What to Consider When Choosing a Forex Broker – Part 2
In our first article, we discussed the importance of using a Forex broker that is regulated in the jurisdiction of your home country, and how the release and adoption of the FX Global Code will create even greater confidence among retail traders new to the Forex market.
I also said that beginning traders want to know that “Their Money is Enough”… namely, that when a person decides to start trading Forex, they want to know that they can start right away and they don’t have to be wealthy to begin. Now, in Part 2, we are going to discuss a concern held by many traders — whether “‘Their Money is Enough” to get started trading Forex.
When new traders begin to think about entering the Forex market, they also think, “How much could I earn, and how quickly?” This is natural, understandable, and even reasonable. But, I want to suggest that it should not be the first concern of any Forex trader, especially a new one.
The world’s Second Richest Man, Warren Buffett famously said: “Rule No. 1: Never lose money. Rule No. 2: Remember Rule No. 1.” In Forex trading, you will have losing trades. Lots of them. So, when we talk about ‘never losing money,’ we’re talking about not losing money on a “net basis,” i.e., anything from (a) making it a goal to have a net winning day, week, or month, to (z) simply not blowing up your account. In other words, however you define your time frame for tolerating losses, let’s consider focusing on Warren Buffett’s Rule Number One before we think about “how much could I earn and how fast.”
Let me give you a couple of examples of how this can work in real life:
Suppose you believe you can earn 5% return per month for five years. Great! If you successfully invested $1,000 at this rate of return, and compounded your investment returns each month, at the end of five years, you’d have a little over $47,000 gross return on investment. Yet, we know that “return on investment” and “risk” are correlated; in other words, to obtain greater returns, we generally need to take greater risks. Thus, let’s say that in order to obtain these returns, you’re willing to risk 5% of your trading capital on each trade and the average ratio of “risked pips” to “reward pips” is 1:1. (Let’s call this 1R.) In this scenario, if you win 50% of your trades, your risk of completely blowing up your account is 100%. In other words, you are guaranteed to go broke!
However, suppose that instead of thinking first about rate of return, we instead think about risk management (Remember Rule Number One!). This time, you decide that you’re willing to risk 5% of your trading capital on each trade and the average ratio of “‘risked pips” to “reward pips” is 1:2. (Let’s call this 2R.). In this scenario, if you win 50% of your trades, your risk of completely blowing up your account is 0.0066%. That’s sixty-six ten-thousandths of one percent. Amazingly, if you take the risk-to-reward ratio recommended by MTI (1:3, or 3R), even when you retain your “risk per trade” at 5%, if you win 50% of your trades, your risk of ruin is a mere 0.0005%. That’s five ten-thousandths of one percent. You are virtually certain not to completely fail!
Now, this shift of focus — from “investment return” to “risk management” is EXTREMELY difficult — but it also has the potential to be LIFE-CHANGING. It is extremely difficult for at least two reasons:
First, when we experience winning trades, the healthy human brain emits dopamine — a neurotransmitter associated with the “pleasure center” of the brain. A winning trade is a success! We’re in this business to succeed, and our bodies know it. BUT, high levels of dopamine can encourage us to take greater risks. Said another way: when we win, we often forget about the risk of loss. Practically, this can happen when we have a winning 3R trade and we might be enticed to “keep up the streak”’ and take a 1R trade (thus, increasing our risk of ruin!).
Second, when we have open trades that are going against us, we may get stressed out! When we get stressed out — physically or psychologically — our bodies produce the hormone cortisol, and this is especially true when we are stressed because we experience something new, uncertain, or threatening. As it turns out, high levels of cortisol encourage us to take greater risks. Said another way: when we lose, we often forget about the risk of loss. Practically, this means when we have a losing 3R trade, we might be enticed to take a 1R trade to ‘make up the loss’ (thus, increasing our risk of ruin!).
In summary: whether the beginning trader has a winning trade or a losing trade, their bodies can sabotage their commitment to selecting trades that represent “good risk,” thus impairing their ability to be successful in the long-term and increasing the likelihood that they forget Buffett’s Rule Number One: Never lose money. And that is one of the main reasons why remaining focused on risk management, as a trader, is extremely difficult. But it is necessary.
Yet, focusing on managing risk (Rule No. 1) can be life-changing! Another way of characterizing a focus on risk management is to speak in terms of “trade selection.” For the Forex trader, effectively incorporating Buffett’s Rule Number One into our trading means focusing on trade selection: only taking trades that have a high reward-to-risk ratio. Let me give you a couple of examples of how this works out in practice.
Take a look at my Forex mentor: FX Pathfinder, aka Josh Martinez, and the results he’s achieved here:
Josh’s results are Josh’s results and reciting them here doesn’t imply they’ll be your results. However, as you can see in the chart, Josh has achieved 6915 pips in 3.5 months. So, let’s assume you only achieved 50% of the results he has achieved, consistently over the course of five years. Let’s say you started with $5,000 and an average trade size of three micro-lots (at about $0.10 per micro-lot, that’d be about $0.30 per pip). Then, let’s assume that you only increased your average trade size by one micro-lot each year (Year One: 3 micro-lots, Year Two: 4 micro-lots, etc). At the end of Year Five, you’d have over $29,000 in gross trading profits!
Or, take a look at another one of my forex inspirations: FX BigDog, aka Gary Fichardt, and the results he’s achieved here:
Gary’s results are Gary’s results and reciting them here doesn’t imply they’ll be your results. However, as the chart shows, Gary has achieved 19,795 pips in 6 months. So, let’s assume you only achieved 50% of the results he has achieved, consistently over the course of five years. If we assume you started with $5,000 and an average trade size of three micro-lots (at about $0.10 per micro-lot, that’d be about $0.30 per pip). Then, let’s assume that you only increased your average trade size by one micro-lot each year (Year One: 3 micro-lots, Year Two: 4 micro-lots, etc), at the end of Year Five, you’d have over $54,000 in gross trading profits.
Now, neither of these examples are intended to imply that you will achieve exactly these results, nor are they intended to suggest that you will achieve these nominal trading gains. Rather, they are meant to provide two illustrations of how starting small ($5,000 account trading with 3 micro-lots), when applied consistently with the strategic edge articulated in these two courses, provides an example that you can make significant gains.
The Bottom Line
Forex trading is not a get-rich-quick scheme — but neither is it only for “rich people.” Diligent traders committed to their training, personal growth, and learning the skills of trading can extract significant capital from the markets, even though they have started with little. It has been said that the best time to plant a tree is 20 years ago. The second best time to plant a tree is right now! Even if you begin with significantly less than the amount in my examples, if you’re reading this blog, I believe your money is enough to start today.
Next up in this series, we’ll discuss the #3 concern traders have, that Their Business Matters.
ABOUT THE AUTHOR: Originally from Huntington Beach, California, Rick Quinn started his trading career in the early 1990s, primarily in stocks and options. After a brief stint with a large investment management firm during the “Dot Com Bust”, he worked as a securities lawyer in Washington, D.C., in securities enforcement at FINRA, and for several years in private practice focusing on U.S. federal regulatory law. Since marrying his amazing wife Charissa, and relocating to the Gold Coast of Australia, he trades Forex full-time.