Big Losers, Small Winners

• Posted by Robert Sinn
• on April 30th, 2012

It is no secret that forex traders as a group are the least profitable and have the least longevity among any group of market participants. There are several reasons for this, however, the primary reasons are rather simple:

• High degree of leverage employed
• Retail forex traders are generally poorly capitalized and relatively inexperienced

The prevalent use of extreme leverage (often more than 50-1) causes tremendous volatility in a trader’s account equity. For example, a 50 pip move in $EURUSD (.38%) is nothing more than ordinary market noise in the grand scheme of things. However, such a market movement is certainly not noise to a trader leveraged 50 to 1 who will experience a 19% shift in his account equity. And for a trader who is fully embracing the forex casino with 100 to 1 leverage the resulting 38% shift in account equity is the difference between a margin call forced liquidation and a home run.

A recent study of customer trades by FXCM (a large online retail forex broker) found that its customers are often right on market direction (about 60% of the time), however, they lose roughly 80% more on their losing trades compared to their winning trades. It doesn’t take a math PHD to figure out that this profitability ratio is unsustainable longer term particularly when commissions and other trading costs are factored into the equation.

I believe that the excessive use of leverage in forex trading directly results in traders exhibiting a loss aversion behavioral bias which ultimately proves to be fatal for their trading careers. Moreover, by employing excessive leverage the market participant becomes susceptible to the whims and noise of the market which is something that all successful market participants strive to avoid.

Even if one is not a forex trader it is worth analyzing your win/loss percentage and win/loss size in great detail – your win size should be greater than your loss size and it is probably better if your win/loss percentage is at or slightly below 50%. In fact it is perfectly acceptable for the majority of ones trades to be losers as long as there are a few home runs among the profitable trades. Peter Brandt goes as far as to write that only 30% of ones trades need to be profitable in order to be a highly successful trader – Peter’s 3rd major point of successful trading from his book “Diary of a Professional Commodity Trader” is worth pondering given the aforementioned FXCM retail trader data:

“Successful trading is a process of doing certain things over and over again with detail and patience.”  

I wonder how many retail fx traders implement a well defined trading process with detail and patience…..

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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