Forex trading is far from easy. Brokers and other vendors would like you to think so because it caters more to people with the gambling mentality. This stems from the fact that you can trade foreign exchange pairs with as little as $100 in your account.
How? Leverage. The first statistic you will read whenever researching forex is: it is the largest market in the world with over 1 trillion dollars changing hands every day. All this nonsense means is that governments and global banks move currencies around for countless reasons, and a lot of it is done using leverage.
This statistic is also thrown around loosely because marketers want to you believe that huge opportunity awaits. They try to lure you in with leverage and the idea that the bigger the market, the more money there is to be made. Meanwhile the retail forex market is more rigged than most financial markets and that has to do with the inherent conflict of interest.
Outside the U.S., you can find brokers who will give you 200:1 leverage. Why are they so generous? Do you think it’s because they want you to succeed and are happy to provide a means for you to participate? Or do you think it has something to do with them making more money?
In forex, leverage comes in the form of being able to control 20,000 units of a currency with only $100 in your account. That is 200:1 leverage. In the U.S., this is capped at 50:1 by regulators which means with $100, you can control 5000 units of currency.
Sure, if you win, you win an out sized return. A $50 profit on a $100 account is 50% return in a day! Wow! If you lose , you can pretty much wipe out your entire account quickly. And guess who gets that money when you lose it? More on this in the next section.
The Conflict Of Interest
Foreign exchange has always had a substandard reputation and if you examine how most brokers operate, it is easier to understand why. The traditional business model is they provide you with access to the interbank market in exchange for a small fee per trade.
Fee? I thought forex was commission free!? The fee comes in the form of the difference between the bid/ask spread which technically is “not a commission”. Forex is not like the stock or futures markets, when you want in you have NO CHOICE but to pay the spread. So much for “commission free”.
Another way forex brokers make money is by “making a market”. They provide the means and liquidity for you to enter or exit, which also means they have the ability to TAKE THE OTHER SIDE OF YOUR TRADE.
If you lose, they win. If you win, they lose. So guess what that means? Brokers are heavily incentivized to put as many obstacles in your way as possible so that you do not win consistently. This is the built in conflict of interest that makes this business much harder than most.
If you further research the public records of many brokers, you will see (at least in the U.S.) many fines were charged against the likes of Forex.com and FXCM and Forex Club (no longer allowed to do business in the U.S.).
Forex.com was fined for changing margin requirements upon the close each Friday without telling customers. Automatically forcing numerous margin liquidations or losses that otherwise would not have been triggered.
Many of these illegal activities were active more than 10 years ago. In recent years, the NFA (National Futures Association) has had success in cleaning up this business in the U.S. at least.
As a result, foreign exchange trading in the U.S. has contracted while it grew in the rest of the world. With such a conflict of interest, is it still possible to make money in forex? The answer is yes.
Forex brokers know the herd is usually wrong. That is why they trade against them, but what do they do with the minority of their customers who are profitable? They hedge against them and only benefit from the spreads (which is how they should manage all of their operations).
Is Forex Worthwhile?
For those who know what they are doing, forex offers unique opportunities on a regular basis. We see it as another market to trade and capitalize on when the conditions are right. Even in the face of all the conflict of interest.
With the right methodology along with best practices, it is possible to get ahead. When navigated effectively, the forex market becomes a place where you can put smaller amounts of capital to work and earn a relatively decent return over the short term. Thanks to effective use of leverage, not misuse or abuse.