For those who don’t already know the answer to this question, it is necessary to apply a great degree of harshness to the answer: forex trading is extremely difficult and most people who try it fail. Anyone who is looking to trade forex as a casual hobby with minimal time commitment should reconsider. Concurrently, anyone who simply jumps into forex trading without the prerequisite research, technical tools, and emotional framework is effectively entering a casino and betting on black.
If it’s so difficult, why are there so many success stories?
Flashy headlines and advertisements have severely distorted the perception of the real success rates amongst forex traders. Definitionally, the zero-sum nature of trading means that only half of all market participants can outperform the entire market. Additionally, brokerage fees and informational asymmetries will reduce the number of fair traders who outperform. That is, the cost of trading eats away at performance and produces a lower net return. Additionally, assuming some number of market participants will always be using material non-public information to their advantage, traders who do not use such information will always be inherently disadvantaged. Given this, it is clear that some number less than 50% of forex traders will outperform the collective market.
With respect to the flashy headlines reporting 10000% annualized returns, these are virtually always sales tactics designed to sell overpriced trading courses. Anyone who claims to have the perfect secret to trading forex would be running a hedge fund and spending money to hide their proprietary trading method, not selling it on the internet. The old adage “if it seems too good to be true then it probably is” seems like it was designed for forex trading.
Forex does not naturally appreciate
Unlike other asset classes (i.e stocks and real estate), the “natural” appreciation on forex securities is essentially 0. It is essentially 0 rather than absolutely 0 because cash can earn a return if it is deposited with an institution and the terms of a given forex position/account structure will dictate that interest (it is usually extremely low). That is, when holding a currency, if the currency is being held as cash rather than a bond or other interest-bearing instrument, it can only produce a meaningful return via appreciation relative to other currencies. If you took a basket of every currency in the world (all held as cash), they would yield something close to a 0% real return (the aforementioned return on cash less total inflation and deflation across all of these currencies would determine this return precisely).
Contrast this to a stock trader: the S&P 500 has appreciated by slightly less than 10% per year since its inception. Stock traders who held stocks for some portion of the year will, on average, have captured that beta in proportion to how long they held the stocks. That is, if a trader held the S&P 500 50% of the time, he would theoretically have earned an average return of 5%. Of course, deriving the precise figure is much more complex because stock returns are not distributed evenly and the days, hours, etc. during which the stocks were held would skew that result. Despite that skew, assuming that stock prices continue to appreciate over time, the underlying tailwind which causes stocks to naturally appreciate will be captured to some degree by stock traders.
Notably, the absence of a general tailwind in forex makes no difference in potential for alpha generation, only in expected absolute returns. Alpha generation (returns above the index) will still follow the aforementioned restrictions of a zero-sum game with asymmetric information and fees. The tailwind which is present in equities represents more of a cushion against bad performance than a reduced difficulty level in achieving abnormally good performance.
How does volatility affect forex returns?
Forex markets generally have substantially lower volatility than other financial markets and traders therefore have a correspondingly greater degree of difficulty in generating large returns. To compensate for this, leverage is often used to produce meaningful percentage gains in the forex markets. The important point is that this lack of volatility makes it all the more difficult to trade forex. To read more about what moves forex markets and why they move less than other markets, check out this article.
Forex trading isn’t easy, but is it impossible?
Now that the challenging nature of forex trading has been established, it is worth noting that making money trading forex is not impossible, it is simply very difficult. For those who decide to undertake such a venture, consider your time availability, capital availability, and emotional capacity to undergo such a difficult process. Whatever you decide, don’t allow temptation to lure you into treating the forex market like a casino; either decide to undertake the dedicated research process necessary or don’t participate at all.