- Trading Forex is not a shortcut to instant wealth.
- Excessive leverage can turn winning strategies into losers.
- Retail sentiment can act as a powerful trading filter.
Everyone comes to the Forex market for a reason, ranging between solely for entertainment to becoming a professional trader. I started out aspiring to be a full-time, self sufficient Forex trader. I had been taught the 'perfect' strategy. I spent months testing it and backtests showed how I could make $25,000-$35,000 a year off of a $10,000 account. My plan was to let my account compound until I was so well off, I wouldn't have to work again in my life. I was dedicated and I committed myself to the plan 100%.
Sparing you the details, my plan failed. It turns out that trading 300k lots on a $10,000 account is not very forgiving. I lost 20% of my account in 3 weeks. I didn't know what hit me. Something was wrong. Luckily, I stopped trading at that point and was fortunate enough to land a job at a Forex broker, FXCM. I spent the next couple of years working with traders around the world and continued to educate myself about the Forex market. It played a huge role in my development to be the trader I am today. 3 years of profitable trading later, it's been my pleasure to join the team at DailyFX and help people become successful or more successful traders.
The point of me telling this story is because I think many traders can relate to starting off in this market, not seeing the results that they expected and not understanding why. These are the 3 things I wish I knew when I started trading Forex.
#1 – Forex is Not a Get Rich Quick Opportunity
Contrary to what you’ve read on many websites across the web, Forex trading is not going to take your $10,000 account and turn it into $1 million. The amount we can earn is determined more by the amount of money we are risking rather than how good our strategy is. The old saying “It takes money to make money” is an accurate one, Forex trading included.
But that doesn’t mean it is not a worthwhile endeavor; after all, there are many successful Forex traders out there that trade for a living. The difference is that they have slowly developed over time and increased their account to a level that can create sustainable income.
I hear about traders all the time targeting 50%, 60% or 100% profit per year, or even per month, but the risk they are taking on is going to be pretty similar to the profit they are targeting. In other words, in order to attempt to make 60% profit in a year, it's not unreasonable to see a loss of around 60% of your account in a given year.
"But Rob, I am trading with an edge, so I am not risking as much as I could potentially earn" you might say. That's a true statement if you have a strategy with a trading edge. Your expected return should be positive, but without leverage, it is going to be a relatively tiny amount. And during times of bad luck, we can still have losing streaks. When we throw leverage into the mix, that's how traders attempt to target those excessive gains. Which in turn is how traders can produce excessive losses. Leverage is beneficial up to point, but not when it can turn a winning strategy into a loser.
#2 Leverage Can Cause a Winning Strategy to Lose Money
This is a lesson I wish I had learned earlier. Excessive leverage can ruin an otherwise profitable strategy.
Let's say I had a coin that when heads was hit, you would earn $2, but when tails was hit, you would lose $1. Would you flip that coin? My guess is absolutely you would flip that coin. You'd want to flip it over and over. When you have a 50/50 chance between making $2 or losing $1, it's a no-brainer opportunity that you'd accept.
Now let's say I have the same coin, but this time if heads is hit, you would triple your net worth; but when tails was hit, you would lose every possession you own. Would you flip that coin? My guess is you would not because one bad flip of the coin would ruin your life. Even though you have the exact same percentage advantage in this example as the example above, no one in their right mind would flip this coin.
The second example is how many Forex traders view their trading account. They go "all-in" on one or two trades and end up losing their entire account. Even if their trades had an edge like our coin flipping example, it only takes one or two unlucky trades to wipe them out completely. This is how leverage can cause a winning strategy to lose money.
So how can we fix this? A good start is by using no more than 10x effective leverage.
#3 Using Sentiment as a Guide Can Tilt the Odds in Your Favor
The 3rd lesson I've learned should come as no surprise to those that follow my articles... using the Speculative Sentiment Index (SSI). I've written many articles about this topic. It's the best tool I've ever used and is still a part of almost every trading strategy I am using, present day.
SSI is a free tool that can be found here that tells us how many traders are long compared to how many traders are short each major currency pair. It's meant to be used as a contrarian index where we want to do the opposite of what everyone else is doing. Using it as a direction filter for my trades has turned my trading career completely around.
Learn From My Mistakes
If I could tell my younger self 3 things before I began trading Forex, this would be the list I would give. I hope they help your trading as much as its helped mine.
---Written by Rob Pasche
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