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Currency Trading: How to Be Quickly Parted from Your Money

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Regarding currency trading, you may have recently seen or heard a commercial such as this one which we found highly reminiscent of the brokerage commercials that aired during the 1990s portraying fictitious aggressive traders who had struck it rich through their on-line trading and now could do outrageous things like purchasing their own island. A recent column from the Wall Street Journal’s Jason Zweig included some numbers that we found to be highly interesting. Quoting a study of social networks and active investing conducted by an economist at the Federal Reserve Bank of Cleveland (Rawley Heimer), based on an analysis of over 110,000 transactions, individual “forex” traders lose an average of 3% a week. For one week, that is an astonishingly high number, and definitely lines up with the recent disclosure by the National Futures Association that 72% of individual forex accounts were unprofitable and that the average life of an account was only four months. As for the size of this market, Javier Paz, a senior analyst at the Aite Group, estimates that individual forex traders in the U.S. generated about $12.6 billion in average daily volume in 2013 compared to $10.7 billion in 2012.

So how do the forex brokers keep finding a never-ending supply of suckers? We believe the answer lies in the 20% standard deviation around the -3% average weekly return. This high standard deviation implies that for every 20 weeks of trading, 9 will be profitable and 11 unprofitable. Since we humans have a strong tendency to remember our successes which we attribute to skill while forgetting our failures which we dismiss as the result of bad luck, it is easy to see how aspiring currency speculators/gamblers can become fooled by randomness into thinking that they can somehow beat the system. Of course, they are forgetting to ask the crucial question, "Who is on the other side of my trades?" As Zweig points out, "In forex, it's probably an institutional trader at a giant global bank. In stocks, it could be a computerized high-frequency trader, a hedge fund or a mutual fund. In options, it's often a market maker or other professional trader. You might know more than any of these people (or machines), but you probably don't. "Zweig left out the newest of the sucker's games—Bitcoin trading. Earlier this year, the largest of the Bitcoin exchanges, Tokyo-based Mt. Gox shut down after declaring that 850,000 bitcoins had disappeared. All of its U.S. assets were seized by the Department of Homeland Security. To date, 200,000 of them have been recovered, but the current value of the remaining 650,000 missing bitcoins is about $246.5 million (based on a 10/18/14 bitcoin value of $379.22.

For people who hold the view that the US dollar will inevitably depreciate, we just love Zweig's suggestion that instead of opening a forex account, they should go take a European vacation where they can extract the maximum value from their dollars while they are still strong. If not that, then just buy an international equity index fund where the expected return is actually positive. If you would like to learn more about how Index Fund Advisors has been replacing speculation with education for over fifteen years, please give us a call at 888-643-3133.