Why All Sensible Investors Should Stay Away From Currency Trading

Of all the get-rich-quick schemes out there at the moment, none of them are as damaging as currency trading. Currency speculation, or forex trading, is extremely easy for retail investors to get into.

It only takes five minutes to open an account. Although the chances, of becoming a successful forex trader, are virtually zero.

High risk, no reward

Trying to predict which way a pair of currencies will move is a hard skill to learn. Even most profession forex traders only expect to be right roughly half the time.

However, retail traders and private investors are lured in by the prospects of a high return. You see, to make a decent profit currency trading, you need to have tens — if not hundreds — of thousands of dollars available for trading… and that’s only for one trade.

Most forex providers get around this issue by offering leverage. For example, if a client puts up £10,000 as a 10% margin, the provider will lever this amount up to £100,000 in currency and take the gains on that, which could be sizeable. For many currency trading ‘newbies,’ this potential for large and quick gains with a minimal deposit is highly attractive.

But this is only a very simple example. Indeed, the example above uses leverage of 10x, which is virtually unheard of. Instead, many providers offer leverage of 100 x, 200 x, 500 x or even, in the most extreme cases, 1000 x your initial deposit.

Wiped out

The best way to show how damaging such high leverage can be to your wealth is to use an example.

Suppose you deposited £100 with a forex broker that offered 1000:1 leverage. You would be able to trade £100,000 worth of currency instantly. But here’s the thing: with this kind of leverage, the market would need to move ten points in the wrong direction before you were wiped out — this is a rough estimate and does vary depending on which currency you’re trading.

An 11-point move would mean that you owed money to your broker. A 20-point move would not only mean that you’d lost your initial capital, but you would also owe your broker £100.

Now, according to my figures, the GBPUSD cross — one of the most traded currency pairs in the London — moves on average around 50 points per day. So, on average with a £100 deposit, levered up to £100,000 you could make, or lose £500 a day on average. Again, this figure will change slightly depending on the currency traded and other factors.

Always wrong

For some reason, according to the Wall Street Journal, 84% of current and potential forex traders believe they can achieve positive monthly returns. They couldn’t be more wrong.

According to an article published in the Financial Times, nearly 89% of private forex traders lost money within France over a four-year period. The average loss per client was nearly €10,900 between 2009 and 2012.

And it’s not just the French that are losing money. FXCM, one of the world’s largest retail forex platforms, reported that during the third quarter of last year, nearly 70% of its active accounts were unprofitable.

One conclusion

All in all, the data point to one conclusion. If you want to preserve your wealth, stay away from currency trading.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.