Be able toCurrency tradingmake you rich? Although our instinctive answer to that question would be an unequivocal “No,” we still need to qualify that answer. Forex trading can make you rich if you are a hedge funder with deep pockets or an exceptionally skilled currency trader. But for the averageretailerInstead of being an easy path to riches, forex trading can be a bumpy highway to huge losses and potential money.
Key learning points
- Many retail traders are turning to the forex market in search of quick profits.
- Statistics show that most aspiring forex traders fail and some even lose large amounts of money.
- Leverage is a double-edged sword, as it can lead to big profits, but also significant losses.
- Counterparty risks, platform outages and sudden bursts of volatility also pose challenges for would-be forex traders.
- Unlike stocks and futures, which are traded on exchanges,forex partrading on the over-the-counter market without a central clearing firm.
Unexpected events
To better understand the danger of forex trading, we can consider a relatively recent example. On January 15, 2015Swiss National Bankabandoned the Swiss franc ceiling of 1.20 against the euro, which had been in place for three years.As a result, the Swiss franc rose as much as 41% against the euro that day.
The Swiss central bank's surprise move has inflicted losses of hundreds of millions of dollars on countless currency trading participants, from small private investors to major banks. Retail lossestrading accountsthe capital of at least three stock exchange companies wiped out,make them bankrupt, and brought FXCM, then the largest retail brokerage house in the US, to the brinkcompetition.
Unexpected one-off events are not the only risk forex traders face. Here are seven other reasons why the opportunities are good for the retailer looking to get rich by tradingforex marked.
Huge forex games, like George Soros'srun on the British poundwhat earned him more than $1 billion is very much the exception and not the rule.
Excessive leverage
While currencies can be volatile, violent swings like that of the aforementioned Swiss franc are not that common. A significant move that takes the euro from 1.20 to 1.10 against the US dollar in a week is still a change of less than 10%. Stocks, on the other hand, can easily rise or fall by 20% or more in a single day. But the appeal of forex trading lies in its sheer sizeaccelerationoffered by forex brokers that can magnify profits (and losses).
A trader shorting $5,000 in euros against the US dollar at 1.20 and then coveringshort positionat 1.10 this would make a nice profit of $500 or 8.33%. If the trader usesmaximum accelerationat 50:1 allowed in the US (excluding trading fees and commissions) the profit is $25,000, or 416.67%.
If the trader had gone long the euro at 1.20, used 50:1 leverage and exited the trade at 1.10, the potential loss would have been $25,000. In some overseas jurisdictions, leverage can reach 200:1 or even higher. Since excessive leverage is the biggest risk factor in retail forex trading,supervisorsit is firmly established in a number of countries.
Asymmetric risk versus reward
Experienced forex traderskeep their losses smalland compensate them with significant profits when their currency calls prove correct. However, most retail traders do it the other way around, making small profits on a few positions but then holding on to a losing trade for too long and taking a significant loss. This could also cause you to lose more than your original investment.
Platform or system error
Imagine your situation if you have a large position and cannot close a trade due to a platform error or system error, which could be anything from a power outage to internet congestion or a computer crash. This category also includes unusually volatile times when orders such asstop tabsdoes not work. For example, many traders had tight stop-losses on their short positions in the Swiss franc before the currency rose sharply on January 15, 2015. However, these proved to be ineffective becauseliquiditydried up, while everyone wanted to close their short positions in the franc.
No information advantage
The largest currency trading banks conduct large-scale trading activities related to the currency world and have an information advantage (for example, commercial currency flows and covert government intervention) that is not available to the retailer.
Currency volatility
Consider the example of the Swiss franc. A high degree of leverage means thattrading capitalcan be used up very quickly during periods of unusual currency volatility. These events can occur suddenly and move the markets before most individual traders have a chance to react.
OTC marked
The Forex market is onefreely availablemarket that is not centralized and regulated like the stock or futures markets. This also means that currency transactions are not guaranteed by any form of clearing organization that may give rise to thiscounterparty risk.
$6 trillion a day
Although the forex OTC market is decentralized, it is enormous, with data from a 2019 Triennial Central Bank Survey of Foreign Exchange showing that more than $6 trillion worth of currencies are traded every day.
Fraud and market manipulation
There have been occasional cases of fraud in the forex market, such as that of Secure Investment, which disappeared in 2014 with more than $1 billion in investor funds.Market manipulation of exchange rates is also widespread and involves some of the biggest players. In May 2015, five major banks, e.g. fine of almost $6 billion for attempted manipulationexchange ratesbetween 2007 and 2013, bringing the total of fines imposed on these five banks to almost $9 billion.
A common way in which market movements can manipulate the markets is through something called a strategystop-loss hunts. These large organizations will coordinate price drops or increases to where they expect retailers to have placed their stop-loss orders. When these are automatically triggered by price movements, the currency position is sold and this can create a waterfall effect of selling as each stop-loss point is triggered, which can create big profits for the market mover.
Is Forex Trading Profitable?
Forex trading can be profitable, but it is importantthink of time frames. It is easy to be profitable in the short term, measured for example in days or weeks. However, it is usually much easier to be profitable over several years if you have a large amount of cash and a system in place to manage risk. Many retail traders do not survive forex trading for more than a few months or years.
Is Forex High Risk?
Although forex trades are limited to percentages of one point, they carry a very high risk. The amount required to make a significant profit in forex is significant and many traders are highly indebted. The hope is that their leverage will result in profits, but usually leveraged positions increase losses exponentially.
Is Forex riskier than stocks?
Forex trading is a different trading style than the way most people trade stocks. The majority of stock traders buy shares and hold them sometimes for years, while forex trading is done by the minute, hour and day. The time frames are much shorter and the price movements have a more pronounced effect due to the leverage. A 1% move in a stock isn't much, but a 1% move in a currency pair is quite large.
In short
If you still want to try itCurrency trading, it would be wise to take a few precautions: limit your leverage, maintain tight stop-losses, and use a reputable forex brokerage. While the odds are still against you, these measures can at least help level the playing field to some extent.
