For some people, the world of financial trading is seen as a financial opportunity – for others, it’s just a bit of fun. Regardless of your intentions, it’s important to understand both the fundamental basics, along with the risks.
There are some universal truths that need to be understood. This article aims to dig into some tips and must-knows before diving in.
Education is Essential
Trading, which is the buying and selling of assets, is an endeavour with a lot of depth. As such, a solid foundation in understanding what it’s all about is indispensable.
Reputable resources like Investopedia offer articles and tutorials for beginners, which is helpful. But, don’t jump into anything too complex early on, as it’s very important to get the fundamentals right and understand how markets actually work.
However, don’t just spend all of your time reading; humans learn by doing, too. Of course, you don’t want to jump straight into real money right away, so consider either backtesting some of your strategies or simply trade with a demo account.
Emotions are a Trader’s Adversary
One of the biggest pitfalls for novice traders is letting emotions drive their decisions. Various studies have shown humans to be overly risk-taking when confronted with losing positions, because they feel that “well, I’m losing anyway, may as well not bother selling”. The opposite is also true, with people pulling out prematurely of winning positions to secure their gains.
Proper money management serves as an antidote to these emotional missteps. By allocating only a predefined portion of your capital to each trade, you can mitigate the risk of massive losses from any single decision. And, of course, sticking strictly to your strategy, keeping improvisation to a minimum.
It’s advisable to determine in advance the maximum percentage of your portfolio you’re willing to risk on a trade, ensuring that even a series of unsuccessful trades won’t drain your resources. This approach not only preserves capital but also instils discipline.
Know the Risks of CFDs, Margin Trading, and Short selling
CFD platforms that offer Forex trading and other assets provide educational resources. Forex gets straight into the technical analysis side of things – which is to look at patterns in historical price and trading data – a skill useful in trading all assets.
Unlike traditional investing where you own the asset you buy, trading Contracts for Difference (CFDs) allows you to potentially profit (or face losses) from price movements without owning the underlying asset. This is a derivative, because the value derives from the asset underpinning it. CFDs magnify both gains and losses because they’re traded on margin. This means you’re essentially borrowing to increase the size of your position.
Margin trading increases potential profits but simultaneously heightens the risk of substantial losses, possibly exceeding your initial investment. One reason CFD investing is unique is because it can allow you to bet on prices going down, unlike when you own an asset.
Short selling involves borrowing an asset to sell, hoping its price will decline, allowing you to buy it back at a lower price. This strategy can amplify returns when prices drop. However, since there’s no upper limit to how high a price can go, short selling risks are potentially infinite.
Diversify… But Not Too Much
Diversification is the only “free lunch” in investing; it’s the most reliable way to improve your risk-adjusted returns. It is essentially the practice of spreading investments across various assets or markets to reduce risk. When one asset underperforms, others might fare better, thereby balancing out potential losses. This may mean diversifying not just between different currencies, for example, but asset classes too, like commodities, equities, and bonds.
However, there’s a fine line between diversification and over-diversification. While the former can shield against unforeseen market downturns, the latter can dilute potential gains and make it challenging to monitor and manage the portfolio effectively. For novice traders, you don’t want too much going on at once, and to understand more sectors and assets classes is quite an ask.
So, while it may be something you’re headed towards, start off with diversifying investment simply within the same asset class and really understand this market first.
In Closing
Trading is an activity that can lead you to some very interesting places. Communities, collaborators, but also some unique skills… Perhaps coding, financial literacy, and even reading the news more often.
But, trading isn’t without its risks. For this reason, it’s vital to get the fundamentals right by instilling proper money management, understanding the risks, and educating yourself on the basics.
Disclaimer: The content above is for informational purposes only and should not be considered as financial advice. Always consult with a financial advisor before making any trading decisions.
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