Can you become money via FX trading? We should qualify our answer even if our first impulse would be to say “No” without any hesitation. If you are an exceptionally good currency trader or a hedge fund with huge funds, forex trading might make you wealthy. However, for the typical retail trader, forex trading may be a difficult path to massive losses and even destitution rather than an easy path to riche
Key Points in Forex Trading
- In quest of quick returns, many retail traders flock to the forex market.
- According to statistics, the majority of ambitious forex traders fail, and some even incur significant financial losses.
- Leverage is a two-edged sword since it may result in both astronomical gains and significant losses.
- To potential forex traders, platform issues, counterparty concerns, and abrupt spikes in volatility all present difficulties.
- Forex pair trading occurs in the over-the-counter market without a central clearing company, in contrast to the exchanges where equities and futures are traded.
Consider a reasonably recent example to have a better understanding of the risk involved in forex trading. The Swiss National Bank abolished the three-year-old ceiling of 1.20 for the Swiss franc to the euro on January 15, 2015. 1 The Swiss franc increased by as much as 41% versus the euro as a consequence on that day.
Numerous players in forex trading, from small individual investors to huge institutions, suffered losses of hundreds of millions of dollars as a result of the central bank of Switzerland’s unexpected action. At least three brokerages had their capital destroyed by losses in retail trading accounts, making them insolvent. FXCM, the biggest retail forex brokerage in the United States at the time, was also on the brink of going out of business.
The danger that forex traders face is not limited to unforeseen one-time occurrences. Here are seven more factors that work against ordinary traders who wish to make money on the FX market.
Although currencies may be erratic, ferocious swings like the one seen by the Swiss franc are uncommon. For instance, a significant adjustment that causes the euro to drop from 1.20 to 1.10 vs the U.S. dollar over the course of a week is still less than a 10% difference. On the other hand, stocks may easily fluctuate by 20% or more in a single day. But the large leverage offered by forex brokers, which may increase profits, is what makes forex trading so alluring (and losses).
If a trader shorts $5,000 worth of euros at 1.20 and subsequently closes the short position at 1.10, they will have made a tidy profit of $500 (8.33%). The profit would be $25,000, or 416.67 percent, if the trader employed the highest leverage of 50:1 allowed in the United States (avoiding trading fees and charges).
Of course, the potential loss would have been $25,000 had the trader been long the euro at 1.20, utilized 50:1 leverage, and closed the position at 1.10. Leverage in certain foreign countries may reach 200:1 or more. Regulators are cracking down on high leverage since it is the single largest risk factor in retail FX trading.
Uneven Risk to Reward
Experienced forex traders limit their losses and make up for them with big returns when their currency prediction turns out to be accurate. However, most retail traders go about it the opposite way, achieving modest gains on a lot of trades while hanging onto a lost transaction for too long and suffering a significant loss. Additionally, you can lose more than you invested as a consequence of this.
System or Platform Malfunction
Consider your situation if you have a sizable position and are unable to finish a trade due to a platform issue or a system malfunction, which might be anything from a power outage to an Internet overload or a computer catastrophe. This group would also include very volatile periods when orders like stop-loss orders fail.
No Information Edge
The largest forex trading institutions have sizable trading operations that are integrated into the currency market and have access to information that retail traders do not (for example, commercial forex flows and covert government involvement).
Money Market Volatility
Remember the Swiss franc illustration. Due to high levels of leverage, trading money may be swiftly exhausted during times of extraordinary currency volatility. These occurrences may happen quickly and affect the markets before the majority of individual traders have a chance to respond.
Unlike the stock and futures markets, which are decentralized and regulated, the FX market is an over-the-counter market. Additionally, this implies that no clearing body of any kind can provide protection for currency deals, which might result in counterparty risk.
Market Manipulation and Fraud
There have been a few instances of fraud in the FX market, such Secure Investment, which vanished in 2014 with over $1 billion in investor assets.
There has also been widespread market manipulation of FX rates, which has implicated some of the major companies.
Stop-loss hunting is a frequent tactic used by market movers to influence the markets. These big companies will plan price changes in accordance with where they believe retail traders will have put their stop-loss orders. The forex position is sold when those are triggered automatically by price movement. This might result in a waterfall effect of selling when each stop-loss point is activated, which can result in significant gains for the market mover.
Is Forex Trading Profitable?
Profitable forex trading is possible, but timelines must be taken into account. In the short term, which is defined as when measured in days or weeks, it is simple to be profitable. However, it’s often far simpler to remain successful over many years when you have a lot of capital to leverage and a strategy in place to control risk. Many retail traders fail to make it through the first few months or years of FX trading.
Forex: Is It High Risk?
Forex transactions are very high risk even if they can only be made in percentages of one point. Since a big investment is required to make a considerable return in forex, many traders use high levels of leverage. Although it is hoped that their use of leverage would provide a return, leveraged situations often cause losses to grow rapidly.
Are stocks riskier than forex?
Compared to how most individuals trade equities, forex trading involves a distinct trading approach. While most stock traders buy and keep their investments for months or even years, forex traders trade by the minute, hour, and day. Because of leverage, the periods are substantially shorter and price changes have a more noticeable impact. A change of 1% in a stock is not much, but a 1% change in a currency pair is significant.
If you decide to continue trading forex, it would be wise to take a few precautions: restrict your leverage, maintain tight stop-losses, and work with a trustworthy forex brokerage. Despite the fact that the chances are still stacked against you, at least these steps could assist you somewhat level the playing field.