Learn How to Invest Safely in the Forex Market

You’ve probably heard plenty of statistics regarding the success rates of foreign exchange traders. While they can vary from source to source, the general consensus is that forex traders have anywhere from a 90-95% chance of going bankrupt in their search for a sea of profits.

These numbers, though, don’t tell the whole story. In fact, most of these statistics are put together to show the difficulty of foreign exchange, when in reality they show only one thing: those who jump into the foreign exchange market simply aren’t ready to deal with the complexities of the marketplace.

To trade safely means that an investor need shield themselves from unnecessary risk. This, of course, is actually very easy to do, however it does require some careful study into the mechanics of the market, and how everything from the news reports, to the market, to each individual broker and trader are connected.

The Spread: A Thing to Fear
Most new investors fail to take into account the most dangerous part of any financial services industry: fees. In the foreign exchange market, the fees aren’t exactly fees, but a very small percentage of each trade known as the spread, or the difference in price between bid and ask.

While the spread is very small, often less than a few pips, over time the spreads become a bottomless drain on the accounts of new investors. In order to see this phenomenon firsthand, we’ll explore two example traders: Jim and Bob.

Jim is a novice foreign exchange trader who is interested in scalping, a trading scheme in which the trader seeks very small, but frequent winning trades. This trading strategy requires Jim to place as many as 10 trades per day, with a take profit set at 7 pips per trade. Thus, in order for Jim to reach his take profit, the pair must move in his favor by 10 pips, or the total take profit plus the spread costs on each trade.

However, to reach his 10 pip stop loss, the trade need only reverse seven pips in the direction in which he has not wagered. As a result, a market that is equally likely to rise and fall by to 10 pips, Jim will win roughly 30% of all trades, and lose 70% of all trades, resulting in profitability of negative 40% each time he cycles through his trading balance.

Contrast Jim’s position to that of Bob, who is also a novice, but one who is far more interested in the long-term investment horizon. When Bob places a trade, he seeks out some 100 pips in profit, meaning that the spread of 3 pips makes up only 3% of his take profit, and only disadvantages him by 3% in his stop loss. Thus, the market must move up 103 pips and down only 97 pips for Jim to win or lose 100 pips.

Making Sense of Spreads and Volatility
Even in the bearish of the bear markets, it would be irrational to expect that you could, with any accuracy, avoid a 7 pip reversal in the general market trend. On the flip-side, however, it is far less likely that a trader will see a 100 pip decline against a strong, bearish trend.

With that very basic understanding in place, it starts to make sense why so many traders fail in the foreign exchange markets. They invest irrationally, betting rather than investing and using timeframes that are not only poor for inexperienced investors, but also unforgiving in the spreads. The simple fact of the matter is that short-term forex trading is gambling—even casinos don’t take a 30% cut of each spin of the roulette wheel, though your forex broker might!

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