Risk, leverage and realistic expectations
Recently I read an article on Reuters about the SEC (Securities and Exchange Commission) warning traders about the risks involved on retail Forex. Amongst other things, they warned about:
- The higher levels of leverage, and
- Fraud/lack of a central clearinghouse (Brokers fraud)
But, is it really riskier than other financial instruments? I don’t think so, and here are the reasons.
Yes, there are some fraudulent Forex brokers who only want your money, they will execute your stop losses even when the market does not reach your SL level, they won’t send you the money you withdrawn from your trading capital, they won’t execute your take profit orders even when the market passed that level, etc. But there is one simple solution to this problem: don’t open an account with a Forex that is not regulated.
When a broker is regulated allows investors to dispute any resolution such as stop hunting, etc. increasing the investors protection. So we just need to make sure we open our trading account with a regulated broker, with good support capital and with good reputation. Here is a checklist to select your broker.
Leverage and realistic expectations
The other day I got contacted by a trader, who wanted me to teach him how to make 100% on a monthly basis. He said “it’s per month eh, not per day or week… I’m not asking something unrealistic here”.
I explained to him it is impossible to achieve like that and he replied, “Well, I better take my business somewhere else”.
Let’s see what happens, just for fun… If a trader starts with US$250 of trading capital (some brokers allow you to open an account with that amount of money) and consistently achieves 100%, on a monthly basis. This is what I get from my spreadsheet:
By the end of the fourth year, you’d be the master of the universe (I’m not kidding, you’ll own everything you see + everything seen through the Hubble telescope).
You think this is possible? Of course not, that’s out of question, but why would someone think this is possible? If you thought lack of education I agree with you.
Some traders are attracted to the Forex market because of sales ads around the web/tv showing how easy is to make money on the Forex market, and of course most of them never mention the risks involved.
Larger returns always require larger risks.
If you want to get 100% of return per month, you’ll need to risk a similar amount of money. And yes, you could get lucky the first few months, but sooner or later, the market will teach you that this is not a game and you’ll probably end up blowing up your entire account because you are risking too much.
Leverage and realistic expectations are tied together, because with higher leverage you’ll get better returns, provided that expected value of your system is positive. But what if it is negative? You guessed it, you’ll get larger losses too.
So, instead of trying to own the world on the first four years of your trading career, why not trying a more realistic approach: growing your account steadily, risking a small percentage of your account per trade, using sound money and risk management techniques, handle each trade, being disciplined? From my point of view, this is how it’s done.
It requires discipline, hard work, commitment, managing risk and capital, a sound strategy, to know yourself, control emotions, and more to make it possible. Yeah, it’s not easy (there is no free lunch), but listen, once consistent, it is probably the most rewarding job on the world.
At the end, I think articles such as the one you are reading, or the one on Reuters I mentioned above are good, not because of Forex being riskier than other markets, but because the better traders are educated about the risks involved using leverage, the better their possibilities to succeed in their task to become profitable traders.
“Risk comes from not knowing what you are doing.” Warren Buffet
Feel free to comment!