit. It exposes you to more risk of losing. Forex trading should be based on strategy and strictly adhere to carefully laid plans. To sustain your trading career, aim for reasonable profit and take it once you earn it.
Accept defeat when you have apparently lost and do not resort to revenge trading. Choosing a supportive forex trading platform is also a step in the right direction.
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