Why does everybody lose at Forex?

There is nothing like relaxing on an exotic coastline while your spread betting account locks in money. I like to imagine this is the life of the full-time retail trader. We have all seen those forex trading adverts of those morons sitting on the beach shoreline with their laptops (this is surely a bad idea?). Needless to say I have a long way to go before reaching this quality of life.

Currency markets tend to be quite volatile and for the inexperienced forex spread betting can be a license to lose money. Planning beforehand is essential. Currency trades tend to be substantially leveraged so market movement will have proportional affect in your account value based on the amount of gearing.

When you enter into a spread trade there’s basically a 50% chance that you will end up on the winning side – think about it: the market direction can either go up or down – so why is that so many spread traders and investors end up losing money in the long term?

“HOW CAN YOU MAKE MONEY FROM THE FOREX MARKET? To make money from the Forex market you simply need to purchase a currency at a lower price than you sell it for (or vice versa)…sound a little too easy? The hard part is knowing when to buy and when to sell…”

Shouldn’t the law of averages ensure that about half of the investors trading currencies make money in the long haul? It is interesting to note that most traders have the problem of opening a spread betting position and immediately start in negative territory (due to the spread).

So why is that most forex traders are losers? You don’t hear of many people that tend to do well trading foreign exchange and being consistent.

People tend to focus on day trading and short-term movements which can be quite random, as opposed to longer term moves, which tend to be based on the economic fundamentals; namely interest rates and inflation. High interest rates and low inflation make a currency of a nation more attractive to global investors, causing the currency to appreciate in value. Most traders also tend to over-leverage themselves, risking in excess of 2% of their capital in any one foreign exchange trade. They also tend to be impatient so they overtrade themselves, and bomb out their account in just the first few trades. That’s way, WAY to aggressive. Caused by greed and impatience…which probably resulted because they knew they had a good strategy, and they wanted to get rich by tomorrow.

Day trading does give you an adrenaline rush which some people crave for (just like gambling), but is rarely profitable. Trading longer term movements is not so thrilling (just as thrilling as watching plants grow), but tends to be more profitable. Choose wisely! =).

Let’s suppose you are trading randomly, without any trading strategy whatsoever, but stick to a fixed stop loss and profit target levels.

  • If your profit target on every spread trade is equal to your stop loss level, you’ll be equally likely to win or lose money on any one trade. So you’ll end up losing money in the long haul due to the spread.
  • If your profit target is higher than your stop loss level, you’ll be more likely to lose than to win, because the market movements are likely to hit your stop loss.
  • If your stop loss level is larger than your profit target level, you may be more likely to win, but when you lose, you’ll end up losing too much money and chances are that you’ll end up in a situation where it would be impossible to recover from your losses.

So as you can see all three scenarios will cause you to lose money in the long run.  This follows that the only way to trade successfully is to use a strategy.  i.e. you have to be able to predict the market direction.  Most spread traders don’t have a trading strategy and trade based on gut feelings.  And when they lose, they try even harder to recover, which tends to make them lose even more.

Most traders fail because they trade based on what they want the market to do as opposed to trading what the price action is telling them.  If you allow your losses to grow bigger and bigger, it is because deep down you want the market to reverse, but  the chart and market are telling you otherwise.  Instead of admitting that you’re wrong and closing the trade, you permit the losses to paralyze you.  And then you end up with massive losses.

Most strategies and spread betting systems out there work in that they win more than 50% of the time.  But most people are unable to follow the system.   Give a proven trading system to 20 traders.  The same setup, with identical risk/reward ratios, the same trading rules, the same foreign exchange pair, the same time frame and allow them all to trade that spread betting system in a determined time.  Chances are that the performance of these individual traders would vary a lot from one another.  The truth is that only disciplined traders who are able to control their emotions can successfully implement a good strategy.  This is the very essence of trading – your mental state is very important. Likewise, maintaining a well-balanced risk/reward ratio and reducing the size of your forex positions during particularly volatile periods can help reduce risk.