10 Forex Trading Myths That Just Won’t Die

FOREX TRADING MYTHS

By Adam Kritzer

There is a terrific amount of information on the internet surrounding forex, but much of it should be treated with skepticism. "Objective" advice often masks a hidden agenda, such as to convince you to buy a particular product or service. Anyone can call themselves an expert and draft a list of phony trading guidelines, supported by impressive-looking statistics and charts. You have probably heard that the markets are "scientific" and with 4 easy payments of $29.95, you can purchase a kit that explains this science, guaranteed to yield a 400% return in only one week.

Okay, so we all realize that the forex web is full of exaggeration and misinformation, but how do we go about separating fact from fiction. Google the phrase Forex Myths and you will certainly feel overwhelmed by the results. The same group of self-styled experts that wants you to buy their products is also eager to pontificate about the myths and mistakes that plague novice traders. Naturally, the myth that underlies their particular trading strategy is omitted. In order to end this confusion, I have attempted to sift through the contradictions to produce the definitive list of forex trading myths.

1. Listen to the Experts: From the introduction above, it’s pretty clear that I don’t think most experts offer valuable advice. In fact, one of the themes of this list is that it’s important that as a trader, you learn to think for yourself. While there are undoubtedly many knowledgeable and successful forex experts, one would expect the majority of them to keep the true secrets of their success hidden from the public in order to preserve their trading strategies. Instead, the "gurus" that make known their techniques often have suspect credentials and exaggerated stories of success. Even in Singapore, according to Sebastian Sim, "For newbie, investing and trading seem complex and mysterious. This type of Gurus likes to perpetuate this myth so you’ll enroll in their ‘Superstar’ courses at ultra-high prices. They want you to believe that there is a super-magic formula to ‘trade like the pros in the banks.’ " In short, while experts can provide you with the basic information and a general approach to the markets, most of your education should and will be a product of your own mistakes.
2. Day Trading is Profitable: This myth is actually a combination of two smaller myths. The first concerns day trading, itself. While statistics on day trading are scant, both anecdotal evidence and financial theory suggest that the vast majority of day traders lose money. The primary reason is that exchange rates, like stock prices, follow a stochastic process, as opposed to a deterministic path. While there are certainly long-term trends (to be discussed below), the minute-to-minute fluctuations are essentially random, which means you have a 50% chance of being right in predicting whether a currency will be higher or lower in value five minutes from now. Those who do do manage to turn a profit from short-term directional movements are probably assisted by asymmetric information. Professional traders not only have access to better data, models, and research, they may also have inside information about specific trades that are moving the market. According to a poll by EuroMoney magazine, the ten most active traders represent more than 75% of daily foreign exchange turnover. Deustche Bank, alone, accounts for 21.7%. As a retail trader who is not even trading through a primary market-maker, it’s not likely that you will be able to compete with these institutions in the short-term. The second myth is that of commission-free trading, which many brokers advertise. While there is not technically a commission, brokers profit from the bid/ask spread, which is deceptively large enough to ensure that the broker profits from every trade. This is important in the context of day trading, because even if you somehow manage to guess right more than 50% of the time, you will still have to account for the costs associated with constantly churning your positions, which can be significant.
3. You Should Always Be in the Market: This myth is borrowed from Learn Currency Trading. The author notes: "You don’t earn a reward in currency trading for effort or how often you trade – you earn your reward from being right." Many currency traders are initially sold on forex because of the oft-repeated line that "forex markets are open 24/7." While this is essentially true, it doesn’t mean that you need to be monitoring, or even invested in it all day, every day. In fact, I would argue that it is just as important to know when not to invest, as it is to when to invest. Perhaps you are having trouble making sense of a surplus of data and/or you can’t identify a definitive trend. In this situation, it is probably more sensible to take the "wait and see" approach rather than rush headlong into the markets. Periods that are especially volatile, or especially flat, often signal that the markets are having a difficult time coming to a consensus about the present, or the future, respectively. This last sentence probably sounds meaningless, but read on to find out why it’s not.
4. Buy Low, Sell High: When volatility is especially high or low, a temptation will develop to try to predict tops and bottoms on "micro-trends." Unfortunately, due to the stochastic nature of exchange rates that was discussed above, this is a high-risk, low-return strategy. As a forex trader (or a stock market trader, for that matter), your goal should be to maximize return and minimize risk. This is best achieved by identifying medium-term and long-term trends. Medium-term trends tend to be technical or event-driven. Examples would include an oversold currency or the perception of positive political developments, both of which would presumably cause the currency to appreciate. Long-term trends are typically fundamental/economic in nature. Factors include interest rate differentials, inflation, and economic performance. Movements in currencies caused by these factors are likely to be somewhat stable, such that it doesn’t make sense to focus on the infinitesimal ly small blips that punctuate a sustained upward or downward path.
5. Diversification is Key: This is essentially a half-myth. Of course, currency investment/speculation should be undertaken as part of a broad and diversified investment strategy. However, within currency trading, diversification probably isn’t necessary. Trading more than one currency pair is time-consuming and often redundant. In the stock market, there are literally thousands of stocks from which to choose, and prudently investing in multiple stocks can limit exposure. In the forex markets, in contrast, there are only a couple dozen currencies that trade with an acceptable level of liquidity and transparency. Moreover, there arn’t usually more than a couple, let alone one, coherent threads woven through the forex markets at any given time, which means its best to concentrate on one story at a time. If you want to hedge your exposure, there are better strategies than to buy multiple currencies.
6. Stop-Losses are for Wimps: One way to minimize (though not eliminate!) risk is to utilize stop-loss trades. This type of trade is contentious in forex circles, with one side swearing by the stop-loss and the other side mocking it. Day Traders, especially, have been known to point out that errors in forex quotes and broker malfeasance could lead to an unwanted execution of a stop-loss trade. These scenarios, however are extremely rare, and are almost always corrected by the broker. There is something to be said for developing a trading strategy and feeling so confident in it that you don’t feel the need to protect yourself from blips. At the same time, one of these blips could easily wipe out your entire account, especially if you are trading with leverage. Says the FX Instructor: "If our stop gets hit, we will live to trade another day, however if our trade goes hundreds or thousands of pips against us there may be no tomorrow for our trading account." Ultimately, your decision to forgo stop-losses involves an assessment of your comfort with risk, but it seems foolhardy given what’s at stake. Rather than holding out for that elusive giant payday, perhaps it would be wiser to capture a series of smaller profits.
7. Forex is Risk-Free: This myth could easily be dispelled from the examples cited above. Not only is forex not risk-free, but instead, it is among the more risky types of financial speculation. It’s important to remember that there is no long-term value in investing in currencies, unless you include the interest rate spread that is earned on a carry trade. Whereas stocks trend upwards over the long-term, currencies trend sideways, since one currency’s appreciation must necessarily match the depreciation of other currency(s), in accordance with the rule of triangular arbitrage. In short, don’t invest with funds you can’t afford to lose.
8. Trade the News: This is another nuanced myth, since at one time, trading the news was actually quite profitable. According to an excellent summary prepared by the Forex Hound, traders previously capitalized on inside information and/or broker ineptitude, to turn consistent profits from major news events. Either way, it would be nearly impossible for retail traders to gain a competitive edge. In addition, thanks to advances in electronic communication, news is instantly disseminated and priced into the markets, such that it is even more difficult for amateurs to profit. Nonetheless, there remain traders who insist that currencies and other securities move in a predictable manner both before and after an important news story is made public. Caveat Emptor: Trading the news is like trading ups and downs, tantamount to gambling. That doesn’t mean that you should stay out of the market altogether during news releases or even that you shouldn’t factor the news into your trading strategy. Rather, it means that you would be well-advised to not attempt to anticipate how the markets will respond to the news (both before and after it is released), and instead focus on how the overall picture changes as a result.
9. Demo Accounts are a Great Way to Practice: Most forex brokers try to soften the risk of trading by focusing on the demonstration accounts that you can use to hone your technique. While this is theoretically true, it probably isn’t that helpful in practice. Some novice traders are dismayed to spend hours practicing on a demo account only to discover that their strategies fail when they start playing with real money. Basically, it boils down to discipline. When the stakes are low, it’s easy to commit yourself to a particular strategy and lock in fake profits, but professionals can vouch for the difficulty of doing this consistently and fearlessly.
10. Trading Strategies should be Complex: Most brokers include primer courses on the various technical trading strategies, including the indicators useful in identifying short-term trends. Fibonacci Numbers, Bollinger Bands, Elliot wave Theory, Candlestick charting, to name just a few. But does more information really make for better trading. The answer is probably No. Ockham’s Razor suggests that the simplest explanation is usually the best one, an idea that is especially true when applied to currency trading. This is not to say that the technical indicators listed above don’t have any merit when understood and utilized properly. Instead, the idea is that too many indicators and data can ruin any good strategy. If trying to spot a technical trend, consider using two indicators at most. If trading on fundamentals, think about limiting the scope of your analysis to only a couple factors.

In time, you, too, can expect to have your own list of myths. An expert’s advice that proved to be bunk. A trading strategy that never delivers. The idea that there is any "science" involved in currency trading. As you become more adept at navigating the world of forex and become more comfortable with your strategy(s), you will learn how to spot these myths and avoid falling prey to them.