Welcome to a three-part mini-series on Trade the Day.
Forex trading can seem like a daunting challenge before starting on this journey, which begs the question.
“Why Trade at All?”
According to the Efficient Market Hypothesis (EMA), the prices of financial securities reflect all information regarding those securities.
Because of this, the theory goes, it is impossible to undertake any analysis – technical or fundamental – that will help you generate excess market returns.
That is because prices are efficient, no amount of technical or fundamental analysis will enable you to determine price movements such that you can make significant profits.
The theory seems to make a lot of sense and can help explain why trading is so hard.
Because trading is hard, no one is denying that. However, does this mean you should not bother; especially when making a profit is considering somewhat impossible by the EMA?
The Efficient Market Hypothesis (EMH) graphically displayed
What does it mean then if we have heard stories, know of or have even seen people make a significant amount of money trading?
Why would all the big institutions have trading desks and invest so much in things like algorithmic trading if there was nothing to be gained from it?
Trading is indeed profitable for people, whether at the retail or institution level. That statement is a fact. As such, this may mean that the EMA is wrong. For how can there be people generating significant profits in trading if the markets are efficient?
In actuality, it is not so much that the EMA is wrong but rather that it is a bit understated.
The hypothesis should be stated as follows: given an infinite amount of time, resources and people then the prices of securities reflect their true value and generating excess returns is impossible.
That is, if you had an endless amount of people spending an endless amount of time analysing absolutely everything then, yes, you would find the absolute truth about the value of an asset. However, there are only so many hours in the day, there are only so many people studying a particular market and each of these people have their own lives to lead and their own needs to be met.
As such, there is only a limited amount of time, resources and people that can be put into studying financial markets. This, therefore, means that it is not possible for everyone to know everything about the markets. And so, there would necessarily be inefficiencies in prices that can be exploited for excess returns.
It is through these inefficiencies that people, retail and institutional, can and do indeed make money trading.
The question is whether you can too.
Read “Why Trade at All?” – Part 2 here
Welcome to Part 2 of the three-part series “why trade at all” on Trade The Day.
Actually, the question is first whether to trade FX or not and why to trade FX at all.
With many Forex brokers, you can leverage your account balance up to 500 times its value (500:1).
In other words, by signing up with xyz, you can enter into positions worth up to 500 times your deposit.
Let us say that you have a balance of $1,000 and enter into a trade worth $100,000 (in this case it would be an implied leverage of 100:1, as for every $100 in position you had $1 in deposit): a reasonable price movement of 1% with respect to your position value equates to $1,000.
You could effectively double (or wipe out) your entire deposit with just a 1% move in the value of the underlying instrument.
By trading leveraged instruments, it is possible to earn far more in a given amount of time than by trading the underlying instrument
So now that it has been established why trade at all and why trade FX, the next thing to determine is what to look for when trading so you can answer the question of ‘why bother’.
Regardless of whether you trade based on fundamental or technical analysis; every trading style is based on pattern recognition.
Technical analysis is based on the idea of analysing chart movements and predicting future price movements based on similar conditions seen in the past.
Fundamental analysis, in contrast, is where future price movements are predicted based on market information. However, fundamental analysis is still based on predicting future human (market) behaviour based on expectations built from past behaviours.
In either situation though, past performance cannot guarantee future results. Nevertheless, what other information do we have to predict the future than everything in the past?
The difference between successful traders and unsuccessful traders – at any level – is whether they have found exploitable patterns overlooked by everyone else.
As indicated previously, due to limited time, resources and people; it is not possible for market participants to be aware of every market pattern and inefficiency.
And so, for every trader, there is an opportunity to find some. These do not necessarily need to complex either. For example, think about all the times you could not see something that was right in front of you.
This is a very human phenomenon and at the end of the day it is either human’s trading or at least algorithms coded by humans, and it is surprising how often the obvious is overlooked.
Furthermore, there could be an indicator that was “all the rage” in the past, which fell out of fashion, now works again precisely and perfectly because everyone forgot about it.
Trading is a personal skill and at the end of the day, you also need to find a strategy or system that works for you.
There’s no use trying to trade in a style that creates more confusion for you.
Trading is much like starting a new small business – as you are trying to generate a new income stream – and so it would be foolish to not treat your trading with a similar professional attitude.
It can take at least two solid years of full-time work for a small business to become profitable.
It would be reasonable to expect that to be successful at trading it will require a similar level of commitment and investment.
Considering the commitment you are making; it would be worth finding a strategy that works for you.
It is almost like starting a new job where you get to pick how you can do your job; why would you want to do a job in a way that you do not enjoy or understand?
Finally, there is a somewhat amusing analogy about trading in relation to brain surgery: imagine picking up a book on brain surgery one night, reading through it, and then deciding to walk into an operating theatre tomorrow.
FX trading is one of the few professional ventures that you can start as you learn.
Making mistakes is one of the best ways to learn and unlike brain surgery you have the opportunity to make and learn from your mistakes as you go.
You can pick up a book on FX trading, fire up a demo account and start today.