Despite being highly risky, foreign exchange trading is expected to grow in popularity. Here’s what you need to know about forex trading and whether it is right for you.
Forex is short for ‘foreign exchange’, and refers to the trading of one currency for another. Forex trades are performed via a globally connected financial market which trades 24 hours a day, five days a week.
In a nutshell, a forex trader attempts to profit off movements in the currency markets. This is accomplished by buying and selling a pair of currencies.
For example, the Ringgit (MYR) is now trading at historical lows against the Singapore Dollar (SGD). At the time of writing, 1 MYR = 0.315 SGD according to xe.com.
Let’s say you buy up MYR 1,000 worth of Ringgit, which costs you SGD 315. When MYR rises against the SGD, say, 1 MYR = 0.330 SGD, your stack of MYR 1,000 is now worth SGD 330, giving you a profit of SGD 15.
Of course, nobody gets out of bed for a mere S$15 profit, but this is just an example to illustrate the principles at play here. The actual numbers involved in a real forex trade is a lot higher, with trades lasting as short as an hour,
Is forex trading profitable?
The forex market is one of the largest financial markets in existence, standing at a total value of US$702 billion in 2021. Forex trading is so popular that in 2019, daily trading volume reached a jaw-dropping US$6.6 trillion.
With such a frenetic market, it is not unreasonable to assume that forex trading is profitable. However, this doesn’t seem to be the case for the average investor.
A review of 50 randomly selected FX traders on trading platform eToro saw only eight traders managed to achieve a profit — meaning that 84% of FX traders lost money.
This depressing statistic is supported by another equally devastating finding — across 28 of the top brokers offering CFDs (contract-for-differences, one of the main methods used for forex trading), an average of 76% of all accounts were in the red.
Clearly, the vast majority of forex traders are unlikely to find success.
Why is forex trading popular?
With a success rate of around 15%, you’d think investors wouldn’t exactly be lining up to get involved. But surprisingly, that’s not the case.
Not only does forex trading remain highly popular, the market is expected to grow at over 7% per annum over the next five years to breach the US$1 billion mark.
Why? Well your guess is as good as ours, but we think it could be because of the following reasons.
Lure of fast money
Forex trades are very fast-paced, with trades concluding in one hour or less. This creates a perception that profits can quickly be racked up, while making it easy to lose track of losses. Due to the speed at which you trade, you may find yourself continuing long past the point when you should stop.
Rise of social forex
Here’s yet another thing that social media is ruining. There has been an increase in the number of ordinary investors getting swept up in the shady world of social forex, which is best understood as a combination of forex trading and multi-level-marketing.
There are two ways you can make money in social forex — one is by currency trading, and the other, by recruiting your friends. A membership fee is often involved (part of which goes to the person who recruited you), and participants are sold on the idea that they are helping their peers attain financial independence.
Ability to start with very little capital
Forex trading is performed using lot sizes, which refer to currency units numbering 100,000, 10,000, 1,000 or 100 units. These are known as standard, micro, mini and nano lots, respectively.
This allows you to start trading with a small capital — for example, if you decide to trade the EUR/USD pair, and assuming the quote price is US$1.30, you can start trading with a nano lot (i.e.100 units), which translates to a capital of just US$130.
Additionally, many forex brokerages allow the use of leverage, which can potentially amplify your profits (and losses). This further reinforces the perception that forex trading can offer high profits even with a small capital.
Tips to help forex traders improve their odds
In case it’s somehow still not clear by now, forex trading is highly risky, and the majority of traders fail to turn a profit. This makes forex trading highly unsuitable for the average retail investor.
(I’d go as far as to add that forex trading isn’t investing — it’s gambling, but that’s just my personal opinion).
For those of you who are still interested in trying your hand at forex trading, here are some tips that might help to improve your odds.
Never invest more than you can afford to lose
Set a fixed budget for your forex trades, and stop when you’ve exhausted this budget. As mentioned, forex trading can be very fast-paced, which can make it easy to invest more than you mean to.
Stick with popular currency pairs
While the forex market trades round the clock, it is important to trade only during peak hours to ensure there is a sufficient level of liquidity, so you can exit your position when you need to.
As such, sticking with the most highly traded currency pairs is advisable, especially for newcomers. Start by trading US currency against other foreign currencies, such as
Adopt a disciplined approach
Forex trading demands a high degree of discipline in order to foster success.
For instance, you should train yourself to take profits when your trading goal has been reached, instead of maintaining your position in anticipation of a larger profit. This is because the market could shift against you, wiping out your gains and plunging you into the red.
Consider making use of automated trading strategies to help enforce discipline when trading in forex.
A note on trading with leverage
|Can dramatically boost profit
|Losses are amplified
|Can take a larger position with a smaller capital
|Fees and commissions may be payable
Forex trading is commonly available on leverage, and an experienced trader can use it to improve their results. On the flip side, trading forex on leverage increases the risk for those who do not know what they are doing.
Trading on leverage means borrowing funds from your broker to execute your trades. This allows you to take a larger position (for example, trading a standard lot instead of a mini) in the market, which amplifies your gains correspondingly.
Remember that in forex trading, you profit off the spread between the two currencies in the pair you are trading. This means that using leverage to take a larger position will give you a higher profit when the trade goes your way.
But if the trade goes against you, your losses will also be similarly amplified. Worse, trading with leverage can increase your losses beyond your ability to pay, which will expose you to serious and long lasting repercussions.
Hence, using leverage when trading forex — which, remember, already has a high chance of failure for the average retail investor — is almost always a bad idea.
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