First of all, it should be stressed that all forms of financial trading involve significant amounts of risk with traders capital being at risk. In fact, in some instances it is possible for a trader to lose more than his initial deposit. But many people with an interest in financial markets make the claim that Forex trading is riskier than other forms of financial trading. In this article, we are going to look into whether FX trading is in fact riskier than other types/forms of financial trading and bring up some of the main points put forward by those who consider FX trading as more risky than other forms of financial trading.
The Majority of FX Traders Lose Money
It is often stated that the vast majority of FX traders lose money, therefore suggesting that retail investors/traders should avoid the Spot FX market. It is in-fact true that the vast majority of FX traders lose money from the limited data available it has been suggested that only 10-20% of retail FX traders actually turn a profit. If this is in fact the case it would mean that 80% of retail FX traders end up losing money.
In America, brokerages are required to release data showing the percentage of their client base who were profitable each month. The data released by these American brokerages typically show between 20-40% of traders turning a profit. It is not however possible to determine from these figures the exact percentage traders who are consistently profitable. The provision of retail FX in the USA is highly regulated, with strict limits being placed on the amount of leverage which can be used and firms being only allowed to provide their services to those who qualify as eligible market participants. This means that the data collected from these US firms cannot be applied to those who are trading with brokerages who operate outside of US regulation.
It seems pretty conclusive then that the vast majority of retail FX traders in-fact lose money. But does this mean that Forex trading is riskier than other forms of financial trading? Not necessarily, data collected by researchers from CASS Business School suggested that only 20% of retail Stock traders actually turned a profit. Other data focusing on US Retail Stock traders, has suggested that only around 10% of traders make a profit.
If all of this is true, it suggests that while Forex trading is highly risky it is not necessarily more risky than other forms of financial trading, with a similar number of retail equity traders losing out. It appears that retail traders are more than likely to lose money, whatever form of financial trading they engage in.
FX Markets are highly efficient
The daily FX Spot market boasts daily huge volumes, with around $120-140 billion dollars of transactions occurring each day according to data from Thomson Reuters. With so much trading activity, any new information is very quickly reflected in the price of Spot FX pairings which suggests that the FX markets are highly efficient.
Those who are familiar with the efficient market hypothesis will know that the stronger forms of the hypothesis suggest that if a market is efficient there is very little chance of a speculator turning a profit. In it’s weakest form (weak-form efficiency) the efficient market hypothesis suggests that it is not possible for traders to predict future prices by analysing the past performance of an asset. This means that technical analysis and other charting methods would not allow a trader to consistently turn a profit. This would leave traders having to turn to fundamental analysis, which may still provide them with returns. However retail traders face often face significant costs when keeping a position open over a longer time period leaving many traders seeking to trade over a short time period guided by technical analysis.
In the stronger forms of the efficient market hypothesis, even fundamental analysis wouldn’t allow a trader to turn a consistent profit. This is due to the fact that all the publicly known information regarding an asset will be reflected into the asset’s current price. Those who turned a profit from speculating on the direction of FX pairing would simply getting lucky. If the FX markets did in-fact exhibit these stronger forms of market efficiency, it would be advisable for retail traders to stay well away.
Despite this the efficient market hypothesis is particularly controversial with many doubting that markets display the kind of efficiency as claimed by proponents of the theory. It also fails to explain why certain individuals are able to consistently beat the markets over significant time periods which would extremely improbable according to such theorists. Even if some of the major pairings may display some evidence of weak-form efficiency this doesn’t necessarily prevent retail traders from making a profit via fundamental analysis or by turning other pairings.
Volatility of FX Markets
It is often said that the Spot FX Markets are highly volatile and thus should be avoid by retail traders who are likely to be taken out by the large swings in prices. This statement is only partially true, with historic studies of FX markets showing that major pairings are often less volatile than a number of high profile stocks commonly traded by retail traders. What is unique about retail FX trading however is the significant amounts of leverage that traders are able to use. For instance, many brokerages allow clients to use leverage of up to 500:1 on Major pairings. The market would only have to move 0.20% against the trader for his whole account balance to be wiped out. It is important to note that traders are not forced to use such excessive leverage, but are instead attracted to the impressive returns that can be made using such leverage assuming everything goes to plan.
Many Minor and Exotic pairings are more volatile, but these pairings tend to be thinly traded particularly by retail traders. Those trading these pairings will face significant risks and may be on the end of vicious swings in price, but at the same time the amount of leverage offered to them is likely to be more limited.
Spot FX is not inherently more volatile, the amount of volatility faced by a trader will be determined by the amount leverage used and the currency pairings chosen. By limiting leverage and trading only major currency pairings, it can be argued that traders face no more risk than they would do if they opted to trade stocks etc.
While like all other forms of financial trading, Forex trading is highly risky there does not seem to be any real evidence to suggest that Forex trading is inherently more risky than other forms of financial trading. While it is true that the vast majority of retail traders lose money, this also appears to be true of retail traders who turn their hand at training other financial markets. This may simply reflect how difficult and complicated it is to successfully profit from trading in general, explaining why the top hedge fund managers are re-enumerated as they are.
Forex trading is clearly risky, but there seems to be a lack of any credible evidence which suggests that Spot FX trading is any more risky than any other forms of financial trading for the average retail trader.