The Perils of Over Trading in the Currency Market

by Stephan Smith on January 18, 2012

In this article I will be discussing the perils of over trading in the Currency Market. Though information contained on this page is directed toward currency traders, it is also applicable to stock traders, commodity traders and many other types of security investors. Please note that the information I present is of my own opinion and doesn’t mean that those with differing views cannot trade their respective markets profitably.

When it comes to trading currencies, I feel that there is an extreme aptness toward over trading. But what is over trading? In the realm of Forex, the way that I use the term ‘over trading’ is unique. For me, it has a duel meaning.

Executing Too Many Trades

The first definition of over trading is performing too many trades within any given time frame. What constitutes too many trades? Everyone has their own opinion, as do I. Do you find yourself trading 3 to 5 times a day on average? If you do, I would consider that over trading. In fact, 3 to 5 trades a week on average is over trading in my eyes as well. You may not consider that over trading, but I do. Here’s why.

It has been my personal experience that the fewer trades I’ve taken and the longer I had open positions, the more profitable I was. The more active I was at executing trades, the less profitable I became and the more profitable my broker was. The less active I was at executing trades and just holding fundamentally sound currencies, the more profitable I became and the less profitable my broker was. I credit Warren Buffett partly for opening my eyes to this simple, yet powerful philosophy.

“Wall Street makes its money on activity. You make your money on inactivity. If everybody in this room trades their portfolio around everyday with every other person, you know you’re all going to end up broke…and the intermediary is going to end up with the money. … Stay away from any environment that stimulates activity.”

- Warren Buffett, Legendary Investor

Warren Buffett is well known for his equity investments, but his words are profound and resonates with me even though I participate in the Foreign Exchange Market. Whenever I find myself buying and selling currencies on a frequent basis, the more stressed I became and the more money I lost. Now I am not so obnoxious to claim that anyone and everyone who trades currencies frequently will loss money. I will simply state that the likelihood of profitability with frequent trading is suppressed for many over the longer term.

Buying and selling currencies is like buying and selling countries. Sometimes I don’t even acknowledge I am dealing will currencies at all. At times I just see the countries. Do I want to buy the United States? Is it time to sell Canada? Do I want to get involved with Japan? When buying and selling I imagine myself entering a commitment with the countries I’m dealing with. I want to feel good about the countries I’m dealing with; not just for a day or two, but for the next week, two weeks, a month, three months, six months and possibly more.

Buying and selling a currency pair and holding it for 2-5 minutes simply because a line crossed over another line while some indicator is flashing, doesn’t fit my personality and makes me feel uneasy. There is no economic or monetary policy reasoning involved in the transaction. Its just a ‘chance trade’. Not to say longer term trading is absent of chance or risk. I personally believe that the probability of success is greater with long term trading backed by solid fundamentals with a hint of technical analysis because they give a reason for currency price action. I recommend you take some time to read my article titled: “5 Reasons Why I Prefer Long Term Forex Trading” when you get a chance.

Taking Excessively Large Positions

The second definition of over trading in my view is taking excessively large positions based on your account balance size. We all want to earn as much as we possibly can from our trades, so it is quite common for traders to be tempted to enter trades with excessively large positions in order to increase their profit potential. Over trading in this sense is very dangerous, for it exposes one’s account to unnecessary risk. Sometimes the thought of high profits can entice a trader to the point where the trader finds oneself justifying taking excessively large positions.

I know, because I myself have fallen victim to this. Many currency traders get burned because they take trades that are too large relative to their account size. Having an account that is undercapitalized is a major reason why I personally experienced unprofitable trades early in my trading career, and I wouldn’t hesitate to say that many currency traders with low investment capital experienced the same.

There are two solutions to make sure that doesn’t happen to you. One is to take smaller positions. Yes, your profits will be smaller, but your risk will be too. Smaller positions increases your longevity in the Currency Market. I truly believe that currency traders, including myself at times, focus too much on profits. Though the reason why most investors participate in the Foreign Exchange Market is to acquire profits, profits in my opinion should not be the number one objective. The number one objective should be capital preservation. I recommend you read my article titled: “Capital Preservation and The Break Even Stop Loss” for more information about that. The second solution is to simply increase the capital in your brokerage account.

The Perils

Now that you have an understanding of the duel definitions I have attributed to the term “over trading”, I now feel it is time to disclose the perils I am warning you about. The perils of over trading in the Currency Market are the following…

  • Increased broker transactional costs (associated with excessive trading).
  • A significantly decreased tolerance for market fluctuations (associated with large position sizes).
  • An increased need for a higher win lose ratio (associated with excessive trading & large position sizes).
  • Elevated stress levels and fatigue (associated with excessive trading & large position sizes).
  • Decreased account longevity or staying power (associated with large position sizes).

Allow me to expound in detail what I mean with each of the 5 perils I’ve listed. The first peril is when a trader exposes oneself to elevated broker transactional costs due to over trading by executing too many trades. The more buying and selling a currency trader performs, the more fees or spread a trader has to pay the broker. Remember what Warren Buffett said.

“Wall Street makes its money on activity. You make your money on inactivity.

- Warren Buffett, Legendary Investor

Of course, you would substitute “Wall Street” with the name of your Forex broker. Now if a trader is somehow able to generate profit consistently, regardless of the additional transactional costs, then by all means, keep trading. However, trading less increases the probability of profit due to less transactional costs. With less expenses, one needs less revenue or price interest points (pips) to make a profit.

The next peril a currency trader who over trades needs to be wary of is a significantly decreased tolerance for market fluctuations due to taking large trades. The larger your trades, the greater the risk of substantial loss. It won’t take many losers to wipe out an entire account balance if a currency investor is taking on large position sizes. I’ll admit, I use to be guilt of this in the past and even now at times. Discipline will be required put a stop to that.

As an investor of currency future contracts, you need to be able to withstand the horrid volatility this market can throw at you. There is nothing worst then entering a position, getting liquidated due to insufficient capital, then sitting and watching in horror as the currency pair trading price u-turns and moves in your direction, just as you through it would. Take heed to these words, for I am speaking from experience.

Now I am going to talk about the next peril, which is the increased need for a high win lose ratio. If an investor is going over trade in the Forex Market, that investor is going to need to profit more trades then lose in order to see a return on one’s account overall. If a trader is going to take large positions, that trader is going to have to win a lot more trades than lose in order to be sustainable. It is even more true if the same trader is going to trade frequently.

The next peril of over trading in the Currency Market is elevated stress and fatigue levels. Becoming stressed and or fatigued can be caused by being overly active in the Currency Market or taking on too large positions. Whenever a person feels overly stressed or fatigued, good judgement can be negatively affected. That can cause mistakes to occur more frequently which will lead to additional losses.

Yet another peril a trader will face if he or she over trades the Currency Market will be a decreased account longevity or staying power. Such a peril is associated heavily with one who takes excessively large positions based on account balance size. To my knowledge, every currency trader experiences loses every once and awhile. But if you’re trading large positions, it would not take many losses to wipe out your entire account. That’s what I mean when I say: “staying power”, because one or two losses can clean out all your funds and leave you broke. If a currency trader doesn’t take very large positions based on account size, then it would take many losses to clean out one’s trading account. That is staying power (account longevity).

To contact me for questions, comments, adverting or other business related inquiries - please visit my contact page.

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