This is a guest post by Roman Sadowski, chief analyst at Humble Traders
We all get into trading the Forex Exchange Market wanting to be that guy who beats the market into submission with our own bare hands, and comes out smiling from ear to ear with a huge account balance!
The guy who drives a Ferrari while only having to work for 30 minutes a day!
That one in a million-success story! Sadly, It is not that easy to trade Forex for a living.
The industry is awash with tons of misconceptions and if you want to make it, you must learn how to distinguish between proven facts and half-truths.
Here are few most widely spread common misconceptions
I will get rich quick!
Many traders keep dreaming about the AWESOME amount of cash they will generate from trading or how they will be able to trade and live on it.
But the reality is a bit different:
Marketers and brokers give new comers an unrealistic picture about the potential income or a promise of becoming financially independent by working 10 min per day.
They make it look like hedge fund and pension fund returns are small compared to the opportunities waiting in the Forex market.
Traders are expecting to make 200%, 300%, 500% in a few weeks.
All the above should sound at least suspicious to an intelligent person.
To get matters into perspective, it is important for you to start by looking at how the professional traders trade and consider their annual targets.
According to Investopedia:
In 2017 Hedge Funds Returned 8.5% Vs 21.8% for S&P 500
Can you really outsmart the world’s investing elite and achieve 300% return per year, EVERY YEAR.
You need to understand that:
Wealth is not made overnight, wealth is a product of a statistical edge compounded over a long period of time.
There is no other way without exposing your capital to enormous risk.
The equation below shows how your equity could grow over 20 years with 20% annual return.
This is assuming $1000 initial investment.
It all comes to maths and time.
Anything else is gambling.
This leads to another misconception
I will be able to live on my trading profits while I grow my equity
Let’s do some numbers
Say you want to draw a wage from your trading account – for example $50K per year. (This is a decent wage to support you and your family)
If your trading account generates 20% per annum (a decent return),
You need a $250K account balance to make $50K in profits every year right?
What size is your account today?
Do you have $250K in your account?
If you have $500 now, how are you going to draw $50,000 from it?
Also, many novice traders forget that
If you draw a wage from your $250K account, your equity will never grow and even 10 years later, your account will still be $250K.
You will lose the power of compounding and you will never grow your capital.
See the below table.
This is based on $250K initial investment, assuming 20% annual growth for 7 years
Account 1 drew the profits every year, whereas Account 2 used the profits to re-invest every year.
Which trader is richer after 7 years?
* Drawings during 7 years for Account 1 are spent and non-existent in year 8.
Trader 1 spent $350K during 7 years on living expenses while trader 2 re-invest proceedings to compound his edge. He is much better off.
The figures grow exponentially after year 7. Trader 2 becomes a millioner, while trader 1 never grows his capital.
So as you can see there are many things to consider if you want to be serious about trading and your career.
Normally, people who think they can get rich quick despite statistics and evidence being against them, they also think that:
Financial markets are a breeze and trading is easy
There are so many people out there who think that trading is easy. I do hope you are not one of them.
Most of these people believe that they can take a $20 course on Udemy on trading and be on their way to making money in the market.
Those that have tried to take this approach will tell you, from experience, that trading is not as easy as they initially thought.
In truth, success in Forex comes from a combination of qualities that include:
- Knowledge of statistics and finance
- Risk and money management
Ask yourself this all-important question, why does it take doctors, lawyers and engineers many years of study before they become fully qualified to practice?
Well, this is not meant to dim your hopes of becoming a profitable trader; as a matter of fact, trading is not rocket science and yes, you can join the rank of professional traders, but you need to be committed.
This leads to another misconception:
One needs to be super smart to make money trading
Although trading is not a walk in the park, you don’t need to be the smartest person in the world to make it.
An experiment conducted by two traders- Richard Dennis and William Eckhardt- whose aim was to see if they could train and transform ordinary people into exceptional traders.
They called this the turtles traders project
The two traders picked some ordinary people who responded to the ads that they had posted. After a series of interviews, they selected 14 traders who were trained for two weeks and allocated funds to trade. These traders proved the fact that “smarts” was not a requisite for being an excellent trader.
From their experiment, Richard Dennis and William Eckhardt proved that psychology, statistics and emotion management were the main determinants of trader success and not IQ or intelligence or even the market knowledge.
As you can see, there is a lot of evidence that even an average Joe can succeed in trading without any special skills.
So why so many people still lose money trading?
This leads me to another misconception
I can make money using only technical analysis
Technical analysis attempts to understand the market sentiment behind price trends rather than analyzing fundamental valuations and economic forecasts. It is widely used among Forex traders, compared to fundamental analysis.
It is quite common among traders to over-use technical analysis and indicators. Traders pay more attention to the indicators then to the price itself.
I wish I knew this years ago but instead I have spent years jumping from one indicator to another thinking that this time I will finally beat the game.
Today I know that technical analysis alone won’t make me money. It matters to some extent but there is more to trading.
This is because
No matter how trivial it may seem, SUPPLY AND DEMAND determines the price. It might be partly driven by emotions or rationale but after all – the volume of orders will decide which way the price will go. Supply & Demand is a basic principle in economics and drives all prices
Once you understand the above, your odds will improve immensely.
Then you will need to move into statistics and risk management. There are few misconceptions around these too.
I need many winners to make money
Most trades think that they need to have many winners for them to close the day, week, month or year in the positive.
That is a misconception!
Accuracy is the most overrated metric in trading
Most successful traders have an accuracy rate of less than 50% but still make it big in the markets.
What these traders have learned to do is to ensure that their winners are bigger than their losers.
This they do using what I call a risk reward ratio.
Point to note: You can easily make money with a trading system with a low accuracy (win) rate as long as you have a good risk reward ratio.
Consider this, if your risk reward ratio is 2:1 you need a win rate or accuracy rate of 35% to break even. This means that you can score 65 losses and 35 wins and close the account at break even.
From the above we can then see that: your failure has nothing to do with the accuracy of your system, instead it has everything to do with your money management or lack of it and your ability to handle the emotional roller coaster during the losing streaks.
If you can keep your emotions in check and use statistics to manage your risks with proper money management, then chances are that you can make good money even with a mediocre system.
Do you know the answer to these questions?
- What is your average risk reward ratio?
- What is your win rate (accuracy)?
- What is your biggest winner?
- What is your biggest loser?
- What is your probability of scoring 3, 5 or 8 losers in a row?
- What will you do if you get 5 losses in a row?
- What is your maximum expected drawdown?
Most people don’t know the answers to these important questions, don’t be among them
Pay more attention to risk and emotion management than technical analysis
This leads me to another misconception
There is a trading system with no losses
Most traders ditch their trading systems after registering a few losses. They do this in search of the elusive non-loss, Holy Grail trading system,
No one can fault them for doing this; After all, it is human nature to try and run away from losing, which is associated with pain but as one of the leading commodities’ trader points out:
“The elements of good trading are: (1) cutting losses, (2) cutting losses, and (3) cutting losses.
If you can follow these three rules, you may have a chance.” – Ed Seykota
In truth, there is no way you can run away from losses in trading; therefore, you should accept losses and learn how to manage them by cutting them short before they can inflict a serious damage to your account.
The quicker you learn to accept the losses, the quicker you become profitable.
If you have reached this point,
I’d like you to take a pause and breath because this point here is the mother of all misconceptions in Forex trading.
Forex brokers want to help me to become a profitable trader
Yes, you heard me right the first time, brokers DO NOT have your BEST INTEREST at heart
They often masquerade as educators offering free forex education via webinars, videos and eBooks
What they fail to tell you is that this so-called education is filled with misinformation aimed at ensuring that you ALWAYS lose
Let me ask you a question
Do you HONESTLY think that brokers, who happen to make money when you trade often and lose, will, out of the “kindness of their hearts” equip you with skills to beat them at their game?
It is what we call CONFLICT OF INTEREST
For you to beat the broker, you will need to know how they operate and one good place to start is by watching this awesome presentation by one Anton Kreil.
Anton Kreil, a former trader with Goldman Sachs, is the current Managing Partner of the Institute of Trading and Portfolio Management.
He shot into the limelight when he partnered with a hedge fund manager, Lex Van Dam, to run the BBC reality show program dubbed The Million Dollar Trader.
This program had some striking semblance to the Turtles program. You can watch the three-part mini-series here
In a GROUND-BREAKING lecture that he presented at the University of Westminster. Anton took time to explain:
- How the trading industry works
- How it is designed for you to lose
- Conflict of interest between educators and brokers
You can watch the 2-hour long documentary here
IS THAT ALL?
Yes, and you can trust me when I tell you this combination will make you a good trader!
This article has looked at a few common misconceptions in Forex Trading.
I do hope that the next time you come across someone peddling these misconceptions you will be wiser.
Let us close by reiterating the facts as proven above:
- Forex is not a get-rich quick scheme
- Forex trading is not as easy as some think but, at the same time:
- You don’t need to be very smart to make it as a Forex Trader but don’t forget
- Focusing only on technical analysis will not build your wealth
Building wealth is about maths, psychology and time.
- There is no trading system without losses and that’s ok because
- You don’t need many winners to make money and be careful because
- Forex brokers are not your friends.
I truly believe the journey to profitability and freedom is a function of hard work, commitment, persistence and boring routines.
There is no magic to trading. I believe in making calm rational decisions what, when and how to trade based on a decade of intense learning.
Visit us at Humble Traders