As high as 80% of retail traders lose money trading forex & CFDs with ASIC & FCA regulated CFD brokers, depending on the broker. This figure could be even higher in other regions where the regulators don’t require brokers to display the percentage losses on their website.
Several factors are responsible for these losses.
The fact that retail trading in the forex market is not regulated in some geographies, relentless advertising campaigns by scam brokers offering high leverage and even promising return on investments, insufficient knowledge etc. have all contributed to this grim statistic.
We shall discuss in detail some reasons why retail forex traders lose money.
Factor #1 - Using Excessive Leverage
Except you are a big financial institution or corporation, you may find yourself needing to use leverage to trade forex if you want to make a reasonable profit. That is okay when used moderately, and when you understand the risks.
Traders need to understand 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 losses occur such that it is close your margin requirements, the broker will close your position.
A leverage of 400:1 means that for every $1 of your trading capital you can control $400 worth of currency or similar derivative.
A leverage of 400:1 also means that the trader’s margin is 1/400= 0.25%
If a forex trader wants to transact as follows:
Quantity sought=1 standard lot (100,000 units)
Currency pair= EUR/USD
Exchange rate= 1.14
Initial deposit required for trader to open a position= 0.25% of 100,000 UNITS = $250
The forex trader only has to deposit $250 dollars to open a trading position of 1 Standard Lot with 1:400 leverage on Forex. The difference is borrowed to him by the broker. Such is the power of leverage.
But what if the EUR/USD exchange rate declines before the trader is able to sell?
This means the trader will sell at a loss and still have to repay the loan the broker gave him. This is why using too much leverage is dangerous.
Always remember, leverage is a two-edged sword that amplifies gains as well as losses.
The alarming statistics of forex traders losing money has caused regulators in some parts of the world to intervene by limiting the leverage available to retail traders. See some intervention measures below:
Leverage Restrictions in Australia
The Australian regulator the ASIC has reduced leverage available to traders from a whopping 500:1 to 30:1.
In the United Kingdom
The United Kingdom’s regulator, the Financial Conduct Authority alias FCA, also ordered that leverage on CFD and CFD-like options be reduced to between 2:1 and 30:1 depending on how volatile the asset is. They also ordered that a trader’s position be closed once their trading capital falls to 50% of the margin needed to keep their positions open.
In Europe the regulatory 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 30:1 for major currency pairs, 20:1 for non-major currency pairs, CFDs on gold and major indices, 10:1 for CFDs on commodities other than gold, 5:1 for CFDs on individual equities.
Factor #2 - Patronizing Unlicensed Brokers
Many new retail forex traders 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 on investments. It is only after they have been duped that they report to the regulating authority.
If your broker guarantees you risk free return on investment from trading, it is probably a scam.
To help you spot a scam broker let us make some put them in categories.
Category One - Brokers who operate without a license
Any forex broker who operates without a license is doing so illegally. Although the forex market is not regulated in some parts of the world, the forex broker should still hold a license from regulators in developed countries like the UKs FCA, or Australia’s ASIC.
Forex traders should always check the regulator’s website for the list of brokers that are regulated in their region and compare forex brokers based on factors like fees, safety of funds, ease of withdrawals, platforms supported & trading conditions before committing funds. Some of the major regulators that a trader must check if a broker is regulated with are FCA, FSCA, ASIC, BaFin & CySEC.
Forex traders should also avoid referrals. This is when a forex broker refers you to another website in a region with lean regulations. Many forex brokers follow the practice of registering their clients under Offshore regulations to offer high leverage.
Category Two - Brokers who operate with a license but are undercapitalized
A forex broker may be licensed but may not have sufficient capital to meet the trading obligations. This has caused the regulators to order that a financial disclosure statement is mandatory for brokers. This will enable a potential trader to determine if the broker’s assets can cover their liabilities.
Category Three – Fake Brokers operating with cloned licenses
A scam broker could also use the name and registration number of a licensed broker to clone a website or to impersonate the licensed broker. Forex traders are advised to check on the regulators website for the phone number associated with the forex brokers name and call that number to confirm if the broker is legitimate.
Factor #3 - Inadequate Knowledge
Many retail traders jump into the market without the right preparation. They don’t take the time to be familiar with basic terminology used by forex market participants.
An aspiring forex trader 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 a basic understanding of math.
Forex traders should also keep in mind that the market operates in four different time zones-
Ø Sydney (10pm GMT to 7am GMT)
Ø Tokyo (11pm GMT to 8am GMT)
Ø London (7am GMT to 4pm GMT)
Ø New York (12pm GMT to 9pm GMT)
The best time to trade is when some of the sessions overlap. At this time, there is a lot of market participation, liquidity is highest and spreads are lowest.
Forex traders must learn about the instrument they are trading & how it can be impacted, what can move its price, during what time of the day does it move mostly, and so on.
Without understanding everything about that instrument, the risk of losing is even higher. Most traders jump into the market because they have heard stories of other people making money but enter without adequate knowledge.
Factor #4 – Revenge Trading
This is usually linked to a trader's emotions. A feeling of disappointment when a trading plan doesn’t produce results makes a forex trader want to keep trading over and over again in a bid to make up for the lost funds. It is also known as averaging into a position.
Remember each time a new trading position is opened, fees and commissions are charged. Some forex broker charge as high as $20/lot to open & close a position for a Standard lot. And with each position, you are exposing yourself to a higher risk.
When a forex trader records a loss, it is advisable to stop trading and carry out an assessment of the trading plan. This will enable you to find out what went wrong and make corrections. This is a better approach than to engage in revenge trading.
Factor #5 – Not Enough Practice
Before going live, a forex trader should hone his skills using a demo account.
Demo trading is available on most forex trading Apps. You should also practice how to interpret candlestick charts, price movements etc. There are many useful tools & indicators that have been around for centuries and help to predict price direction.
Factor #6 – Poor Risk Management
Trading forex & CFDs is a risky business, with a lot of complexities. Risk management is therefore not out of place and is the most important thing to learn.
Here are three tips to help you manage your forex trading risk.
1. Only trade currency pairs you have studied & understand
Before trading a currency pair study and find out more about the country, its politics and its economy. This will give you an edge as it helps you predict the exchange rate movement.
2. Use Stop Loss orders
The forex market is open 24hours and a trader cannot be awake all the time. A stop loss order is an automated instruction given by the trader to the forex broker to close his trading position should the value of the currency pair he is trading in fall to a certain level.
A forex trader buys EUR/USD at 1.1403 exchange rate.
He hopes to sell when the exchange rate appreciates. He knows there’s a risk the exchange rate may drop so he sets a stop loss order to sell off the currency pair if the exchange rate drops to 1.1390
By doing this if the exchange 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 as 13pips (ignore the zeros)
3. Use take profit orders
A take profit order automatically sells the currency and closes the forex trader’s position when the exchange rate of the currency pair being traded rises to a predetermined level.
4. Apply the 2% rule
Part of a trader’s forex plan should include not putting all eggs in one basket. Use no more than 2% of the money in your trading account for a day’s trade. This will limit your loss in the event the market moves against you.
These tips don’t prevent loss totally but they limit a forex trader’s exposure.
Factor #7 – Inadequate Technology
Many retail traders trade forex & CFDs using smartphones. This is not convenient or advised as they have small displays which may not display the charts properly, and carry out proper analysis.
Using a Smartphone for trading is not smart, as it simply encourages trading without proper reasoning or data. They also give room for distractions when used continuously.
Computers have more capable microprocessors that are able to load charts used in technical analysis of the market speedily and carry out complex algorithms. Also, you will be able to access & analyse a large set of data. For active forex trading, a computer or a laptop should be used.
If there is a delay in executing trades or your computer begins to lag, the exchange rates may change before your computer executes.