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Five Reasons You Do NOT Want to Trade Forex

Google “trade forex” and you get almost half a billion results. Forex trading has gone mainstream in the past two decades. A couple of years ago I took an Uber from the Panama City airport – the driver was trading forex while driving! It is easy to understand its popularity – easy to open an account, simple to enter transactions, and it promises to make you rich quick. Here are five reasons you want to stay as far away from this market as possible.

1) The Foreign Exchange Market is too Smart For You

Everyone tells you to follow the “smart money.” That is HORRIBLE advice. You should follow the dumb money. Why compete with the smart guys when you can compete with the dumb asses? So where is the smart and clever stupid money located? To answer this question, we go to the greatest financial fuck up in modern economic history – the Great Recession of 2008. The global banking system almost collapsed when Lehman Brothers went bust in September 2008. The crisis gave us an insight into how different markets operate. It separated the smart money from the stupid money.

How do we separate the smart and dumb money? I am looking for the market that was the quickest and most efficient to assess the gravity of the crisis, discount all the immediate factors, and then project what would happen in the future. Financial markets are discount mechanisms. .The markets that reacted quickest are smart and the markets that reacted slowest are dumb. The four major markets are equity (stocks), fixed income (bonds), currency (U.S. dollar), and commodity markets. The fifth market is the derivatives market, but it derives its value from these four base markets.

The first market to hit the bottom and then recover was the currency market. The U.S. dollar, as measured by the dollar index, cratered one week after the Lehman Brothers collapse on September 22nd and then rallied 17 percent through to March 5th, 2009. Gold reached its minimum point on November 12th, 2008, and then rallied 40 percent to February 20th, 2009. The third market to hit rock bottom was the U.S. Treasury market. The yield on the 3-month treasury dipped into negative territory for one day on December 4th, 2008. This was a point of extreme pessimism showing that people had lost confidence in the banks and were prepared to pay the U.S. Federal Reserve to look after their hard-earned cash. When did the stock market hit the bottom? Three months after the treasury market. Both the Dow Jones Industrial Average and the Standard and Poor's 500 Index found their bottoms on March 9th, 2009.

This is the timeline:

22 September 2008: Currencies (U.S. dollar Index)

12 November 2008: Commodities (Gold)

4 December 2008: Bonds (the U.S. 3 month Treasury)

9 March 2009: Equities (Dow Jones and Standard and Poor’s 500 Index)

2) The Forex Market is Manipulated

Most countries are either looking to weaken or prevent the strengthening of their currencies. This sounds bonkers and flies in the face of conventional wisdom. Surely a strong currency is a sign that the economy is in good shape and therefore preferable to a weak currency? The reality is that the strong currency does more harm than good. It crimps a country’s exports. If your local currency is strong, it makes your product relatively more expensive in the global marketplace. Assume you are a wine farmer in the Western Cape of South Africa. Your bottle of wine is priced at R300. If the rand is trading at 15 rands to the US dollar, that bottle costs US$20. If the rand strengthens to 10 rands to the dollar, that same bottle of wine now costs $30 – or 50% more.

So what happens when a country exports less than it imports? It is akin to spending more than you earn. Think of exports as income and imports as expenses. When a country exports something, it receives money. When a country imports something, it needs to pay. When you spend more than you earn, you create a deficit. You need to fund this deficit by borrowing money. Given that the majority of global trade is denominated in US dollars, most countries need to fund their deficits by borrowing money in foreign currencies. They do this by issuing bonds and selling them to foreigners. In other words, they need to rely on the kindness of strangers. Deficits are perfectly useful provided that foreigners continue with their generosity of buying your bonds, but generosity can be fickle. Countries know this and therefore try to keep their deficits small by weakening their currencies.

This leads to currency wars. Currency wars could not be further removed from the reality of conventional warfare. They are stealth battles. No one ever admits to waging a currency war and only surfaces when policymakers are accused of deliberately driving down their exchange rate. Front and center of these wars are the banks – both central and large commercial. When you jump into forex, you are pitting yourself against a competitor that will outmatch you in intelligence, systems, and resources.

3) Forex Trading is Highly Leveraged

Forex trading platforms provide leverage and this is reflected in the deposit percentage. For example, if you are required to deposit 10% of the total transaction value as margin and you intend to trade one standard lot of USD/CHF, which is equivalent to US$100,000, the margin required would be US$10,000. Your leverage is 10 times. In other words, your 10,000 dollars gives you exposure to 100,000 dollars. How does this happen? The forex platform is effectively lending you 90,000 dollars. This is very generous of them, but why are they doing this and what does it mean? They are doing it for two reasons – firstly, they will charge you an interest rate on the 90,000 dollars, and secondly, this leverage means you can make money far quicker – and lose money far quicker. Currency pairs are quite volatile – on average they move between 1 and 2 percent every day. Developed country pairs – like the US dollar versus the EURO, will move less than a developed currency pair versus an emerging currency – like the US dollar versus the Mexican peso. This leverage is a two-edged sword – it amplifies the movements of the underlying pair. If you are leverage 10 times (some forex platforms offer leverage as high as 400 times), you can make and lose money 10 times quicker. If the underlying pair moves 1 percent in your favour, you make 10 percent. But if it moves 5 percent against you, you lose 50 percent. This leverage starts to turn the forex market into a casino.

4) Trading is Harder than You Think

Mark Twain had the following to say about trading and speculation: “There are two times in a man's life when he should not speculate: when he can't afford it and when he can.” There is a big debate between short-term traders and long-term investors. Are humans better suited for the former or the latter? The average human is not a great trader, because he/she tends to be emotional, especially when it comes to money. When you trade, many emotions bubble to the surface – fear of losing and greed of winning are two of the strongest. It turns out that the fear of losing is far greater than the joy of winning. It is common knowledge that most traders fall into the same trap – they cut their winning trades and hold onto their losing trades. For example, they enter a trade and quickly make 10 percent. They think they are geniuses, close the trade and realize the profit. The same is not true when the trade moves 10 percent against them. Their fear of realizing a loss forces them to hold onto the trade. It goes down another 10 percent, and that same fear paralyzes them further. Before they know it, they are down 30 percent and filled with remorse and self-hatred.

It is easier to invest than to trade. To understand this, consider the facts from the stock market. Two of the greatest long-term investors are Warren Buffett, founder of Berkshire Hathaway, and Stephen Schwarzman, co-founder of the private equity firm Blackstone. Both men made their fortunes taking long-term investment bets on companies. As of September 2021, according to the Bloomberg billionaire’s index, Buffett was the 9th wealthiest man in the world with a net worth of $101 billion and Schwarzman was 36th with a net worth of $36.5 billion. We now move across to the hedge fund billionaires. Hedge funds are unconstrained funds that tend to have shorter time frames and therefore are more often associated with trading.

According to Bloomberg, the richest hedge fund manager as of September 2021 was James Simons, the founder of Renaissance Technologies, with a net worth of $25.7 billion. Second on the list is Ray Dalio, the founder, and co-chief investment officer of Bridgewater Associates was worth $15.6 billion. Simons and Dalio occupied positions 64 and 136 respectively.

So let's do some averaging. The average wealth of the top two investors is $68.7 billion while the average wealth of the top two traders is $20.6 billion. The universe is clearly saying to us that long-term investing is more profitable. This is a random exercise but let me tell you one thing for sure – it is easier to replicate the strategies of Buffett and Schwarzman than the strategies of Simons and Dalio.

You might say that you will settle for $20.6 billion! Simons and Dalio have both taken trading to Olympic levels – they are the gold medal winners. They have dedicated their lives to their trade, and trading is a zero-sum game. If someone is making one million dollars a day, then someone else is losing one million dollars a day. The average trader is on the losing end of this game.

5) Technical Analysis is Seriously Flawed

Technical analysis is the most commonly used trading strategy in Forex. Technical analysis has many merits. Firstly it eliminates the one thing that makes human beings horrific investors and that is emotion. If you look back over the last 50 years, there is one attribute that great investors share - cold-blooded independent thinking. They do not get spooked by market turbulence and they do not get greedy in the face of market exuberance. They are cold, clinical, and unemotional.

Technical analysis does not allow you to be emotional and that is good. It strips out almost all emotions from the business of investing. Technicians do not read research reports that are filled with subjective opinions, they do not watch CNBC and get mislead by unscrupulous economists, they do not look at macroeconomic metrics like interest rate cycles and inflation. All they look at all day and every day are price graphs - squiggly lines on a computer screen that provide buy and sell signals.

Technicians make money when the currency pairs break out and enter into a strong trend – be it to the upside or the downside. Technicians typically lose money when pairs are range bound or when there is a decline in volatility. Unfortunately, the money they lose in these range-bound markets often exceeds the money they make in trending markets. Technical signals are lagging indicators. Signals are triggered after the fact. This is not a strategy that is going to make you rich.

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