According to the Bank of International Settlement (BIS) 2019 report, the global foreign exchange average daily turnover stands at $6.6 trillion. Around 5% of that volume is retail trading. This liquidity has attracted many retail traders into the forex market.
However, all retail traders do not understand that it is difficult to make a profit in forex trading. You compete against big Banks, high-frequency trading firms who use algorithms to spot trends and cash-in on them in a matter of seconds and sometimes even against your own broker.
It is no longer news that an average of 70% to 80% of retail forex traders lose in their trades. Some estimates calculate that this percentage is even higher. The misconception that forex is a get-rich-quick scheme is also a factor contributing to the high percentage of losses among forex traders.
Given the high percentage of retail traders losing in the industry, it is important to discuss some of the major reasons why retail forex traders make losses.
Not Having a Strategy
In business as in every form of human endeavour that involves competition, Strategy is an important factor in determining success or failure.
There are several strategies forex traders use, some of them include day trading, scalping, swing trading, and position trading. The strategy you will use depends on your personality.
Firstly, if you have time on your hands to monitor your trades all day, and a high risk tolerance, you might want to go with a scalping or day trading strategy. This is because these strategies involve placing several trades frequently, and taking little profits. The potential for loss here is higher.
Secondly, if you are busy and don’t have the luxury of time, and your risk tolerance is low, you could opt for the swing trading or position trading strategy. These strategies involve holding positions open for days to week. Losses are not as high with these strategies since you don’t trade often, and you also have enough time to analyze the market.
Each strategy has its merit and demerits but trading is all about risk management, so you need to choose which is best for you.
Overconfidence from demo trading
A demo account is a trading account where new traders practice in a simulated market environment with virtual funds. It is meant to develop their knowledge and understanding of the market before they go into live trading. However experience has to be earned.
Demo accounts are also used by older traders to test out new strategies and trading Bots before deploying them to the live market.
Many traders believe if they are successful in demo trading, it can translate into success in the live market but this isn’t always the case. Demo trading conditions don’t always reflect what goes on in the live market.
For example in demo trading there’s an absence of emotion, and counterparty risk. However in the live market, your emotions (fear, anxiety etc.) affect the way you trade.
Trading via Bad broker
Whether you have the skills, experience and all you need to trade forex, a bad broker can make you lose money continuously, by manipulating the spreads & other fees.
Firstly, if your broker operates a ‘dealing desk model’, it means when you sell, they buy from you, and when you buy, they sell to you. The broker doesn’t send your trades to the other liquidity providers such as Banks and hedge funds. Your broker is the counterparty to all your trades.
These brokers are market makers. It is important to know that even a market maker can be regulated, so you don’t have to worry too much about counter party risk.
But Karan Singh from Safe Forex Brokers is of the opinion that this is a conflict of interest since they directly profit from your loss, so traders should avoid market maker brokers & trade with regulated brokers that operate on an ECN model.
But even dealing desk brokers can manipulate the pricing as they make most of their money from spreads & commissions, so they can make their spread wider or charge higher commission, so there must be proper check of the counter party’s industry reputation before you decide to deal with it; adds Karan.
Secondly, if your broker operates a ‘Non- dealing desk model’, they pass your orders straight to liquidity providers. The end result is tighter spreads for you.
This also means when you want to buy, liquidity providers sell to you, and when you want to sell, liquidity providers buy from you. There is no conflict of interest here.
However, since non-dealing desk brokers use expensive ECN/STP computer networks to match you to liquidity providers, they could charge high commissions to cover operational costs. With them you have tighter spreads, but higher commissions.
Using High Leverage
Leverage allows traders to open large trading orders with very little deposit. You make a good faith cash deposit, and your broker loans you more money to add to it to enable you trade larger lot sizes.
For example, let’s say you have $50 and your broker gives you a leverage of 1:100. This means that with just $50, you can trade currency worth $5,000.
If the market sways against you by 10% you will lose $500. So you invested $50 and made a 1,000% loss.
Also, imagine you open a trade with $50 with lower leverage of 1:30, this means you can open orders worth $300. However a 10% market fall means you have lost $30 which is 60% of your initial capital and is much lower than when you used 1:100 leverage.
The takeaway here is that the higher the leverage, the higher the losses you would make if the market moves against you.
Not Managing Risk
In forex trading, you must properly manage risk if you are to minimize loses. There are different strategies to manage risk such as the use of stop-loss orders, guaranteed stop-loss order etc.
Firstly, a stop-loss order is an order you give to your broker to automatically close your position when the price of the currency pair you’re trading crosses a set price known as the stop price.
For example, you are trading USD/EUR exchanging for $1.0526 and order your broker to sell off your exposure if the exchange rate falls to $1.0520.
The $1.0520 is the stop price and once it is crossed, any currencies you went long on, are sold off at the next available market price.
Secondly, a Guaranteed Stop Loss Order (GSLO) is a type of stop-loss order where the broker must close your trade at the stop price irrespective of high market volatility or slippage. Most forex brokers charge for executing GSLOs.
Thirdly, a Risk to Reward ratio (RR ratio) is a way of assessing the estimated profit and loss in a trade before you get in. It is calculated with the formula:
RR = (Entry price – Stop loss price) / (Profit target – Entry point)
For example, if you enter a trade with an entry price of $50 and put a stop loss at $45 while you project that the profit will rise to $60. The Risk to reward ratio will be
RR = ($50 – $45)/ ($60 – $50) = 0.5
An RR ratio below 1 is considered low risk but anything above 1 is considered too risky.
Not keeping up with global events and macroeconomics
If you must trade in the forex market, you should always stay current on International geopolitics and economic events.
This is because these events in one way or the other have profound effects on the forex market. An ignorance of global events and their significance will leave you exposed to market risk.
For example, when a country devalues its currency so as to make its exports more attractive to foreign buyers, it affects those trading its currency, this is because devaluing a currency weakens it.
Also, a country engaging in conflict such as Russia in Ukraine can see sanctions placed on it, which will weaken its currency against other global currencies.
Risking too much capital
While the lure of making a large profit can be enticing, you should be careful how much you risk for that profit. Many forex traders commit a large amount of their trading capital to chase a perceived winning trend in the market.
Some traders who are into copy trading, also risk too much capital in copying master traders who they believe have high winning rates.
However, nothing is guaranteed in the forex markets and even the best traders can have the worst days where they record huge losses.
Experts advice that you should never put more than 2% of your available capital (equity) on one trade. If you are a new forex trader, stick to trading small lot sizes.
Poor Drawdown psychology
Drawdown has to do with your reaction to seeing your hard earned money keep disappearing as a result of losing trades. It can be very discouraging. There is a need for psychological toughness if one would thrive in the market.
Having poor drawdown psychology can make you engage in revenge trading, and this will only lead to more losses and debt.
According to many experts, one way to minimize losses in forex trading is to develop a good drawdown psychology.
Learn from the mistakes of others
You cannot rule out making losses completely as it comes with trading. However you can minimize the extent of your loss by learning from the mistakes of other traders.
Have a healthy dose of respect for the market, and tread carefully; managing your risk as you go.
Don’t be overconfident and calculate your risk to reward ratio to gauge how risky a trade is before jumping in. Reading and continuous self-development will also be needed if you are to make it as a forex trader.