Forex Trading – 5 Reasons Why the Odds are Stacked Against Individual Investors.
Many traders have flocked to the Foreign Exchange (Forex) markets in recent years, with current estimates suggesting that there are more than 10 million Forex traders worldwide. At least some of this influx is due to the advertisements found on many media platforms nowadays that flaunt their money-making strategy. These adverts often claim that their strategy allows them to make large sums of money whilst they work from home, or even enjoy a round of golf.
In reality, the percentage of retail investors that lose money on the Forex market lies between 65-80% - and this is just for breaking even! The percentage that can solely rely on Forex trading as their only source of income is even smaller than this. But why are the odds so stacked against individual investors?
1. Lack of Reaction Time.
When compared to the stock market, currency pairs between developed economies have an exceedingly low volatility. As such, currency pairs such as the EUR/USD can swing just 0.5% in a day. However, swings in the Forex market can happen rapidly, leaving no time for retail investors to react. This phenomenon is often seen after major events such as a news announcement, as liquidity dries up. Consequently, it can be impossible for an investor to get out of a losing position, rapidly depleting their capital.
2. Leverage.
Another impact of the Forex market’s low volatility is the need for leverage to net substantial returns. This leverage is typically offered through margin trading in brokerage accounts, in which the broker provides the borrowed funds. In the US, the maximum real leverage available to retail traders is 50:1, whilst in the UK it is 30:1. If, however, you are a professional trader, it is possible to use leverage as high as 500:1.
The use of this leverage allows traders to amplify small variations in currency pairs, which are measured to the fourth decimal place – known as a pip (with the notable exception of the Japanese Yen, which is measured to two DP). Unfortunately, this leverage can also drastically amplify the losses.
3. Lack of Market Information.
A big advantage that large corporations have over typical retail traders is the sheer amount of market information that they hold. It is not unheard of for these firms to know about a government’s plan before it is announced, allowing them to get a head-start on the average Joe. This head-start is amplified even further by the fact that they often have teams of analysts plugged directly into the market, enabling them to make rapid decisions.
4. Emotions.
One of hardest things for a new Forex trader to overcome is the emotional attachment to every trade that they make. This can cause traders to hold onto a losing position for too long, exit a position too soon, or fail to cash in on a winning position before it flips. In truth, even the very best traders will experience losses on the Forex market. However, expert traders differentiate themselves from standard retail traders with their ability to bounce back and move onto the next opportunity.
5. Relying on an Overcomplicated Strategy.
Those that are new to the Forex market may believe that a complex strategy based on mountains of historical data will net them a profit. However, this can often be their downfall. Optimising a strategy based on historical data does not necessarily mean that it will perform well in the future. Instead, Forex traders need to be able to adapt rapidly.
Conclusion.
In reality, there is no golden strategy that will always make money. If there was, then everyone would be doing it. Instead, it is better for aspiring Forex traders to understand why the odds are stacked against them, and to know how to counteract the underlying bias. For example, it is wise to be wary of leverage, and instead take the time to slowly build up a successful strategy. Furthermore, traders can reduce their risks by using tight stop losses and simplify their strategy by focusing on a few currency pairs that they truly understand. If all goes well, then maybe, just maybe, they can beat the odds.