The cruel reality of trading the Forex market is that nearly ninety percent of traders are losing their first deposit within the first six months. Furthermore, the ones that do not lose their initial investment, are subject to increased volatility in the trading account and are bound to see significant drawdown levels.
Why is Forex trading still so popular? What makes investors decide to trade currencies when chances are against them?
Before continuing, it should be mentioned that retail trading is only a small part of the overall Forex market. To be more exact, retail trading makes up around only five percent (5%!!!) of the market.
Even though the number of retail traders is a small part of the Forex market, the number of people joining the trading arena is on a constant rise. There are multiple reasons for this, starting from aggressive advertising (have you noticed that Forex brokers are sponsoring main sporting events that address men between 18 and 60+, like soccer, racing, etc.) and ending with the increased high speed internet coverage throughout the developed world. As the trend continues, the number of people being drawn to Forex trading will only increase.
The market is subject to many swings and the daily market changes require traders to invest, not only money but also time in order to be successful. This make the whole trading experience a challenging environment for most beginning traders who do not devote enough time to research and learning. The status quo matters as well, in the sense that trading the markets seems something that few people understand; it provides the aura of doing something exotic for a living. Not to mention, the possibility of making a profit. Those who make it in the Forex market enjoy a privileged status from a reputation point of view.
To have an idea about the adverse forces in the market, one should look at who is on the other side of the trade. If retail trading is only five percent of the overall market, what makes up the other ninety-five percent?
Beating the Odds
To start with, the interbank market is the ground play for the game of speculation. Those that buy or sell a currency against the other are doing that in the interbank market.
The ECN (Electronic Communication Network) brokers, the true ones, are offering the possibility to take a look at the Level 2 market participants. That is, to spot who is the one on the other side of the trade.
You’ll be surprised to find out that other Forex brokers are listed, as well as commercial and central banks, investing houses, hedge funds, money managers, liquidity providers, etc. There is a saying that when someone buys, somebody else sells, and therefore there is always a counterpart to every trade.
Depending on the way the brokerage house is organized, Forex brokers are the best example of contrarian trading. Most of them take the other side of their customers’ trades! In a way, it is logical to do that. If the percentages mentioned at the start of this article are true, then the broker, by being a contrarian, stands more chances to win than the actual trader.
In this case, contrarian trading works like a charm. Brokers that are market makers or a mix between ECN and STP (Straight Through Processing), are routing some or all of their trades to liquidity providers for execution.
In doing this, they keep all or some of their customer’s trades in house and take the opposite side of those trades. There are trading departments built especially for this, and we can safely say that contrarian trading is a successful endeavor at least when it comes to Forex brokers.
Believe it or not, central banks are big players in the Forex market. Not only do they set up the monetary policy for the period to come, but they are actively involved in pursuing that policy.
For example, now that unconventional measures are the norm in the Forex market, some central banks are ending up buying U.S. equities (it is known that one of the biggest buyers of the U.S. equity indexes lately has been the SNB – Swiss National Bank), other central banks buy their own equity index via ETF traded funds (BOJ – Bank of Japan – owns around thirty percent of the whole Japanese equity market), and the list can go on.
In this case, trading against the monetary policy set by the central banks is not wise as contrarian trading will not bear fruit. Correlations being as they are, higher equities attract higher USDJPY and just like that, the link between the Forex market and the stock market is made.
Such factors may end up offering greater chances to profit when the market is in so-called overbought or oversold territory if contrarian trading is applied. Namely, instead of buying in oversold and selling in overbought territory, why not do exactly the opposite?
If central banks and brokers are taking the other side of the trades, then it is only wise for traders to start thinking outside the box and use the contrarian trading principle in their favor.