As high as 80% ofretail traders lose money trading forex & CFDs with ASIC & FCAregulated CFD brokers, depending on the broker. This figure could be evenhigher in other regions where the regulators don’t require brokers to displaythe percentage losses on their website.
Several factors areresponsible for these losses.
The fact that retailtrading in the forex market is not regulated in some geographies, relentlessadvertising campaigns by scam brokers offering high leverage and even promisingreturn on investments, insufficient knowledge etc. have all contributed to thisgrim statistic.
We shall discuss indetail some reasons why retail forex traders lose money.
Factor #1 - UsingExcessive Leverage
Except you are a bigfinancial institution or corporation, you may find yourself needing to useleverage to trade forex if you want to make a reasonable profit. That is okaywhen used moderately, and when you understand the risks.
Traders need tounderstand that trading with leverage involves taking a loan from the broker,and you keep margin money with the broker. If things don’t go as planned, and lossesoccur such that it is close your margin requirements, the broker will closeyour position.
A leverage of 400:1means that for every $1 of your trading capital you can control $400 worth ofcurrency or similar derivative.
A leverage of 400:1also means that the trader’s margin is 1/400= 0.25%
For example:
If a forex trader wantsto transact as follows:
Quantity sought=1standard lot (100,000 units)
Currency pair= EUR/USD
Exchange rate= 1.14
Leverage= 400:1
Margin= 0.25%
Initial depositrequired for trader to open a position= 0.25% of 100,000 UNITS = $250
The forex trader onlyhas to deposit $250 dollars to open a trading position of 1 Standard Lot with1:400 leverage on Forex. The difference is borrowed to him by the broker. Suchis the power of leverage.
But what if the EUR/USDexchange rate declines before the trader is able to sell?
This means the traderwill sell at a loss and still have to repay the loan the broker gave him. Thisis why using too much leverage is dangerous.
Always remember,leverage is a two-edged sword that amplifies gains as well as losses.
The alarming statisticsof forex traders losing money has caused regulators in some parts of the worldto intervene by limiting the leverage available to retail traders. See someintervention measures below:
Leverage Restrictionsin Australia
The Australianregulator the ASIC has reduced leverage available to traders from a whopping500:1 to 30:1.
In the United Kingdom
The United Kingdom’s regulator,the Financial Conduct Authority alias FCA, also ordered that leverageon CFDand CFD-like options be reduced to between 2:1 and 30:1 depending on howvolatile the asset is. They also ordered that a trader’s position be closedonce their trading capital falls to 50% of the margin needed to keep theirpositions open.
In Europe
In Europe theregulatory body known as the ESMA (European securities and markets Authority)has put some additional restrictions on CFD trade in place. These include:
Leverage limits of 30:1for major currency pairs, 20:1 for non-major currency pairs, CFDs on goldand major indices, 10:1 for CFDs on commodities other than gold, 5:1for CFDs on individual equities.
Factor #2 - PatronizingUnlicensed Brokers
Many new retail forextraders don’t confirm if a broker is licensed before doing business with them.They are also carried away by promises of huge leverage and high return oninvestments. It is only after they have been duped that they report to theregulating authority.
If your brokerguarantees you risk free return on investment from trading, it is probably ascam.
To help you spot a scambroker let us make some put them in categories.
Category One - Brokerswho operate without a license
Any forex broker whooperates without a license is doing so illegally. Although the forex market isnot regulated in some parts of the world, the forex broker should still hold alicense from regulators in developed countries like the UKs FCA, or Australia’sASIC.
Forex traders shouldalways check the regulator’s website for the list of brokers that are regulatedin their region and compare forex brokers based on factors like fees, safety offunds, ease of withdrawals, platforms supported & trading conditions beforecommitting funds. Some of the major regulators that a trader must check if abroker is regulated with are FCA, FSCA, ASIC, BaFin & CySEC.
Forex traders shouldalso avoid referrals. This is when a forex broker refers you to another websitein a region with lean regulations. Many forex brokers follow the practice ofregistering their clients under Offshore regulations to offer high leverage.
Category Two - Brokerswho operate with a license but are undercapitalized
A forex broker may belicensed but may not have sufficient capital to meet the trading obligations.This has caused the regulators to order that a financial disclosure statementis mandatory for brokers. This will enable a potential trader to determine ifthe broker’s assets can cover their liabilities.
Category Three – Fake Brokersoperating with cloned licenses
A scam broker couldalso use the name and registration number of a licensed broker to clone awebsite or to impersonate the licensed broker. Forex traders are advised tocheck on the regulators website for the phone number associated with the forexbrokers name and call that number to confirm if the broker is legitimate.
Factor #3 - InadequateKnowledge
Many retail tradersjump into the market without the right preparation. They don’t take the time tobe familiar with basic terminology used by forex market participants.
An aspiring forextrader should have the meaning of forex trading terms like spreads, pips, lot,Bid and ask price etc. at his fingertips. A forex trader also has to have abasic understanding of math.
Forex traders shouldalso keep in mind that the market operates in four different time zones-
Ø Sydney (10pm GMT to 7amGMT)
Ø Tokyo (11pm GMT to 8amGMT)
Ø London (7am GMT to 4pmGMT)
Ø New York (12pm GMT to9pm GMT)
The best time to tradeis when some of the sessions overlap. At this time, there is a lot of marketparticipation, liquidity is highest and spreads are lowest.
Forex traders must learnabout the instrument they are trading & how it can be impacted, what canmove its price, during what time of the day does it move mostly, and so on.
Without understandingeverything about that instrument, the risk of losing is even higher. Mosttraders jump into the market because they have heard stories of other peoplemaking money but enter without adequate knowledge.
Factor #4 – Revenge Trading
This is usually linkedto a trader's emotions. A feeling of disappointment when a trading plan doesn’tproduce results makes a forex trader want to keep trading over and over againin a bid to make up for the lost funds. It is also known as averaging into aposition.
Remember each time anew trading position is opened, fees and commissions are charged. Some forexbroker charge as high as $20/lot to open & close a position for a Standardlot. And with each position, you are exposing yourself to a higher risk.
When a forex traderrecords a loss, it is advisable to stop trading and carry out an assessment ofthe trading plan. This will enable you to find out what went wrong and makecorrections. This is a better approach than to engage in revenge trading.
Factor #5 – Not EnoughPractice
Before going live, aforex trader should hone his skills using a demo account.
Demo trading isavailable on most forex trading Apps. You should also practice how to interpretcandlestick charts, price movements etc. There are many useful tools &indicators that have been around for centuries and help to predict pricedirection.
Factor #6 – Poor RiskManagement
Trading forex &CFDs is a risky business, with a lot of complexities. Risk management istherefore not out of place and is the most important thing to learn.
Here are three tips tohelp you manage your forex trading risk.
1. Only trade currencypairs you have studied & understand
Before trading acurrency pair study and find out more about the country, its politics and itseconomy. This will give you an edge as it helps you predict the exchange ratemovement.
2. Use Stop Loss orders
The forex market isopen 24hours and a trader cannot be awake all the time. A stop loss order is anautomated instruction given by the trader to the forex broker to close histrading position should the value of the currency pair he is trading in fall toa certain level.
For example
A forex trader buys EUR/USDat 1.1403 exchange rate.
He hopes to sell whenthe exchange rate appreciates. He knows there’s a risk the exchange rate maydrop so he sets a stop loss order to sell off the currency pair if the exchangerate drops to 1.1390
By doing this if theexchange rate drops drastically he won’t lose much. His exposure will be just$0.0013 per unit/lot size of currency he bought. This can also be written as13pips (ignore the zeros)
3. Use take profitorders
A take profit orderautomatically sells the currency and closes the forex trader’s position whenthe exchange rate of the currency pair being traded rises to a predeterminedlevel.
4. Apply the 2% rule
Part of a trader’sforex plan should include not putting all eggs in one basket. Use no more than2% of the money in your trading account for a day’s trade. This will limit yourloss in the event the market moves against you.
These tips don’tprevent loss totally but they limit a forex trader’s exposure.
Factor #7 – InadequateTechnology
Many retail traderstrade forex & CFDs using smartphones. This is not convenient or advised asthey have small displays which may not display the charts properly, and carryout proper analysis.
Using a Smartphone fortrading is not smart, as it simply encourages trading without proper reasoningor data. They also give room for distractions when used continuously.
Computers have morecapable microprocessors that are able to load charts used in technical analysisof the market speedily and carry out complex algorithms. Also, you will be ableto access & analyse a large set of data. For active forex trading, acomputer or a laptop should be used.
If there is a delay inexecuting trades or your computer begins to lag, the exchange rates may changebefore your computer executes.
