The foreign exchange market is one of most popular
markets for speculation, due to its enormous size, liquidity and tendency for
currencies to move in strong trends. Presumably, these characteristics would enable
traders to have tremendous success. However, success has been limited mainly for
the following reasons:
- Many traders
come with false expectations of the profit potential and lack the discipline required
for trading. Short term trading is not an amateur's game and is usually not the
path for quick riches. Because currencies may seem exotic or less familiar than
traditional markets (i.e. equities, futures, etc.), it does not mean that the
rules of finance and simple logic are suspended. One cannot hope to make extraordinary
gains without taking extraordinary risks. A trading strategy that involves taking
a high degree of risk means suffering inconsistent trading performance and often
suffering large losses. Trading currencies is not easy (if it was, everyone would
already be a millionaire), and many traders with years of experience still incur
periodic losses. One must realize that trading takes time to master and there
are absolutely no short cuts to this process.
- The
most enticing aspect of trading currencies is the high degree of leverage used.
Leverage seems very attractive to those who are expecting to turn small amounts
of money into large amounts in a short period of time. However, leverage is a
double-edged sword. Just because one lot ($100,000) of currency only requires
$1000 as a minimum margin deposit, it does not mean that a trader with $10,000
in his account should easily be able to trade 10 lots or even 5 lots. One lot
is $100,000 and should be treated as a $100,000 investment and not the $1000 put
up as margin. Most traders analyze the charts correctly and place sensible trades,
yet they tend to over leverage themselves (take a position that is too big for
their portfolio), and as a consequence, often end up forced to exit a position
at the wrong time.
- For example,
if an account value is $10,000 and the trader places a trade for 1 lot, he is
in effect, leveraging himself 10 to 1, which is a very significant level of leverage.
Most professional money managers are not allowed to leverage even this high. Trading
in small increments on the account will allow the trader to endure many losing
trades without experiencing large monetary losses.
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