6 Common Misconceptions Of Forex Trading

Forex trading is a global pastime that includes individuals from all walks of life and geographic locales. From the most experienced market veteran to the greenest novice, the forex market facilitates the pursuit of a broad spectrum of financial goals. Whether you are an active speculator looking to generate steady cash flows or an institutional hedger, trading currencies is a viable avenue for success.

Despite the forex markets's massive popularity, a number of common misconceptions prevail. Unfortunately, false beliefs surrounding the basic functionality of the forex as well as other trade-related misnomers plague many participants. For some, the prevalence of disinformation and a lack of a basic market education proves costly.

Empirical evidence shows that an overwhelming majority of traders end up losing money and opting for another profession within a relatively short period of time. A primary reason behind the high washout rate is adherence to incorrect folklore associated with the forex. Below are several of the most common trading myths:

  • The forex market is an exchange-based market
  • Forex trading is a great way to get rich quick
  • There is only one correct way to trade
  • It takes a lot of money to make small returns
  • More is better
  • The only good trading strategies are complex in nature

The examples listed above are only a sample of the falsehoods that plague the global currency markets. However, before signing up with a forex broker or placing another trade, it is a good idea to address several of these forex trading legends.

The Forex Is A Standardised Exchange

One of the most common fallacies attributed to the forex involves its function. The forex exists as an over-the-counter (OTC) marketplace, not a standardised exchange. This means that there is no central clearing house. Trade is conducted through a network of traders, brokers, liquidity providers and other financial institutions.

An OTC market is a decentralised venue that facilitates the trade of its participants. Liquidity providers, known as "dealers," act as market makers quoting prices in which they will buy or sell a specific currency. Traders and investors then place orders on the market and have trades executed accordingly. The forex has no physical base of operations, which means regulatory bodies function largely as regional entities. Conflict resolution can prove more difficult than simply filing a grievance against an exchange.

In contrast to exchanges, OTC markets are not subject to transparent clearing. Participants are able to interact with one another in a private capacity, without other traders and investors becoming aware of their dealings. Often, the private nature of transactions leads to concerns regarding market transparency, fair dealing and pricing integrity.

Discrepancies in regulation and transparency are capable of influencing the market dynamic in times of financial distress. More so than in the trade of exchange-based products, the selection of a competent, trustworthy broker can help reduce the negative aspects of engaging an OTC market such as the forex.

Forex Trading Is A Way To "Get Rich Quick"

The financial rewards of active forex trading attract an abundance of new participants to the marketplace. Readily available leverage, small margins, extensive market hours and a wealth of trading options are a few attributes that promote the notion of "easy money."

Contrary to popular belief, success is not 100% guaranteed for market participants. In fact, losing money and account drawdowns are simply parts of doing business. At the end of the day, professional traders understand this point, while many market newbies do not. However, given adequate time and experience, it's possible for anyone to grasp the idea that a successful trader is someone who has long-haul performance in mind.

By definition, the contemporary forex is a hyper-competitive atmosphere defined by cutting-edge technologies and sophisticated participants. As a result, sustaining profitability over extended periods of time can prove to be a monumental challenge. Aside from having the personal attributes of desire and dedication, achieving success in the forex requires that traders thoroughly address several foundational elements. These include the following:

Technology

In order to compete, one must have adequate computing power, market connectivity and a robust trading platform. Subsequently, your computer and software trading platform must be virus-free and up-to-date. Also, it's imperative that your internet connection is as fast and strong as possible.

Competent Brokerage

Minimal trade-related fees, dedicated customer service and reliable market access are elements necessary to efficiently engage the market.

Trading Strategy

A comprehensive strategy is the cornerstone of fruitful trading. Rules-based systems for market entry/exit and money management are crucial to achieving consistently positive returns. No matter the time frame, currency pair or lot size being traded, a detailed strategy is an essential part of making money in forex.

Psychological Makeup

Forex trading is not for everyone. People prone to impulsive or reckless behaviour may not be cut out for the constant decision-making required by active trading. Before you jump into the market with both feet, it's a good idea to do a quick self-evaluation regarding your personality type, as well as your psychological strengths and weaknesses.

While there are many variables in forex trading, one thing is for sure: any shortcomings in these areas will be exposed over time. Each has the potential to compromise the integrity of the entire trading operation and undermine profitability. Without each of these elements being accounted for, undue loss of capital is all but assured.

There Is Only One "Correct" Way To Trade

Forex trading is not a one-size-fits-all type of activity. Traders come in all shapes and sizes, each with a unique approach to the marketplace. There are nearly infinite trading strategies in practice, with consistent profitability being the only relevant measure of effectiveness. When it comes to excelling in the live market, one's know how is measured by profitability!

A viable trading methodology is a combination of the following basic elements:

  • Technical or Fundamental Analysis: Strategies may be based on the study of price itself or the reasons driving price action. Many trading strategies are a combination of both technical and fundamental analysis.
  • Duration: The length of time a position is to be left open at market is a key element of strategy definition. Intraday, day, swing or longer-term trades all have different functions, goals and risk exposure.
  • Style: Fully automated trading or a manual discretionary approach are two examples of different trading styles. No matter which one is adopted, many nuances are present in its application to the markets.

It is important to realise that there is no right or wrong way to trade. As long as a proven strategy is adhered to with consistency and discipline, success in the forex is attainable. At the end of the day, the only "correct" way to trade is one that makes money.

Greater Leverage Equals Greater Returns

Extensive degrees of leverage are readily available in forex trading. Brokerages regularly offer small margins and upwards of 200/1 position leverage to attract clients. The ability to implement a high degree of leverage ensures that a large amount of currency may be controlled by a fractionally smaller account balance.

While the potential rewards of high leverage are lucrative, the risk is not always easily quantified. As the number of lots assigned to a specific trade is increased, the amount of currency risked per pip grows substantially. In the event that an imbalance develops between the size of the open position and the trading account balance, an exorbitant risk is being assumed.

If this is the case, the following elements of market behaviour can deem heightened leverage more of a liability than an asset:

  • Periodic Volatility: Pricing volatility can spring up at any time and prove catastrophic to a highly leveraged position.
  • Slippage: Entering and exiting large positions can be challenging amid less than ideal market conditions. If liquidity levels are limited, considerable loss due to slippage may occur.
  • Trade Liquidation: In the event that margin requirements set forth by the brokerage are violated, the open position will be liquidated. This can come as a surprise to the trader, as an eventual profitable trade may be exited prematurely.

No matter how great a trading opportunity appears to be, the old adage "leverage is a double-edged sword" encourages prudence in its engagement. While a sure thing may be attractive, larger positions increase possible losses exponentially. An unforeseen swing in pricing may serve to blow out a trading account before any expected gains are made.

Complex Strategies Outperform Simple Ones

The forex, and financial markets in general, are often found attractive by individuals with an academic background. Doctors, lawyers, engineers and technology professionals are drawn to the markets not only for financial reward but for intellectual challenge. It is due to the mental acuity of many participants that extremely sophisticated strategies are developed and championed.

For less experienced traders, an abstract approach may seem to be the best avenue for success. Combining intricate technical tools with proprietary software products appears to create an "edge" for the trader. However, this is not always the case.

The relative complexity of a trading strategy can have very little to do with its eventual effectiveness. A historical example of this idea is the late 1990s meltdown of Long Term Capital Management (LTCM).

Nicknamed the "Genius Fund," LTCM was a company that implemented intricate currency arbitrage strategies built by Nobel Prize winners, Phds and other stars of the financial world. LTCM achieved annual returns of more than 40% before losing more than £3.3 billion in less than one year. [2] Although the strategy was on the cutting-edge of trade-related sophistication, it eventually failed.

Profitability in forex trading stems from interacting with the market efficiently. Obtaining market access via minimal fees, securing low trade-related latency and applying structured money management can be just as vital to a healthy bottom line as strategy performance. If these elements are in place, even the simplest trading plan can prove successful.

More Is Better

The forex is open on a 24/5 basis and offers more than 100 currency pairs to participants. The extensive market hours and availability of products provide seemingly infinite opportunities for active traders. However, attempting to trade everything around-the-clock can be detrimental to profitability.

In most cases, restricting trading operations to a specific time period and group of products is the best plan of attack. Several factors illustrate why more is not necessarily better:

  • Limited Resources: Adequate time is needed to prepare, actively trade and document results. Attempting to trade 24 hours a day places tremendous strain on the individual and is one of the most common mistakes made by forex newbies. In addition, holding open positions in multiple currency pairings can spread capital resources thin.
  • Liquidity Concerns: In order to trade efficiently, there must be adequate market liquidity. Less popular currency pairs are traded infrequently, meaning there is a shortage of both buyers and sellers. Bid/Ask spreads are larger and pricing moves are more dramatic.
  • Correlations: It is commonplace for currency pairs to show a correlation with one another. If true, taking trades in separate pairings may prove to offset gains or enhance losses.

With so many options, opportunity is seemingly always afoot. In most cases the opposite is true. The longer one stays in the market, the greater the chance of falling victim to many pitfalls. Overtrading, lapses in discipline, systemic risk and fatigue can all destroy profitability.

Summary

Misinformation and misconception are particularly costly themes in the forex marketplace. Developing a rock-solid knowledge base through trader education is a key element of engaging the market from a position of strength. Ultimately, the responsibility falls upon the individual to debunk many of the existing forex myths before entering the market.

This article was last updated on 13th January 2022.

FXCM Research Team

FXCM Research Team consists of a number of FXCM's Market and Product Specialists.

Articles published by FXCM Research Team generally have numerous contributors and aim to provide general Educational and Informative content on Market News and Products.

References

2

Retrieved 22 Jan 2017 https://www.businessinsider.com/the-fall-of-long-term-capital-management-2014-7

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