FXEvery trader who starts his contact with Forex market first looks for a “Holy Graal” – a trading strategy which will bring him enormous profits. Expectations about this kind of system are often too high – we want to earn on Forex market as much as possible. According to trader’s perfect scenario, buy positions should be opened on local lows (historical lows would be even better) and sell positions all the way on tops. After this first period of looking for a perfect solution, a trader starts to change his previous thoughts about markets and starts to look for more realistic Forex scenario. Then trader is going to define his needs, whether it will be Elliott Waves theory, harmonic trading, Price Action or any other strategy. Then he focuses on developing and perfecting this one strategy, which is a very good sign. However, at this moment there are also threats connected with speculation showing up. He starts to realize that trading does not bring an enormous return, there is even some kind of drawdown. Currencies are really volatile instruments what influence the score of every single transaction. At this moment trading looks really hard and the trader can start questioning this activity. To answer the question of whether Forex success is possible we just have to define what is a success first. What is this mystical state of mind which is described in thousands of books about self-development.
English dictionary by Merriam-Webster defines success as:
- degree or measure of succeeding
- favourable or desired outcome; also: the attainment of wealth, favour, or eminence
According to this definition, we should understand that the base of success is planning. How could a trader decide if he realized the target if he did not define it? Of course, having a plan is only a beginning which will get us to lose to become a professional and successful Forex trader.
Statistics and Forex success
It is important to realize one fact which is very uncomfortable for many dishonest CFD brokers who lure their potential customers with the promise of huge returns and limitless possibilities of this market. The clue is in statistics. According to them over 80% detail customers investing in Forex are losing money. Potential candidates to become FX traders are terrified by this fact and often resign from investing. Of course, it is better to resign in the beginning rather than losing money but the truth about the Forex market is more complex. It is not easy and simple market like in the commercials. However, it is worth to notice that there is no other business that would be easy and simple. When we take a look at trading like on business we should also consider how many new companies will survive for the next five years or how many of them will generate profit in the longer term. After analysing this data trader can think that it is not worth to invest in this market. Well, it is worth to, you just have to answer a few basic questions about that. Do you have a prepared strategy to trade on Forex market? Is trading a branch in which you want to develop? Are we ready to sacrifice our time and capital to achieve success? If not and our only motivator of investing in Forex market is to get “quick and easy” money, it is better to let go trading on the most liquid market in the world. This way we will save a lot of capital which would be lost.
What disturb in achieving success on Forex?
When we talk about achieving success on Forex market it is worth to remember that daily volume is as high as 5 trillion dollars, what makes it really resilient to any kind of manipulation by single market participants. At the same time, we have to remember that no matter if we will invest with 1 micro-lot (1000 units of base currency in currency pair, for example, 1 micro-lot of EURUSD is 1000 EUR expressed in USD) or maybe 10 lots (1,000,000 units of base currency) it is really hard to have influence in direction of the market. Unfortunately (or happily) it is practically impossible to manipulate the Forex market. Therefore, remember that the only thing we can influence is ourselves. Any other matter relating to the formation of trends and specific sentiments are dependent on interbank market participants such as JP Morgan, Goldman Sachs or Deutsche Bank and of course central banks.
Curtis Faith – the most famous of “Turtles Project” which was created in the ’80s by Richard Dennis and William Eckhardt – wrote in his book “Way of the Turtle” about cognitive biases which should be conquered by a trader who wants to achieve success:
- Outcome bias
- Recency effect
- Disposition effect
- Sunk cost fallacy
Outcome bias depends on giving too much weight to the score of a single transaction instead of its quality. It might seem wrong on first sight. Traders open positions because they want to have a profit. However, Faith in his book writes that the base of the success on the market is not a score of single transactions but the consequent realization of system with the positive expected value. Because of that quality of single trade should be decided based on the trading strategy. If the transaction ended with profit but the trader opened position, not on the base of his scenario, it was a bad transaction. The strength of the trader’s success is to stay to the system with the positive expected value. Faster we understand it, faster we will achieve success on the Forex market.
The recency effect is a problem of people testing different trading strategies. Many traders put more weight to recent data than to the previous one. According to the saying “new is better than old” traders reject wide view on the market and they focus only on the newest history. Unfortunately, this bias is also affecting many traders. It is easier to believe in “magic system” when trader shows few or dozen recent transactions ending with profit. At the same time we reject system with positive expected value if lately there were few losing transactions. People selling any kind of trainings or selling signals know that perfectly, they offer to their clients their services showing them just statement with “recent transactions”.
Disposition effect happens when trader keep losing positions too long hoping that trend will finally reverse with closing profitable transactions too fast at the same time. When during some kind of trainings professional traders say “Cut losses, let profit grow”, people tend to nod understanding this wisdom. However, when they start to invest every trader at least once was a victim of this effect. It happens because every time we have to book losses our mind takes it as a failure and every profit is a success. It is natural that traders try to feel pleasure and avoid suffer by not closing losing positions and waiting until it will be profitable. When the transaction finally brings profit, the trader automatically close it with a small profit. During my lifetime I have met many traders waiting for bad transactions to reverse but I do not know a single person who would not lose all their capital eventually using this strategy.
In the end, I wanted to say a few things about sunk cost fallacy. It is a paradox which is just a self-perpetuating machine of financial destruction. We can describe this effect as a situation when the trader had to pay some costs connected with trading. He could buy some “magic bot” for a few thousand dollars which started to generate massive losses then. Therefore he use it all the time putting more money into it or spends money to some update of this bot etc. Logically thinking he should resign from using this bot but the perspective of lost money makes him dive further so he does not have to consider spent money as lost. The only problem is that this money is already lost, simply the trader exposed to sunk cost fallacy cannot realize it.
Which personal qualities determine success on Forex market?
Once we know where is the trader’s problem with achieving success, we should collect it all together and find the common rule of a successful trader. First, successful Forex trader need to be a person who is not afraid to fail. On the other hand, he should have the ability to quickly draw conclusions on how to avoid these failures in the future. He must have a system with the positive expected value. The expected value consists of two elements:
- Average risk to average profit ratio
In case of weak efficacy, the trader needs to make up with profit/risk ratio so he will have much bigger profits than losses. When he already has this kind of system he need to be consequent and disciplined in realizing his trading plan. As it was mentioned before a single transaction does not matter. Once we can book profit, the other one loss. However, in longer-term our system will bring more profits than losses. Anyone can make a profit on a single transaction using only luck. You need to be a pro to regularly increase capital. World-class traders understand this perfectly so they cut the losses quick. If the price of the instrument reached the level at which we should close it, we should do it without any regrets. Although the temptation of keeping opened order is big in hope it will reverse soon, you should remember that it may happen few times but only one unfortunate event happen and we will lose all our capital. This is why prominent trader never risks more than he can potentially earn. The situation in which our take profit is 100 pips and stop loss is 300 pips maybe increase the probability of winning, but how will our account look in case of series of losses which happen even to the best traders? You have to remember that success on FX market is primarily a matter of working on yourself and the desire of development. For many, it will be hard and long-term work, but when you are passionate about trading you will look at the effects of your work with pleasure.