Can forex mercantilism cause you to wealthy? though our spontaneous reaction to it question would be an unequivocal "No,” we should always qualify that response.
Forex trading might make you rich if you're a hedge fund with deep pockets or a strangely adept currency trader. except for the common retail trader, instead of being a simple road to riches, forex trading may be a rocky road to monumental losses and potential penury.
Can Forex Trading Make You Rich?
- unexpected events
To better understand the risks of forex trading, consider a relatively recent example. On January 15, 2015, the Swiss National Bank abandoned the Swiss franc's ceiling of 1.20 to the euro that had been in place for three years.
As a result, the Swiss franc rose as much as 41% against the euro on that day.
The sudden move by the Swiss Central Bank caused hundreds of millions of dollars in losses to countless forex trading participants, from small individual investors to large banks. Losses in retail trading accounts wiped out the capital of at least three brokerages, rendering them insolvent, and taking FXCM, then the largest retail forex broker in the United States, to the brink of bankruptcy.
One-time unexpected events are not the only risk facing forex traders. Here are seven more reasons why odds are stacked against a retail trader who wants to get rich trading the forex market.
- Excessive leverage
Although currencies can be volatile, violent fluctuations like the Swiss Franc mentioned above are not uncommon. For example, the significant movement of the euro from 1.20 to 1.10 against the US dollar over the course of a week still represents a change of less than 10%. On the other hand, stocks can easily trade up or down 20% or more in a single day. But the allure of forex trading lies in the huge leverage that forex brokerages provide, which can magnify gains (and losses).
A trader who sells $5,000 worth of EUR/USD at 1.20 and then covers the short position at 1.10 will make a good profit of $500 or 8.33%. If a trader uses the maximum leverage of 50:1 allowed in the US (ignoring trading costs and commissions), the profit is $25,000, or 416.67%.
Of course, had the trader been long the Euro at 1.20, used a 50:1 leverage, and exited the trade at 1.10, the potential loss would have been $25,000. In some offshore jurisdictions, the leverage can be as high as 200:1 or even higher. Since excessive leverage is the biggest risk factor in retail forex trading, regulators in a number of countries are putting pressure on it.
- Disproportionate risk reward
Experienced forex traders keep their losses small and compensate them with big gains when their currency order proves to be correct. However, most retail traders do it the other way around, making small profits on a number of positions but then holding a losing trade for a long time and making a big loss. This can also result in you losing more than your initial investment.
- Basic system or system malfunction
Imagine your plight if you had a large position and were unable to close a trade due to a platform malfunction or system failure, which could be anything from a power outage to internet overload or a computer crash. This category will also include exceptionally volatile times when orders such as stop losses are not working. For example, many traders had tight stop-losses on their short CHF positions before the currency rallied on January 15, 2015. However, it proved ineffective as liquidity dried up even as everyone rushed to close CHF short positions.
- No edge information
The largest forex trading banks have huge trading operations connected to the world of currencies and have an informational advantage (for example, forex trade flows and secret government intervention) not available to the retail trader.
- currency volatility
Cite the example of the Swiss franc. High degrees of leverage mean that trading capital can be depleted very quickly during periods of unusual currency fluctuations. These events can come on suddenly and move the markets before most individual traders have a chance to react.
- OTC market
The forex market is an over-the-counter market that is decentralized and unregulated like the stock or futures markets. This also means that forex trades are not guaranteed by any type of clearing institution, which may lead to counterparty risk.
Fraud and market manipulation
There have been occasional cases of fraud in the forex market, such as the case of safe investing, which vanished with more than $1 billion in investor money in 2014.
Market manipulation in forex rates was also widespread and involved some of the biggest players. In May 2015, for example, five major banks were fined nearly $6 billion for attempting to manipulate exchange rates between 2007 and 2013, bringing the total fines imposed on these five banks to nearly $9 billion.
A common way for market engines to manipulate the markets is through a strategy called stop loss hunting. These large organizations will coordinate the price drop or rise to where they expect the retail traders to have set their stop loss orders. When triggered automatically by price action, the forex position is being sold, it can create a waterfall effect of selling as every stop loss point is triggered, and it can bring big profits to the market mover.
Is forex trading profitable?
Forex trading can be profitable but it is important to consider time frames. It's easy to be profitable in the short term, as it is when measured in days or weeks. However, to be profitable over a period of several years is usually much easier when you have a large amount of money to cash in, and you have a risk management system in place. Not many retail traders survive forex trading for more than a few months or years.
Is forex high risk?
Although forex trades are limited to one pip ratios, they have a very high risk. The amount required to make a big profit in forex is large and therefore many traders enjoy high leverage. The hope is that their leverage will lead to profit but more often than not, leveraged positions increase losses dramatically.
Is Forex more risky than stocks?
Forex trading is a different trading style than the way most people trade stocks. The majority of stock traders buy stocks and hold them for years sometimes, while forex trades 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% movement in a stock isn't that great, but a 1% movement in a currency pair is rather significant.
- bottom line
If you still want to try your hand at forex trading, it would be wise to use some guarantees: limit your leverage, keep your stop loss, and use a reputable forex brokerage. Although the odds are still stacked against you, at least these measures may help you level the playing field somewhat.