Forex Trading: 12 Reasons to Avoid (Warning)
We have in a number of Tweets, posts, courses, and articles mentioned that the stock market offers the “lowest-hanging fruit” in trading. The reason is simple: We believe you can develop more robust and profitable trading strategies in stocks than in any market, and forex should mostly be avoided.
One of the markets we find extremely challenging to trade is the forex market. In this post, we provide you with 12 reasons why you should avoid forex trading:
Reason 1: Leverage
The most important reason why avoid forex trading is leverage. Period. More traders lose in forex because of leverage than any other reason.
Most forex traders trade forex because they have no other option. Their trading capital might be just a few thousand and this limits their options (a lot). If you are trading an asset because that’s the only option you have, then it should be obvious you should quit or at least reconsider.
Forex brokers gladly give their clients leverage up to 50 times their deposit, and you don’t need to be a rocket scientist to understand the odds are stacked against you. Only a tiny move leads to ruin:
Thus, leverage is the forex trader’s enemy number one. You never stand an honest chance to survive the learning curve when the leverage is high.
We recall one of the quotes from Victor Niederhoffer’s The Education Of A Speculator: The retail trader’s purpose in the market is to provide prey for the professionals. In other words, their role is to lose their capital. There are always other idi*** to fill in for the losers.
Reason 2: Small random market movements have a big impact
Because of the leverage, only small movements make your trading deposit a temporary winner or a permanent loser, most likely the latter. You only pay a fraction of the value of your trade up-front, but you are still responsible for the full amount of the trade.
When the leverage is 50 times the equity, only a 2% move can wipe you out! In practice, this is why most traders stop trading.
When traders start, they dream of striking it rich because a 2% move doubles their tiny capital. They might be lucky and double the capital, only to lose it the next trade. It’s almost inevitable they’ll lose it all.
Look at the statistics from the CFD market:
- 58% of retail traders lose money when trading CFDs with Interactive Brokers.
- 65% of retail investor accounts lose money when trading CFDs with SaxoBank.
- 67% of retail investor accounts lose money when trading CFDs with eToro.
- 71% of retail CFD accounts lose money with CMC.
- 72% of retail CFD accounts lose money with 500Plus.
- 81% of retail investor accounts lose money when trading spread bets in IG
Please read this article to understand your odds of success:
Reason 3: Exchange rates are very volatile
Forex moves around a lot even within very short periods of time. There are significant investment risks as currency fluctuations may move against you, causing you to lose money. Again, leverage bites!
Reason 4: Currency markets are a zero-sum game
Exchange rates are a zero-sum game. Over the long term, you have no tailwind from inflation or productivity gains as you have in stocks.
In stocks, you get a “free” 0.04% gain every day you own stocks, at least based on historical returns, something we have covered in our article about night and overnight trading edge. Stocks have proven, barring any revolution or expropriation, to be a very good wealth creator, something which is impossible in the forex market. You can’t buy and hold forex! Forex is a relative relationship between two (political) economies. You can’t build wealth over time!
- The Best Performing Stock Markets In The World Since 1900
- 180 Years of Stock Market Drawdowns (but still you get rich owning stocks)
As a matter of fact, the US dollar has lost nearly all of its purchasing value over the last 75 years!
Reason 5: Currency markets are extremely difficult to predict
Good luck predicting the future forex rate!
There are a zillion reasons why a certain forex trade takes place: it could be an importer, an exporter, a speculator, a hedger, a central banker manipulating the price, or a Russian money launderer. This is why it’s volatile and difficult to make predictions. That said, over the long run, the purchasing power parity has held up pretty well.
The forex market is dependent on a zillion factors, and thus it’s an utterly pointless exercise in predicting. In all research, we have seen that the best predictor of the forex market is the sum of the market: the forward rate N-months forward. That’s a better predictor than practically all economists and consultants.
Reason 6: Limited protection from risk management systems
Because of erratic and unpredictable moves, any risk management system or strategy is unlikely to help you (in the long run). You might even have to pay a premium to guarantee your stop-loss order!
Reason 7: Plenty of forex scams and fraud
The forex world has had plenty of scams and frauds, like all markets, but nearly not as many as in the forex broker world.
Offers and advertisements that sound too good to be true probably are. Please read what the US Commodity Futures Trading Commission has to say about foreign currency trading fraud.
Reason 8: Forex provider risks (counterparty risk)
If your FX provider becomes insolvent, you may not get your money back. Every transaction has a counterparty (the party taking the other side of the trade), and the counterparty might default on its obligations. This is counterparty risk. The forex market is less regulated than the stock market.
Reason 9: 24-hour markets
Because the markets are open 24 hours, you might get tempted to trade more than necessary. You overtrade.
Reason 10: Systematic/algorithmic trading requires a lot of work
If you’re a systematic/algorithmic trader, like we are, there is another important reason why avoid forex:
Any profitable backtest is unlikely to pass the incubation period. Our own trading strategies in forex futures have the highest failure rate among all the asset classes during the incubation period. Even worse, if they pass incubation, they rarely last long before we are forced to stop trading them.
The reasons for the high failure rate should be obvious to you if you have read so far.
Reason 11: forex market attracts gamblers
If you find yourself setting up a forex account, ask yourself why: are you a gambler? We suspect most of the forex accounts belong to impulsive “gamblers”. Ask yourself why you are setting up an account.
Reason 12: Almost nothing is backtested
Avoid the forex market because of unbacked promises.
Many forex traders start trading because they have seen a strategy that promises winners on a grand scale, normally without any results backing the claims.
If you don’t know how your trading system has performed in the past, why would you trade it? Backtesting offers no guarantees, but at least you know if it has provided you with a positive statistical trading edge in the past.
The forex market is full of “strategies” that are based on anecdotal evidence. Practically nothing has been backtested, especially those that promise lots of gains.
Reasons why you should avoid forex trading – conclusion
Success in trading and investing comes down to several factors. One of them is which market(s) to trade.
Forex trading is VERY difficult to trade, and we believe you should be very careful before you dip your toes in the water. If you are considering forex trading, please do yourself a favor and reread the 12 reasons why you should avoid forex trading.
Related reading: Forex trading vs Options trading
FAQ:
Why is leverage considered the enemy of forex traders?
Leverage is a double-edged sword in forex trading, and excessive leverage often leads to significant losses. It amplifies both gains and losses, making it a crucial factor for traders to consider. Small movements in the market can have a substantial impact on a trader’s deposit due to high leverage. Understanding the relationship between market movements and leverage is essential for risk management.
What makes predicting currency markets extremely challenging?
Currency markets are influenced by numerous factors, making them volatile and challenging to predict. The article highlights the complexities involved, including the diverse motivations of market participants. Forex operates as a zero-sum game, meaning that for every winner, there is an equal loser. Unlike stocks, there is no inherent tailwind from factors like inflation or productivity gains in the long term.
Why is risk management challenging in forex trading?
Erratic and unpredictable moves in forex markets make risk management systems less effective. Traders may face difficulties in implementing strategies to manage risks due to the nature of currency market fluctuations. Forex providers may pose counterparty risks, especially if they become insolvent. The article emphasizes that the forex market is less regulated than the stock market, increasing the importance of understanding counterparty risk.