It’s truly a nightmare scenario: Hundreds of millions of dollars in trading losses happening so fast that even affected traders in the know could do nothing to stop them. Entire retail trading accounts wiped out, and even some professionally managed funds forced to close amidst the carnage. Sounds like it couldn’t—or shouldn’t—happen, right? But it just did.
Last Thursday (January 15), following the unexpected decision by the Swiss National Bank (SNB) to remove the cap on the Swiss franc (CHF) against the euro (EUR), EUR/CHF fell by almost 30% in a matter of minutes, costing big global banks tens or even hundreds of millions of dollars, and obliterating the accounts of unsuspecting retail traders, many of whom were trading on margin.
Now, the bigger-picture economic and market impact of this stunning event is far reaching and still yet to be seen, but at the very least, this is something of a black eye for the forex industry, which has taken great strides towards improving its once “shady” reputation.
Perhaps above all else, though, this the latest reminder that trading on margin can indeed wreck your trading career, especially if “gambling” borrowed money on an unsound or unproven trading strategy.
Fearsome Facts about Trading on Margin
Using leverage, or trading on margin, is a way for traders to increase their purchasing power and trade larger sums while still only using small amounts of their own capital. The rest, they borrow from the broker, but often unbeknownst to them, trading on margin quickly and exponentially amplifies the risk. Here are some telling and rather frightening facts to consider:
- In the US, leverage is capped at 50-to-1, but in Europe and parts of Asia, it can be as high as 200-to-1!
- Given even 50-to-1 leverage, traders can take a given position for as low as two cents on the dollar, in which case a 2% move could double their money…or lose it all in one fell swoop.
- While currencies typically don’t move by entire percentage points in such short order the way CHF did recently, when it happens—and it does happen—price may “jump your stop,” never triggering the intended action and essentially exposing the position to unlimited financial losses.
Now look at these stats made public by leading forex brokers, and let’s seriously reconsider whether most retail traders are in any way fit for trading on margin: Nearly 70% of broker-held forex accounts are unprofitable, and new accounts stay open, on average, for only about four months before the client, or the broker, shuts them down.
In light of all this, you really have to wonder, why don’t more retail forex traders avoid trading on margin altogether, and if you’re one who does, ask yourself, should you keep doing it?
How to Keep from Becoming Yet Another Victim
More than just reinforcing the dangers of trading on margin, however, this controversial event also reiterates the importance of using a proper, proven trading strategy. After all, unless trading strictly for leisure and not for financial gain, you have to have a quantifiable edge in the markets, otherwise, it’s just gambling, and such activities should never have been considered investing in the first place!
In an era when small retail traders like us go up against big banks, computers, and seasoned professionals with every trade, a documented edge has never been more crucial. And here’s the good news: There are tactics available to retail traders that big banks and institutions can’t touch. These are simple, yet powerful tools that help level the playing field and bring about the kind of success and staying power that even part-time traders covet. Here’s what they are:
Invest for the long run – The big boys and computers are trading the same market as us, but they aren’t playing the same game! Their aim is to turn fast profits, and they employ leverage and risk as tools to do it. You can—and should—be different, taking only qualifying set-ups and being mindful of risk in the process. Each trade, therefore, is a means to a long-term goal, and not a short-sighted attempt to make a killing right now. If you invest for the long run, there’s no real need for trading on margin.
Get back to basics – The longtime pillars of successful investing still apply to this day, even when new products, techniques, and so-called “tools” like trading on margin are available to traders. Make sure your strategy protects your capital and has a reasonable expectation for returns. Test it mercilessly, don’t trade even a unit of your own hard-earned capital, and don’t even consider trading on margin until you have real, quantifiable proof of your unique edge in the market. That’s the difference between investing and simply speculating, and it’s the very reason why so many traders ultimately fail!
“Forex trading involves significant risk of loss.” Seven little words you see and hear everywhere, and then when—not if—it happens, well, they told you so. But for the traders hardest hit by the recent meltdown in the CHF, it wasn’t really the mere nature of the markets that cost them so dearly; it was that they were leveraged to the hilt while trading on margin.
Some may never get a chance to recover from this or even place another trade. This is really serious business, but the message is quite simple: Trading on margin is not for everyone, nor is it even necessary to become a successful forex trader. So take a good, honest look at what you’re doing with respect to your strategy, risk, and leverage, and given this recent and very difficult lesson, you may well decide never to trade on margin again.
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