How can you become rich through forex trades? Although our instinctive reaction would be an unequivocal “No,” we should qualify that response. Forex trading may make you rich if you are a hedge fund with deep pockets or a currency trader with exceptional skills. Forex trading can, however, lead to enormous losses and possible penury for the average retail trader rather than being a quick road to wealth.
A series of unexpected events
Consider a relatively recent example of forex trades that may help you to better understand its dangers. For three years, the Swiss National Bank capped the Swiss franc at 1.20 against the euro. Recently, this cap was abandoned by the Swiss Bank. This resulted in a 41% appreciation of the Swiss franc against the euro.
Small retail investors to large banks suffered losses ranging into the hundreds of millions of dollars as a result of Switzerland’s central bank’s surprise move. At least three brokerages went bankrupt after losses in retail trading accounts rendered them insolvent, including FXCM, the largest retail forex brokerage in the United States at the time.
Forex traders face more risks than one-time events. Listed below are seven more reasons why forex traders have difficulty making money:
Leverage is excessive in forex trades
There are times when currencies can experience violent gyrations, such as those seen in the Swiss franc. In the case of the euro, a substantial move from 1.20 to 1.10 over a week represents less than a 10% change. In contrast, stocks can easily rise or fall 20% or more in a single day. For forex traders, the appeal lies in the leverage provided by forex brokerages, which magnifies gains (and losses).
A trader who shorts $5,000 worth of euros against the U.S. dollar at 1.20 and then covers the short position at 1.10 would earn a profit of $500, or 8.33%. Profit would be $25,000 or 416.67% if the trader used the maximum leverage of 50:1 permitted in the U.S. (ignoring trading costs and commissions).
The trader’s potential loss would have been $25,000 had he been long euro at 1.20, had he used 50:1 leverage, and if he had exited the trade at 1.10, he would have lost $25,000. Leverage can be as high as 200:1 or even higher in some overseas jurisdictions. Several nations are clamping down on excessive leverage because it is the single biggest risk factor in retail forex trades.
Risk-reward asymmetry in Forex Trades
When their currency call proves to be correct, seasoned forex traders offset their losses with sizable gains. However, most retail traders do it the other way around, making small profits on several positions but then holding on to a losing trade for too long, incurring a substantial loss as a result. Investing in this way can also result in a loss that exceeds your initial investment.
Malfunctions of a platform or system
Suppose you are holding a large position and are unable to close it due to a system failure or platform malfunction, which could be anything from a power outage to an Internet overload. Orders such as stop-losses would also fall under this category during exceptionally volatile times. The currency surged on Jan. 15, 2015, and many traders had tight stop-losses on their short Swiss franc positions. While everyone stampeded to close their short positions on the franc, these measures proved ineffective because liquidity dried up.
A lack of information edge
Large forex trading banks have massive trading operations that are plugged into the currency world and possess information advantages (for example, commercial forex flows and covert government intervention) not available to retail traders.
Volatility of currencies
Consider the Swiss franc as an example. When currency volatility is unusual, high degrees of leverage can quickly deplete trading capital. Individual traders may not be able to react to these events before they happen.
In contrast to stock and futures markets, the forex market is an over-the-counter market that is not centralized or regulated. The lack of a clearing organization means that forex trades are also subject to counterparty risk.
Daily revenue of $6 trillion
More than $6 trillion worth of currencies are traded every day on the forex OTC market, despite being decentralized.
Market manipulation and fraud
Fraud in the forex market has occurred occasionally, such as with Secure Investment, which disappeared with more than $1 billion in investor funds in 2014.
A number of the biggest players have also been involved in manipulating forex rates. A total of nearly $9 billion in fines was imposed on five major banks in May 2015 for attempting to manipulate exchange rates between 2007 and 2013.
Stop-loss hunting is a common strategy used by market movers to manipulate the markets. Retail traders’ stop-loss orders will be coordinated by these large organizations where they anticipate price drops or rises. As each stop-loss point is triggered by price movement, the forex position is sold automatically, resulting in a waterfall effect of selling, which can net the market-mover large profits.
Forex Trades: Are they Profitable?
Trading forex can be profitable, but timeframes must be considered. When measured in days or weeks, short-term profits are easier to achieve. For long-term profitability, however, it is usually easier if you have a large amount of cash to leverage and a system for managing risk. Many retail forex traders do not last more than a few months or years in the market.
How risky is Forex?
The risk of forex trades is very high, even though they are limited to percentages of a single point. Forex traders are highly leveraged because it takes a significant amount of money to turn a significant profit. Oftentimes, leveraged positions result in exponential losses instead of profits.
Can Forex Trades be riskier than stocks?
The way people trade forex is different from how they trade stocks. The majority of stock traders purchase stocks and hold them for years, whereas forex traders trade every minute, hour, and day. Due to leverage, the price movements have a more pronounced impact on shorter timeframes. It is not much of a move in a stock if the price moves 1%, but it is quite a big move for a currency pair if the price moves 1%.
Using a reputable forex market trading service, like Telegram.forex, and limiting your leverage would be prudent precautions if you decide to trade forex. You may be able to level the playing field to some extent even if the odds are still stacked against you.