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Seven ways forex traders can improve their decision making

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Foreign currency (FX) markets can move with lightning speed, and while it's an adrenaline rush to notch up gains, when markets turn against you it's easy to give in to knee-jerk reactions. Seven steps can help you stay focused.

1. Trade to a plan

Having a game plan or strategy to follow can support disciplined decision making.

investors improve decision making

Decide your currency pairing, understand why you are trading them - don't trade on a hunch, and once you have a strategy in place, stick to it. As experienced traders say, "plan your trade and trade to your plan".

2. Start small

It's a lot easier to make good decisions when you're not under intense financial pressure.

That's why it can pay to start small, especially if you're new to FX. Trade fewer contracts, or trade mini lots with low leverage, at least until you have a firm grasp of how markets work.

3. Cut losses short

It's a no brainer to cut your losses short and allow your profits to run. But studies show that human beings are prone to the so-called disposition effect, which sees us more likely to sell winners and hold onto losers.

Stop-loss and take-profit tools can help you overcome this effect. Make the most of these tools to reduce downside exposure and cut losses short.

4. Invest in research ... continually

FX trading shouldn't hinge on the toss of a coin. The more you know about the factors likely to affect a currency pair, the better placed you are to adjust your FX portfolio to market conditions.

Keep a regular eye on inflation figures, payroll data, trade numbers and other economic factors that could affect your portfolio. Some FX platforms provide financial calendars that make it easy to stay on top of economic releases. The key is to know what's coming up that could affect markets - and how currency markets have reacted to similar information in the past. It lets you trade to the facts, not your emotion.

5. Know your trading platform

Your trading platform is your launch pad to the world of FX, and being completely familiar with how it works is essential for good decision making - especially when markets are moving fast.

The more time spent practicing with the demo account, the better you will know your platform. That can be critical to avoiding common mistakes like incorrect position sizing when markets are volatile and decisions need to be made quickly.

6. Record your progress

The process of recording your trading activity in writing can contribute to better decision making.

Maintaining a trading journal helps you identify exactly what you have been doing in terms of trades, which can be very different to what you think you have been doing. It can help you pinpoint recurring mistakes, which can sharpen your decisions for the future.

7. Take breaks

No matter how sophisticated the trading tools on your platform, or how often you revise your trading strategy, your decisions are the driver that will determine whether you make or lose money in FX. Few things improve our decision-making capabilities more than just taking a break to recharge and refresh.

Walk away from the screens, use the break to update your trading journal, or simply enjoy some headspace away from foreign currency. Your concentration will benefit - and there's every chance you'll get a better sense of clarity about where markets are heading and how you can profit from that movement.

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A former Chartered Accountant, Nicola Field has been a regular contributor to Money for 20 years, and writes on personal finance issues for some of Australia's largest financial institutions. She is the author of Investing in Your Child's Future and Baby or Bust, and has collaborated with Paul Clitheroe on a variety of projects including radio scripts, newspaper columns, and several books.
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