Want to trade forex? Perhaps don’t read this. If you follow me on twitter on @TheSoWW, you probably know I hold a pretty dimmed view of day trading in general and day trading forex in particular. Hence, if you are on the cusp of opening a forex brokerage account and are looking for reassurance, it’s likely you will find none in this post. But hold on, this might just be the other side of the coin you are missing. I have been in the markets for a minute and I know forex trading as a highly romanticized, widely misunderstood, but nevertheless, a ruthlessly marketed concept.
Forex trading is the short form for foreign exchange trading – the simultaneous exchange of two currencies by two parties. Not too long ago, you had to make a call to a broker or be in possession of a Bloomberg terminal to put in trades. Now with a few hundred shillings, a smartphone and internet, you can literally open a trading account and be trading in minutes. Forex trading has become so easy. That doesn’t mean making money forex trading has become any easier!
Retail forex traders are primarily day traders, which makes them by definition short-term traders. Day trading refers to the idea of getting into trades with the intent of closing them out within the same day (related jargon include scalping and swing trading). Investopedia has plenty of information on the basics; you can check out some of that here on investopedia.
So, how easy (or difficult) is it to make money trading forex? Objective, irrefutable stats on profitability are hard to come for a variety of reasons, but it is common knowledge that success rates of day traders in major markets are not just underwhelming, they are dismal. I cannot vouch for the authenticity or the completeness of any particular study, but you can do a simple online search and be the judge.
Despite what “influencer traders” and online marketers have made you believe, being an independent trader in any financial instrument is an incredibly assiduous undertaking, that’s more likely to end in bitterness and frustration than lead to rich land.
I know the forex trading you might have seen on social media is of guys living in a beach house, who wake up and place a few trades before they go out to ride their boat or buff their supercars, then returning home to tinker with their algorithms, as they sip leisurely from their champagne flutes.
I like the anecdotal 90/90/90 rule. It says, 90% of day traders burn through 90% of their capital in 90 days. This may sound like a dismissive one-liner, but numerous studies converge around the conclusion that only about 1% of day traders sustainably make money over the long term. For the vast majority of traders, it’s more of a daily battle against total capitulation than nonchalant profit booking.
But if forex trading was so difficult, why is everybody so eager to do it? I can think of a number of reasons why this happens.
1.The allure of convenience and the tied glamour of “being your own boss”.
2.Very accommodating capital requirements.
3.Availability and ease of using leverage.
4.Misinformation campaigns by interested parties, touting outsized returns.
Are there ways to improve your chances of being a profitable forex trader? Of course, there are. And in fact, wildly profitable, million-dollar forex traders do exist, just rarely on Instagram!
Success in trading any instrument is about knowledge and character. The problem I see is that too many people focus too deeply on the knowledge part and brush over, if not completely ignore the character part. They go in, make a few trades and burn their fingers. They invariably conclude that they could have done better if they knew a little bit more. So they go out and learn about a couple of chart patterns and place some trades again. They may find some success but invariably, any rough patches downstream are met with a barrage of charting tools, news site subscriptions and boot camps.
Character, not knowledge is what differentiates good traders from bad ones. Character in trading pertains to how disciplined you are and how prudently you manage risk. More importantly, character pertains to how well you can manage your emotions before, during and after trades. If you are overly excitable about gains and overly depressed about losses, you will probably make a lousy trader. In other words, if you are a properly functional human being, you are likely to make a bad trader!
What that means is that simply by being human, the majority of people make bad traders. The 90/90/90 rule testifies to this. I could go on and on about how to be a good trader, but with prospects of being one being so unbelievably low, it is probably not a productive use of blog space. I feel like it is more useful to try and save wannabe forex traders from themselves. To tell them that demo account trading success while commendable, is not a good indication of success when trading real money on a real account, because real money does really “eff up” our emotional composure. You might think you have a grip on your emotions because you have aced your demo sessions for the last 6 months until you see your net worth changing second by second on account of numbers blinking red and green on a screen.
Someone recently told me to stop badmouthing trading while banks continue to report bumper trading profits year after year. It occurred to me that folks generally have a very warped notion of how banks come about their “trading profits”. This should be obvious, but banks have an order flow benefit that retail traders cannot even comprehend. Banks make trading profits simply by taking a spread between their buying price and their selling price, with the only risk being that the market will move against them between the time a seller sells to them and the time a buyer comes along. In fact, the global trend is that banks are doing less and less proprietary trading and focusing more, if not exclusively, on customer order flow. Any residual proprietary forex trading is moving to computers which are faster, cheaper to maintain and uninfluenced by the emotions us humans are.
Lastly, forex trading is a zero sum game. There is no overall value creation. At least with investing in stocks and bonds for example, there is additional value created through dividend and interest income. Actually, some corners have argued that forex trading is a negative sum game since in addition to the absence of value addition, value is actually taken out of the system by spreads and peripheral costs of business. It is just a musical chairs game. The problem is, it’s a musical chairs game with a hundred chairs but a million players. Only an infinitesimal number of players will find chairs consistently.
There is a joke that if you are thinking of going into day trading, you should donate that money to a charity instead: a similar financial result for you, but a better result for humanity.