Since the Great Recession, technological development has expanded the accessibility of many markets to ordinary people. I personally think this is a very good thing, because financial market returns have been largely the thing of highly “plugged” and expert crowds in the past, and it is good that ordinary folks get direct access to capital markets more and more. But these people need a bit of knowledge and coaching, which is why I also feel that the new reality increases the necessity and usefulness of financial advisors, who need to be more knowledgeable and competent than ever (note: I am not a financial advisor). Yet many “retail traders” (ordinary people who manage part of their own money) lose money in currency (forex) markets and stock markets. Why? Let’s dig into this a bit more.
The zero sum game
Unlike economic production and exchange, which is NOT a zero sum game due to gains from specialization and exchange, classic “financial trading” is a zero sum game, especially in currency markets. In fact, if you take into account transaction costs, it is a negative sum game.
In other words, in every trade of a currency pair, there is one loser and one winner. In futures stock market trading it is the same thing. In these situations, one party is “long” on some currency (expects it to appreciate) and “short” on another currency (expect it to depreciate), and the counterparty to this trade has the opposite positions on the same currency pair. The fact that the trading platform serves as an intermediate changes nothing to the math: the gain of one is the loss of the other. The sharks eat the easy prey.
The incomprehension of this fact creates lots of illusion and snake oil in various products and services in the financial industry. You are promised the moon with "this magical formula" or with this simple “trick” using graphs and trigger values, or you are told you can make 80% monthly returns in forex… this is all BS to the highest order and these people should be prosecuted for disinformation. It is actually TRUE that you can make incredible returns in forex trading… if you use leverage at risky levels!!
Investing in companies (value) VS investing in “markets”
For various reasons, I personally invest in financial markets, mostly in forex. Yet I fully understand and respect a more fundamental approach: you study a company, you look at its history and reputation for regular dividend payments, maybe you feel that there is future in that “sector” or with the strategic plan and vision of upper management, etc. That’s all good. If that is your thing, study your stuff well, and “buy and hold” essentially forever.
Yet it will never hurt anyone to actually understand global financial forces that operate on all markets, including stock prices of individual companies. Furthermore, this type of investing is quite boring, to be honest. That is what I love about financial markets: there are things to understand and a “puzzle” to put together – it is like a game of chess combined to a puzzle you want to put together to “see the image clearly” – this is one of the reasons I love “financial markets investing” rather than value investing. There are many more reasons as well, such as the fact that global macro forces have more logic in them than individual stock prices that swing on a whim, accounting fraud in specific companies, insider stuff you have no idea is happening, etc.
The illusion of competence
There are many financial markets in the world, and the demand for access by "normal, everyday people" (amateur part-time traders doing it by personal interest, out of curiosity, for fun,or to have a better control over their own financial investments, etc) has created an impressive supply of platforms and firms offering direct or “thin intermediation” for access to money markets, bond markets, currency markets, stock markets, and more exotic emerging markets as well.
If you want to buy and sell currencies, you can do so within a few hours from now. Did you know this? The biggest financial market in the world is freely accessible to anyone who wants to “jump in” and start trading. You open an account with FxPro, FXCM, FOREX.com, XM, Orbex, OANDA, Easy Forex, and MANY others, you read up on how to do it, you get used to your chosen trading platform, and off you go… taking long and short positions on various currencies of the world! You collect interest on your “long” currencies and you make interest payments on your “short” currencies. If the currency pair you buy or sell goes the way you expected, you make a profit. All within roughly one week. Cool!
Maybe you even get fancy and start using “technical analysis”: reading graphs, identifying support and resistance values, stochastic oscillators, Bollinger bands, and more. Sounds fancy? Relax: it’s not. Don't get me wrong, these tools ARE useful, but if you are not a pro trader and don’t have a least some knowledge background, you don’t really understand what is going on in the market – you are suffering from the illusion of competence and expertise because of fancy looking tools and buzz words. You are looking at the tree but you don’t see the forest: you are lost in that forest, but you don’t even know it, because of an extreme focus on the tree in front of you.
News: in the very short run, the market IS “manipulated”
Look at this graph of the EUR/USD pair for one day (April 27, 2016), taken from the excellent website Trading Economics. An increase means the Euro is appreciating against the USD and a decrease means the Euro is depreciating against the USD.
Roughly speaking it fluctuated 0,4% within the day. If you were at the TOP of your game (or just lucky) and didn’t use leverage, you made 0,4% in a day, which is very good. Will you be this lucky tomorrow? And all the other days? Will you stare at your screen all day, waiting for the right timing?
Second, these fluctuations are quite erratic. You can try to follow these fluctuations with tools of technical analysis and following the news, but you don’t stand a chance in comparison to the tools and capital available to large institutions trading in the same big forex pool. Within an hour or a day, the market IS moved by large buy and sell orders from large institutions, and unless you are very close to information sources (you’re not), you may not realize this, but you are essentially guessing and sometimes “getting lucky”… If you like the thrill of gambling in casinos and lotteries, feel free to go ahead and trade this way. Yes, that includes many who use fancy tools: day trading is serious business and is best left to the pros.
However, you CAN trade in forex and stocks with another approach: taking long and short positions for longer periods by understanding market forces and actually knowing what is happening! The knowledge required to do this is even useful for casino type day traders as well.
Losing your mental health with high frequency trading
Some people love to trade on very short time spans: they go short or long for very short periods of time (1 minute, 1 hour, 1 day) and trade all the time. They try to get profit from the fast (erratic and hard-to-understand) fluctuations in currencies. Doing this means you 1) spend a LOT of time in front of the computer and risk losing your mental health like a compulsive gamer; 2) trade a lot, which may kill you with transaction costs (this depends on the platform, etc.); 3) you are very exposed to erratic, unpredictable fluctuations in prices due to things you have no idea are happening behind the scenes. Sounds crazy? I agree!
Unless you are a seasoned trader, if you trade your own money (not “capital”) and you trade with very short time horizon strategies with magical formulas and “tricks”, you are likely to lose money (and friends and precious other things in life, such as your own mental and emotional balance) and expose yourself to excessive risk without the appropriate knowledge to assess this risk by using freely available leverage in the forex market.
There is an alternative to this craziness
Just like most people fall for “miracle diets” that make you thin without effort, self-discipline, or proper understanding of health and metabolism, many people fall for easy “tricks and tips” in forex and stock markets. If you found a real “trick” that really works and you are SURE it will work next time, I say to you: borrow everything you possibly can and make your trade, pocket the money, and get out!
Reality is that without at least some understanding of market forces, you are simply guessing… and guessing sucks. It’s not lucrative, it’s risky, and it’s not intellectually gratifying. This website is about real education of ordinary people, by respecting their intelligence and desire for real knowledge, through wold class pedagogy and integrity, combined to useful, actionable knowledge that makes things less risky, more lucrative, and much more interesting.
Here is the graph of the same currency pair EUR/USD, but for a 5 year period, taken from the marvelous public gift FRED tool of the Federal Reserve Bank of Saint Louis:
I can tell you now that with basic knowledge of markets, the drop in the value of the Euro in 2011 and the drop in 2014 was very easy to forecast! Those who take my forex course and put the effort to understand the content come out of the 8 weeks and are able to fully explain and follow this trend, as well as the flattening since 2015-01.
This is because when you understand what is going on, things become clear. You see the forest. You are combining a good understanding of markets with useful tools of technical analysis. This approach still has risk, as any other investment strategy, but the proportion of “luck” in each decision and result is significantly lower than with the “get in fast, trade lots, use leverage and try to make a big win” philosophy. Actually, EVEN those who want to follow that “casino” approach to trading would do good to educate themselves a bit more on understanding global markets and what drives currencies. Plus, it’s totally fascinating!
Generally speaking, the longer your time horizon (say 3-18 months), the lower the proportion of luck. You will still use technical analysis in all cases, but the proportion of “understanding what is going on” versus technical analysis and indicators is very different between a 1-5 days approach and a 3-18 months approach! And the amount of time you spend in front of the computer, stressing, and losing sleep is totally different!
I will paste the same conclusion as my last post, because it applies perfectly: you have to keep the basics in mind and build a clear picture of global markets, domestic markets, economic and financial conditions, and link that to your trade decisions! Combining a solid economic analysis (accessible to you – yes) with simple technical analysis will put you ahead of 80% of retail traders in forex and stock markets and will even out the power difference between you and the big players! There is an “initial cost” to get this knowledge, but the good thing is that just like a sport that you start doing and is hard at the beginning, you eventually get good at it and it becomes easy, fun… and lucrative!
I hope you enjoyed this post and that things are a bit clearer now! Feel free to “like”, comment, and share. Cheers!
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