What is Overtrading?
Like mentioned on many articles here in our Forex Trading Academy project, money management is key in being successful when trading financial markets in general, and more risky instruments, such as CFDs and binary options in particular. The biggest threat to successful trading is over trading and this means simply taking too many trades, more than needed. Overtrading is a result of greed or panic in the same amount, and the explanation comes from the human nature. It is well known that people are more adverse to risk than favor a profit. In plain English, the idea of losing something is way more painful than the pleasant effect of actually winning something. This is called risk aversion and was one of the vital parts of Daniel Kahneman’s amazing book “Thinking Slow Fast”
Causes of Overtrading on Forex
The same things apply when looking at trading, and especially when looking at binary options and CFDs trading. This is happening because of the short term expiration dates brokers are offering (60 seconds, 5 minutes, etc.) and this leads to trading opportunities to appear to be at each and every moment. Which is simply not true. With CFDs the loss increasing property of leverage can cause people to become even more irrational, trying to gamble for resurrection and putting all they have to return the lost funds, risking even more.
Because binary options are being advertised as an easy game, then choosing a short term expiration date and winning the option gives the impression this is really an easy game when money are being made so easy and this is not true. This is why we have warnings across the website – trading can lead to loss of capital, all of invested capital.
This leads to taking another trade, and another one, etc, and this is over trading. Overtrading instead leads to losses, and when this is happening, people are starting to trade even more because they want to recover previous losses, as mentioned above. And this instead leads to losing the whole account. Overtrading leads to losses as mentioned above but the biggest loss after overtrading is the loss of confidence. Not having confidence in your analysis is way more damaging on the long run than having one or two options that expire out of the money.
There are two instances in which overtrading appears and both of them can be avoided.
One is the situation in which due to the fact that an option is moving against your strike price and the option is out of the mone but still not expired yet, the trader has the tendency to take another trade in the same direction and even to increase the exposure. Then if market still moves against the original price, adding to the original entry would only lead to losses and whipping out the account. Its similar with CFDs, however, the pressure is smaller since exiting current trade is easier than with binary options. With binary options, early close can lead up to 30% loss in position, which increases the potential benefits of risking for resurrection.
While sometimes this works, like doubling and tripling the entry size, on the long run it is nothing but a martingale approach that will fail eventually.
Clear money management rules should be taken to avoid that and one way is to clearly define both the assets to be traded as well as the expiration dates to be used.
It is well-known that binary options brokers are offering end of day, week and month expiration dates as well for a PUT/CALL option and the fact that traders are not really using them is only normal as quick profits are always desired instead of patiently waiting for the option to expire. This doesn’t mean that profits cannot be made as well as it doesn’t mean that by trading an end of month option one should wait for one month until the option expires, but merely it depends on the moment of time the striking price has been reached. If the option is traded starting with, say, 25th of a month, then the actual expiration date is less than one week, even though the expiration date that was originally chosen was “end of month”.
CFDs vs Binary Options Example
Lets say your binary trade was $100 and the forex market is moving against it. If you want to exit, you have to lose 30% or $30. With CFDs, the loss depends on the number of pips market moved x leverage. You can close the position when you are -$2, -$5, -$10 on the position instead of immediately loosing $30 to the broker.
After choosing the assets, consulting the economic calendar is the next step as there is a strong possibility that strike prices are to be found more easily around the time economic events/reports are being released and then depending on the level and the fundamental news, the expiration date can be set.
For example, let’s assume that there is a rumor in the market that the Federal Reserve of the United States is going to raise the interest rates. The thing to do is to watch US dollar related events and on confirmation (actual print is above expectations) call options for the US dollar to be traded with an expiration date that should stretch beyond the moment of time the FOMC is making the announcement.
Another way to avoid overtrading is to not trade pairs that are directly correlated in the same direction. For example, if one is trading GBPUSD to the upside, so call options, it makes no sense to trade the EURUSD to the upside as well as long as the cable pair is in the money as it will effectively mean a double down of the initial position.
If, on the other hand, the initial trade is moving in the opposite direction and the eurusd pair or any other correlated one is reaching a strong support (in the case of a call option) or resistance (in the case of a put option), then trading another one makes sense.