Unscrupulous brokers, market introducers and forex platforms will often market their products to potential traders as a quick way to make a great deal of money. For those looking at forex trading as a potential revenue stream, it’s important to know the facts.
Quite simply, around one-third of retail traders avoid making a loss. That doesn’t mean that these traders make a great deal of money; they may just break slightly above even. For the rest, there’s an enormous potential to lose a great deal of capital.
The reason for this is simple: the risk to reward ratio in forex trading is extremely weighted towards risk. The net sum of global currency shifts is zero, so there is only so far a currency pair can go; it’s extremely unlikely that a quote currency will keep rising against the base, so it doesn’t always pay to play the long game in forex. Where indices and commodities can rise indefinitely, currency pairs don’t, so passive and long-term trading techniques have less relevance.
Institutional traders usually mitigate this by cutting losses short and keeping successful positions open for longer. Unfortunately, there’s a natural tendency among novice traders to do the opposite; they cut a winning position short and watch their losing positions cut into their capital.
A loss can easily lead to revenge trading using increasing amounts of capital, and the vicious cycle continues. Add to this the high levels of leverage offered by some forex platforms, and capital is entirely at risk.
Institutional traders also have the informational edge due to economies of scale. They’re party to information not available to the public, such as covert currency adjustments by governments and information about recent and pending trades. This means that most home investors are flying blind; by the time they receive news that impacts a currency, the shift has already happened.
The lack of regulation of forex is also an issue. Leaving aside fraudulent investment platforms, brokers and schemes, there’s no central governance of the currency markets. This means that forex is traded over-the-counter, and there’s no clearing house to ensure parties to a transaction honour their deals, and can affect liquidity and price timing.
The lack of regulation also means that there’s cases of market manipulation by unscrupulous institutional investors. Currency markets are set in London during a ‘fix’ that takes place over a 60-second period either side of 4 pm daily. The fix takes the median price of any trades that take place during this period to set the price of global currencies. Some speculators save sizeable deals that will lead to a drop in a currency for execution during this period in order to successfully short positions, and they often share this information on private WhatsApp groups.
While this would be illegal in stock trading, it’s not in forex, so the integrity of the daily fix is compromised.
The odds are stacked against retail traders. Anyone considering forex trading should analyse their goals carefully before trading live, and develop a strong strategy before risking any capital.Tags: forex, forex markets, forex pitfalls, forex trading