In this article, we’ll look at:
- Trading forex for a living.
- Why forex MUST have losers.
- How to make big money trading currencies (this is also the danger).
- The skills you need to be a successful trader.
Trading Forex for a Living
Buying and selling currency is a genuine way to make money. Being a currency dealer you can hold a number of different currencies and sell each one to people that need it.
This is what happens at a bank or currency exchange booth when people go on vacation. It means you can change your Dollars for Euros without having to find an individual who has Euros, but happens to need Dollars.
The currency exchange firms make their money on the difference between the price that they sell at, and the price that they buy at. Sometimes 10% depending on where you go.
Nice work if you can get it.
If you have a license to be a currency changer it is almost a license to print money. As long as there is steady demand for the currencies that you hold, then you can make money for shuffling a few bits of paper.
Online Forex Trading
The evolution of online currency trading has opened up a previously unavailable market to the little people. This is fantastic… as well as dangerous. It’s simple to understand and get started. But, it can be brutal if you are not prepared.
Another major attraction of trading forex for a living is that the market is open 24 hours a day. Because there are big currency trading centres in Asia, Europe and America, it means you can trade at anytime. You are not restricted to the opening and closing hours of any particular stock exchange.
Add to this the size. It’s the biggest market in the world where trillions are traded every single day. The advantage here, is that there will always be someone to buy from and someone to sell to… even if you are trading in a more unusual currency pair.
Winners and Losers
One very important thing that you need to accept, is that trading in currencies is a zero sum game. If you make money forex trading, then someone somewhere will have to lose money.
You cannot avoid that fact. This makes it more like gambling in its structure than say (some forms of) trading in stocks.
It is more like a casino with the broker being the house. In a casino, there is an “edge” built into the games that gives a slight advantage to the house. The rules rules of the game mean that over time the casino will win more than it loses.
In forex trading, the edge is more upfront and obvious. The broker makes their money from the spread between the buy and sell prices on their platform.
The spread is very small, often only a few pips (a “pip” is the smallest unit that any currency pair is traded in), but when the volume of trading is accounted for, it can earn the broker huge commissions.
For example, the broker sells US dollars for Japanese yen at 102.31. But they buy US Dollars for Japanese yen at 102.32.
That little difference between the two figures of 0.01 yen (1 pip) is where they (always) make money.
How You Make the Big Money in Forex
If you look at currency value charts you see that, over the long term, currency pairs mostly move in long slow cycles, up and down. Over five or ten years the difference in value between two currencies might be 10%, 20% even 50%.
The key point is that we are talking over long time frames. In a scenario like that, even if the value of a currency halved, you would have to trade extremely large sums to make any decent profit… and you would still be waiting years to get your money.
The profit, the excitement… and the danger, in the foreign currency exchange business come from using leverage and trading short-term volatility.
This is where it can get wild!
These days you hear the term leverage thrown around by people as if it’s a completely sane thing for normal people to get involved. The truth is that it is probably the most dangerous thing a retail investor can be involved in.
You must absolutely understand the risks involved in using leverage. The rewards are easy to understand… just don’t ignore the risks.
An example currency trade:
- You buy $1000 USD (of another currency)
- Then after 5 years it goes up 50%,
- You can sell for $1500.
- You made 500 bucks.
Easy, but it’s not much especially over such a long time period.
You are not going to be able to make a living from that kind of gain.
Now, if you could:
- Buy $1,000,000 of another currency.
- It has a 50% increase.
- You would be able to sell for $1,500,000 after 5 years.
- This would give you a profit of $500,000 (subject to taxes, of course).
That would be a nice earner.
You would still have to wait 5 years to get your money… but it would be worth the wait.
But then is forex trading profitable only to major players with enormous amounts of cash to wager?
No, it’s not.
Forex Brokers Provide Leverage
You don’t have a million? No problem, the broker will effectively lend you a million to trade with (It’s all on paper, you don’t actually receive the real amount). All you need to do is pay them back the million after you’ve taken your profit.
But with the above example, it’s still going to take 5 years, and who wants to wait that long?
So, you need to trade on a much shorter time frame (daily, hourly etc.) where the currencies quickly change value. When you combine these short-term fluctuations in price with margin trading (trading using borrowed money ie. leverage) you can make money all the time.
The Big Problem
However, where there is beauty there is also often danger. If you have $1000 in your account and your broker bumps you up to $100000, you are now trading at leverage of 100 to 1.
For every pip on the way up you are making 100 times more than you would have if you were just trading with your original $1000. Great!
But this is also the same on the way down.
When your trade moves the other way than you predicted, you are losing 100 times what you would have done if you had traded with only $1000.
And you can get wiped out quicker than you can say “Margin Call” (That’s a great film by the way, I highly recommend it).
An Example of Leveraged Trading
Say, you are trading with $1000 dollars in your account.
- You buy GBP at 0.7150 predicting it will increase in value against USD.
- Effectively, you are now holding £715.
- It does go up in value over the course of the day to 0.7100.
- You now sell your £715 for dollars.
- You convert at the new rate of 0.7100 giving you roughly $1007.
- That’s $7 you made.
It’s not enough to live on though, is it? But, if you were trading with 100:1 leverage…
- You would have (effectively) been holding £71,500.
- This would have converted back to $100,700.
- This gives you a profit of $700.
And if you could do that everyday, well, you can see the attraction of forex trading when it is presented like this.
BUT if the pound went down in value to 0.7200, then things would look very different.
- You convert your £71,500 back to dollars at 0.7200.
- This gives you roughly $99,305.
- Take that away from $100,000.
- You have lost $695.
- That comes out of your original $1000.
That’s the potential pain of leveraged forex trading.
Note: Don’t forget either, that professional forex traders regularly blow up accounts. They don’t always get it right, and they lose serious amounts of money chasing trades that go against them. Often though, it’s their clients’ money, so guess what? They may live to fight another day. Not so, for the retail forex trader. Unless of course you have seriously deep pockets.
What You Need to Be a Successful Forex Trader
1. Money Management
Obviously, you cannot risk your whole bank on a single trade as in the above example. If the trade goes against you, then you are finished. Your forex journey will be over quite quickly.
What you need is a money management strategy. You shouldn’t risk more than a couple of percent of your bank on any one trade.
The idea is that your system is not going to deliver all the time. But if you have worked it out robustly enough, it should be successful over the long term.
With this type of approach then, you need more money. If you only had $1000 to trade with, and you only risked $20 a trade, then even with leverage, you wouldn’t be making much money.
You are going to need a bank of at least $10,000 to give you a margin of safety. If you use 2% of your bank on each trade, then you are risking $200 a time.
This will give you room to lose a some trades… sometimes. You still need a system that is going to win more than it loses, though.
Note: Think about this. Red and black ought to come one after each other on the roulette wheel… statistically. But there is no law to say a table couldn’t turn up hundreds of reds or blacks in a row.
2. Learn to Read Charts
If the forex road looks good to you then you need to learn to read the charts.
A massive amount of deciding when to place trades is done using charts and technical analysis. There may be a certain amount of underlying fundamental analysis that will help with long term movements, but most of the day to day stuff is in the charts.
Because there are so many traders all looking at the same charts and following the same strategies, some of the movements become self-fulfilling.
As a ton of traders read the charts a certain way, and see a certain formation occurring, and thus a future movement, they all place the same trades with buys or sells at the same point. When those prices get hit they trigger all the orders and the charts move accordingly.
You could end up staring at charts on your computer screen all day long looking for an entry point. That doesn’t sound like a whole lot of fun to me.
There are services that will supply you with forex trading signals when something interesting turns up. That at least allows you to do other things while you wait to trade.
But then, you are relying on others to provide decent opportunities.
3. The Trader Mindset
There is another critical element to forex trading that exists outside of the market action. That is the “Trader Mindset”.
There is a massive psychological side to trading. It takes enormous amounts of courage to jump in to a trade… and nerves of steel to hold on to your convictions.
This is the main issue people face when they move from their forex trading demo accounts to live ones.
All of a sudden, what seemed like a jolly on the demo is hellishly serious. You are playing with your real money… and some people freeze. Others are too cautious. Some get burned early and can’t get back in the saddle.
The explosion of online brokers has opened up forex trading for beginners and made it easy to access, but the psychology of it is often their biggest challenge.
Go with the Crowd
This is by no means a foolproof strategy (and as always do you own research), but it could be a good idea to follow the trend.
Stay with the popular pairs like USD/EUR or USD/JPY as they will be the most liquid, and there is a lot of data and information written about them. Banks, companies, even countries will be using them to hedge certain positions or satisfy some investment directive.
This means that the little guys can piggy back on the big players.
What do you think about forex trading for a living? What do you think about using leverage? Do you think anyone can be a trader? Please leave your comments below.