Forex Trading: If you Trade Forex Again, I’ll Slap You
Yes, quite rightly read:
If you’re really thinking about dealing with Forex and Forex trading again, I squeeze through your screen and it gets uncomfortable.
I mean it’s just fine!
- Why does the subject of forex bring me to the white heat?
- Forex trading is a zero-sum game
- Forex has transaction costs and therefore a negative expected value
- The amount of trades makes it
- The leverage effect not only affects profit and loss but also transaction costs!
- Do not believe me, believe research on the profitability of Forex and Daytradern
- Bookmakers and the forex business
- Comparison of forex with a game of chance
- Conclusion: Currency trading is bullshit.
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Why does the subject of forex bring me to the white heat?
At regular intervals in my mailbox land emails in which readers point out that with Forex you could have made a fortune on this and that occasion, if only you had seized the opportunity. The currency trading quasi as our all financial Elysium. Sure, of course.
The most recent example is the collapse of the Mexican peso after the 2016 US election.
What you could have done ashes!
So maybe you should reserve a part (“play money”) of your depot to speculate in the currency markets?
I’m always a bit clueless about such news, trying to explain why I do not think that’s a good idea and also refer to my article on the difference between speculating and investing .
I have also in my transparency promise my opinion on the numerous Forexbuden and consorts out there already look.
Here I would like to go into depth once and for all. Ok, by now I’ve calmed down a bit, of course I will not break through the screen to you.
I’ll stay on my side (for today), so you can put the fork or the pepper spray away and we’ll take a close look at why you’d better concentrate on your investment portfolio rather than on wild currency speculation.
Forex trading is a zero-sum game
What is a zero-sum game, please?
A zero-sum game is a game in which one win is exactly the other loss.
Short classic example:
You and I throw a coin. If you win the number, you win by the head. The winner wins € 10 from the other.
If we throw our coin many times, how much profit / loss will you or I have statistically?
That’s right, neither you nor I have made a permanent profit or loss on this game. You win half of the games and you lose the other half of the games, at least in the long run.
Expected value: 0.5 * 10 € – 0.5 * 10 € = 0
Sounds neutral or not? You can not win anything, but you can not lose anything. The same applies to the foreign exchange trade. Here also no value is generated but also not destroyed, but only pushed from A to B.
That’s an important difference to ETF and stocks!
For equities, we hold shares in companies that generate (added) value for people through their economic activities. One is speculation, the other investing.
One of the most important fine differences in the capital markets!
Forex has transaction costs and therefore a negative expected value
Ok, foreign exchange trading is a zero-sum game, unlike stocks.
What sounds so harmless at first has far-reaching consequences for Forextrader. After all, trading foreign exchange costs fees. Since the currency markets are damn liquid these are not particularly high but nevertheless existent.
On much traded currency pairs, the transaction costs are admittedly extremely low, but nevertheless, their expected value shifts into negative territory. If you still have some problems with the concept of the expected value, then please read the contribution to the expected value . It is extremely valuable for your understanding of the capital markets and also here in connection with foreign exchange trading. I guarantee you that the reading will definitely be worthwhile for you.
But back to the topic:
For example, transaction costs from 10 € to 100,000 € volume (also called a lot in the language of foreign exchange trading) per roundturn equal 0.01% . For a much traded currency pair such as EUR / USD, this magnitude is quite realistic. That does not sound like much, but there are two powerful reasons why the bottom line is going to be a hell of a lot more expensive for you.
The amount of trades makes it
Forex trading is a short-term matter. It’s not like opening a position and holding it for 20 years. Rather, it is closed again after a short time. Holding periods from a few hours to days are typical.
The effects of transaction costs (in the forex context, this is usually only referred to as spreads, ie the difference between the broker’s buying and selling price.) Other transaction costs are usually not borne by retail brokers).
- Let’s assume a sporadic trader making a trade a week . So once buying and selling per week.
- If he starts with a fixed starting amount of € 100,000 and converts it completely every time, then transaction costs cost him 0.01% each time. In other words, each time he receives an average of 99.99% of his money back.
- Since Forex is designed as a zero-sum game, after 52 trades profit and loss, on average, the balance will probably be about the same.
After 52 trades the result is:
100,000 € * 0,9999 ^ 52 = 99,481.32 €
Of our start-up capital, € 100,000 – € 99,481.32 = € 518.68 has been cut in costs.
Based on our original € 100,000 seed capital, this equates to 0.51868% of costs incurred for one year of Forexgetrade. That may sound harmless considering the traded volume, but now comes the real trick.
The leverage effect not only affects profit and loss but also transaction costs!
So far, we have assumed that we are trading in equity of € 100,000 , but this is practically never the case with retail traders (fancy term for us small Otto normal traders).
Since the price fluctuations in currencies are usually very low, a decent leverage lever is used, so that a bit more movement in the matter comes.
Let’s assume that our equity is € 5,000 per € 100,000 trading volume.
This is similar to a lever of 1:20 , which is already more conservative in the Forex area. For comparison, some brokers sometimes allow leverage of 1: 400 , which is a similar wise idea as scratching a tiger on the corpse, but only incidentally.
Since the transaction costs always refer to the volume traded and of course not to the equity, after one year and 52 trades also 518.68 € costs incurred. Based on your 5,000 € at the beginning, the cost ratio is therefore 518.68 € / 5,000 € = 10.3736% !
Conclusion: Forex is an incredibly expensive proposition for traders and a very good deal for the broker. That’s also the simple reason why there are 2000 Forexbrokers out there feeling it’s getting bigger every day.
Do not believe me, believe research on the profitability of Forex and Daytradern
Of course you can tell me:
Nice bills Alex, but you can also substantiate your statements scientifically a bit further?
Fortunately, this is not all that difficult, because there are some studies and evidence on this topic, some even by brokers themselves.
An interesting scientific paper on this topic is ” Do Day Traders Rationally Learn About Their Ability? By Barber, Lee and Odean (2010).
- Of all Daytreads, 40% cease after the first month, 80% after one year, 87% after two years and 93% after five years. And no, they do not stop, because they have all become rich.
- Only 1% of all traders really make a profit on cost.
- Traders “learn” nothing from their actions, they remain more or less the same rational / irrational about their (usually short) trader career away. The alleged learning by loss is popular in many forex communities, but can not be proven in this investigation.
Another extremely interesting publication, this time on Forex market efficiency, comes from Shmilovici, Kahiri, Ben-Gal and Hauser (2008), entitled Measuring the Efficiency of the Intraday Forex Market with a Universal Data Compression Algorithm . The efficiency of various currency markets was checked by means of huge amounts of data. As a result, no inefficiencies could be demonstrated, which would have allowed a systematic profit after deducting transaction costs.
The statistics published by Broker are also very informative:
One of the largest brokers ever, Interactive Brokers, regularly publishes figures on the profitability of its Forexkunden . In regularity, the number of lossy accounts predominates.
Other zombies like FXCM or Interbank also (forcedly) publish numbers to their customers. Only 25% -30% of all accounts have been profitable there in recent years. The higher the volume of the account, the more the winner / loser ratio approaches 50:50 . Makes sense, too, because the currency trading is yes, as already more extensively quit, a zero-sum game and from a larger volume to reach at least just a neutral expectation.
One man’s meat is another man’s suffering.
Bookmakers and the forex business
Since I’m a big fan of irony, here are two fun facts:
1. There is a gigantic big market for sports betting, yes, quite right. This is called Betfair and is one of the big players in the betting business. That would not be worth mentioning in and of itself. But a few years ago, this company has expanded its product portfolio in an interesting direction. You now know for sure what’s coming: The company has actually targeted the currency trading. To do this, Betfair has launched a forex broker and consequently named Tradefair.
- Maybe you already know eToro, a relatively well known Forex- / Social-Tradingboutique from Israel. You probably will not know 888.com. This is simply a gambling site, ie an online casino. Interestingly, one co-founder of eToro is a former director of 888.com. Of course this is not forbidden and in my opinion not morally reprehensible. It would not necessarily generate confidence for me as a trader, if the guy who otherwise offers me gambling wants to make it possible to trade forex with joy.
Do not get me wrong, I have nothing per se against gambling, yes everyone should squander his money as he wants, but the fact that gambling companies also have forex on offer or there are connections between the two areas would me without knowing all the others be aware of the above-mentioned facts.
That simply dictates the reasonably healthy and hopefully critical common sense.
Comparison of forex with a game of chance
Since I am really nasty on it today, I would like to take the comparison with slot machines and foreign exchange trading to the extreme.
In summary, the problem with Forex is that it can be broadly attributed to the Stock Market chapter, but it has NOTHING to do with equities or with the creation of added value! Unfortunately, some people do not seem to be directly aware of the difference.
Purpose of Shares: The procurement of capital for a company in order to make something meaningful and thus create economic added value. Purpose of Forex: Change currency from currency A to B. Economic value added does not matter here.
Conclusion: Currency trading is bullshit.
This is the most differentiated and most scientific statement that I can overcome on this topic. However you turn it, the whole thing is just a waste of time.
Of course, the internet is full of semi-scientific trading systems as well as detailed contributions and there are whole forums dealing with nothing else.
But please, leave me: It will not make you happy in the long run and cost you at least as much time as money if you get involved. Save yourself this. Better to use your energy and money to build a solid ETF portfolio over the long term rather than speculating in currencies, hoping for the quick buck.
The road to success is never as fast as we would sometimes wish and it is not easy at all. That’s the way the world is.
And do not forget: If you are ever thinking of trying your luck with Forex I might end up breaking through the screen.
It’s your turn: have you been concerned with currency trading? Did I miss one of two worth knowing points? And what do you think about the whole topic?
PS: Forex is poison for you and your financial independence, that’s my belief and my knowledge, based on scientific findings that I’ve collected and want to share with you here.
That’s why you will not find any affiliate links to any brokers in this post and on Homemade Finance, even if these clicks are worth over € 600 .
Yes, quite right.
Why do you think Forexbroker bloggers and website owners can pay so absurdly high commissions? Are you thinking or not? It is really important to me that both of us can trust in Homemade Finance here.
That’s why it goes without saying for me to forego this money and to advertise for nothing that I know that it will not help you with your goals. Promised.