Forex Education | 2 Myths in Forex Trading
Forex Trading is the most dangerous
Forex trading grew in popularity at a rapid pace in a short period of time, some myths were built around the industry. I refer to them myths because they are not true. However, they are misinterpreted due to a lack of knowledge and understanding. Nevertheless, there is a reason they exist.
Forex trading has become very popular for the reason that brokerage houses sprouted rapidly becoming global through the benefits of internet usage. Anyone with a computer and an internet connection has the potential to sign up as a client with a brokerage house. Transaction costs charged are the smallest in the business among all the other trading instruments like stocks, indices, commodities, bonds or even options.
Forex is a brokerage house main attraction. Brokerage businesses began to aggressive market this instrument. They promoted also the transparency of their platforms as opposed to old practices with stock brokers. One could view live what happened to their balance and the most important thing being that the investor had full access to the platform. This empowered traders to make their own decisions.
A CFD is a perfect financial instrument for individuals who at some point were investing in stocks, but were restrained to trade in the manner they broker instructed. As a result of leverage was introduced. This type of service enabled traders with less capital to enter the market with money loaned by their brokerage house.
The possible profit would have been much higher if brokerage houses gave a leverage of 1:100. It afforded a trader who usually traded $10.000, with this service the opportunity to enter trades with $1.000.000. Their profit, including their loss, would have been hundred times larger. This facilitated the entry of small investors into the market.
An individual did not need tens of thousands of dollars to speculate to invest in stocks or bonds in order to make money. A trader could buy and sell on the Forex Market with just $1000 or $100 and make money. In addition, the next generation characteristic was short term speculation. The price fluctuated rapidly during any given trading day due to the high liquidity. Multiplying market movement hundred times meant a trader could earn a lot of money.
Overall, this became a very good marketing tool to attract investments from any social class. Due to aggressive marketing and promoted Forex as accessible to everyone, a multitude of people began to invest in the market. However, it was not enough to have transparency and small transaction fees.
In order to trade with the goal of making a profit any trader would still need to learn to understand how to make accurate price predictions. Luck does not work in favor of the trader, because luck is not a strategy. Therefore, individuals who blindly invested in the market began to lose money.
From losing small amounts to tens or hundreds of thousands of dollars groups of people spread word that Forex Trading is dangerous and it was impossible for anyone to win in this industry. Of course it is risky when you have no knowledge of the business. It is akin to trying to hike through a jungle without any survival skills.
What are the chances you would get out alive? There are the same chances as an investor in Forex trading without any knowledge about the business. The most interesting thing is that the really great danger or risk is not actually Forex. But it lies in the leverage used to trade. Stock or Commodities usually have higher volatility than the forex market for the reason that those markets have less liquidity.
Imagine adding the same leverage to these particular trading instruments. They would become as dangerous or risky as Forex or even more so. But the overall trading fees are much higher for those instruments, the leverage remains low and they are not very appealing.
Forex trading is the most dangerous! I have heard this hundreds of times when talking to people all over the world and especially to investors who have lost their investment. This is really a myth created by those who have lost their money because they were unaware of the risks and dangers, similarly, their lack of understanding, lack of experience in forecasting the price movement and lack of money management skills. To add to these negative emotions that develop when trading is the frustration of seeing the money from your account flushed away. But when I began to address the arguments against this myth by incorporating basic principles of technical analysis to forecast with a certain accuracy the movement of the price. As well as a trading forecast based on a money managing system and making money not once, but several times in a row; they instantly changed their minds.
It takes a strong arguments and real trading skills to diminish this myth. Any experienced trader can contradict opposition that believes Forex is the most dangerous.
The larger the leverage the riskier the trade
Let us recap by defining leverage and how it is used in trading. In my opinion, leverage is the flexibility given to clients by different brokerage houses to trade more money than they have in their accounts. This is a simpler and unofficial definition of leverage.
Having more money to trade, means that your profits and your risks increase. For example, if a trader uses a leverage of 1:100 and has available in their account 1000 Euros, he can open a trade, using the leverage, 1 lot on EURUSD. With these specifications they will gain or lose $10 per pip. In this case the trader will need 100 pips to double or to wipe out their account.
If this trader has a leverage of 1:200, they could open 2 lots of EURUSD, since the margin required is lower. In this case the trader’s possible gain or loss per pip is $20. We can continue with these examples to a leverage of 1:1000, at which the trader can open 10 lots on EURUSD and have the value of one pip of $100.
In this last scenario the trader will need only 10 pips to double or totally wipe out their account. Non-experienced traders usually do not know how to adjust their volume, according to the leverage they have available.
With a higher leverage trader has the opportunity to use a larger volume when entering a trade. The idea that they can earn more because of the larger volume is in most cases a trap. A trap I fell into several times in the past.
By cause of their ability to enter the market with a volume too large for their account, this makes their trading dangerous. In consequence, it is easier for the market to wipe their accounts out. So the actual menace is the amount of money they chose to trade and not the leverage.
The leverage only gives the ability to open higher volumes. However, it is the trader’s choice if they decide to do so. If the money management system a trader uses permits them to open only 1 lot of EURUSD, that trader should open just one lot. With 1:100 leverage they would need to block in margin 1000 Euros, while using 1:200 the trader will only have to block 500. Moreover, if using 1:1000 they will only block 100 Euros. Therefore, the rest of the balance remains available for opening other transactions.
New traders are not skilled or knowledgeable on how the use leverage in their favor. They also lack a good money management system and discipline as a result end up blaming the leverage for their loss. I currently use a leverage of 1:500 to trade, on one of my trading accounts. This doesn’t mean I use the full leverage to open volumes, it means that I use it on a smaller account with a different trading strategy.
Knowing how to correctly adjust the leverage can give a trader the ability to trade with a smaller amount of money in their accounts. This gives them the opportunity to open more trades if they need to. Only the greedy and those who lack the skills to correctly use leverage expose themselves to risk.