There are a lot of different strategies for Forex trading. It is impossible label on Forex strategy as the “best” because each trader has his or her own style as well as risks. However, there are some strategies which are simply bad and are incredibly likely to cause you major losses. A surprisingly large amount of traders follow these bad strategies in hopes that their risk will pay off. Of all the bad Forex strategies, the most commonly used one is averaging down.
Averaging down refers to buying more assets (in this case, currency) if the value goes down after the purchase. For example, you bought a large amount of Swiss francs and then the currency depreciates in value so you decide to buy more. The idea behind this strategy is that, if the market goes up again, you will be able to capitalize on the upturn with great profits. While this is true, the likelihood is that you are going to end up with a major loss as the currency continues to depreciate.
Traders who prefer to average down use what is known as a contrarian approach to investing. This style gets its name because the traders go against the current trends. Contrarian styles of investing only pay off if you plan to hold on to your investment for a long time and it, over the course of this time, gains value. Contrarian investing only works with Forex trading if the trader also has a long-term vision of the market trends. For example, a trader could realize that a country is about to have a political upheaval and the currency will probably drop further, but then go on an upward turn as the situation stabilizes. Thus, trading in that country’s currency may be a sensible averaging down investment. However, most of the people who use averaging down for Forex are simple bargain shoppers. They hope that the currency will go up but then end up at major losses when this doesn’t happen.
With Forex trading, averaging down is especially ineffective as a strategy because the markets don’t fluctuate as much as other markets, like stocks. Here is an example: let’s say that a newbie investor buys 10000 shares for $600. When the price of the shares drops down to $500, a sensible Forex trader would likely have already sold because of a pre-established stop-loss order. However, the newbie Forex trader instead decides to buy another 10000 shares. That makes the average cost per share $0.055. When the share price drops again, the trader (who still hasn’t learned) may buy even more to reduce the average price of the shares already bought.
The worst part about this averaging down strategy in Forex trading is that it takes funds away from investments which actually are wise and profitable. Instead of trying to recoup losses or bargain hunt by averaging down, you should try to attempt upward trends in the market – the key word being predict, not just hoping that they will occur. Also, never put too much of your account in one investment so you can keep the Forex risk minimum in case the currency is on a continuous downward spiral.