If someone ask ‘can forex trading make you rich’, the obvious answer would be No. And yet, on second thoughts, it is essential to clarify that with the help of a highly skilled trader, forex trading might make you rich. However, the truth is that forex trading might make you rich if you have a hedge fund backed deep pockets or have an extraordinarily skilled currency trader.
For the average retail trader, getting rich through forex trading is an uphill task. It is highly likely that you sustain massive losses and be reduced to a life of penury.
Studies have shown that one in three traders manage to make some profit or at least not lose money through their forex trading account. But, that doesn’t mean they all become rich through their excellent forex trading performance. On the contrary, the number of people becoming poor through forex trading could be higher than those getting rich through it.
Before we get into the details, let’s take a quick look at some of the key points concerning forex trading.
- Many traders look to the forex market for quick profits.
- Statistics tell us that most forex traders fail, and few traders even lose massive sums of money
- Leverage can create huge profits but may lead to substantial losses as well – it is like a double-edged sword.
- Major challenges to forex trading include counterparty risks, platform malfunctions, and sudden bursts of volatility.
- Forex trading is more of an over-the-counter market with no central clearing firm or exchanges
- Forex trading is highly affected by unexpected one-time events – in most cases the impact is detrimental
Apart from the one-off events, there are several other factors on which the forex trading performance is dependent. Here are some of them and you can see why the odds are against the forex trader who wishes to get rich by trading in the forex market.
It is known that currencies can be volatile, and at times a single violent twist, which is uncommon can wipe out an entire firm from the scene. For instance, take the case of a massive move that takes one currency, say euro from 1.20 to 1.10 against the dollar over a week. It would be a change of less than 10%. However, stocks easily trade up or down 20% or more during a day. But the appeal of forex trading is in the huge leverage offered by forex brokerages that magnifies gains (and losses too).
So, if a trader shorts $5,000 worth of euros against the U.S. dollar at 1.20 and then covers the short position at 1.10, he would make a tidy profit of $500 or 8.33%. But if he used the maximum permitted leverage, which could be as high as 50:1 (or more) the profit is $25,000, or 416.67%.3 (without factoring in the commission and costs).
And if it had been long euro at 1.20, and the trader used the 50:1 leverage to exit the trade at 1.10, then the potential loss would have been $25,000. In some countries, leverage can be as high as 200:1 or more. So, excessive leverage is the single largest risk factor in retail forex trading, and hence the regulators are often trying to clamp it down.
Disproportionate risk to reward ratio
Seasoned forex traders know that forex trading has a disproportionate risk to reward ratio. Higher the risk, higher the return doesn’t always work well in this scenario and hence, they try to keep their losses small.
They are also smart enough to offset any of the losses with sizable gains with accurate currency calls. But, many retail traders make small profits on a number of positions and then hold on to a losing trade for too long thereby incurring substantial losses. Most of them end up losing more than their initial investment in the forex trading account.
System or platform malfunction or failure is one of the major reasons for loss in a forex trading account. Sometimes, you have a large position, but you are unable to close a trade because of a platform malfunction or system failure. It could be anything as silly as a power outage, internet overload or system crash. Also, during volatile situations, stop-loss orders also don’t work resulting in losses.
Lack of data and information
Large forex trading accounts and banks have an army of people plugged into the currency world to give them up to date information and data to make informed decisions. This is not available to the retail trader and often he must work with little or no information, which is a huge disadvantage while making decisions.
It is a commonly acknowledged fact that high degrees of leverage means that trading capital can be depleted in no time, especially during periods of unusual currency volatility. Volatile events happen suddenly and affect the markets immensely even before the most experienced individual trader has an opportunity to react.
As mentioned elsewhere, the forex market is essentially an over-the-counter market. It isn’t centralized and regulated like the stock market or futures markets. It means that forex trades do not have any guarantee from any kind of clearing organization.
This in turn can lead to counterparty risk. However, just because it is decentralised and unregulated, it doesn’t mean it is small. The forex OTC markets is in fact massive with more than $6 trillion currencies trading daily across the counters.
Fraudulent practices and market manipulation
Like most other financial sectors, forex trading is also not free from fraud. Market manipulations of forex rates is a widespread problem. The fact that even the big players are sometimes involved in these makes it more difficult and riskier for the retail trader.
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As you can see from the above points, it is not easy to get rich through forex trading.
There are lots of odds stacked against you when it comes to forex trading performance. But, if you feel confident and brave enough to try your hand at forex trading, make sure you move wisely.
Promise yourself to stick to certain safeguards such as limiting your leverage, keeping tight stop-losses, and using a reputable forex brokerage. If you do these, even if the odds are against you, you might be able to create a reasonably level playing field.