What you trade matters

Thursday, Apr 28 I will be answering options questions: live via Twitterfeed. 1:30 PM ET. Submit questions to #smartoptions


Traders love to tell people that they can trade anything. That if you have the skills to be a trader, the specific item traded is unimportant. That may be true for some professional traders who are skilled technicians. However, it’s very different for gullible amateurs.

Consider the following (excerpts) by Nathaniel Popper from the Los Angeles Times. It describes how easy it is to find suckers when using hype to trap the unwary.

Foreign currency trading is easy — an easy way to lose money
More and more Americans are dabbling in currency trading and losing in spectacular fashion. Experts say the structure of the currency market makes it hard for amateurs to beat the house.

D.O. began trading foreign currencies after seeing a TV commercial touting it as a way to make extra money…

“The ads made me think, ‘This is easy,'” said the 52 year-old administrator with a Texas, police department.

She used her credit card to fund an account with an online currency broker. Within a few weeks of swapping dollars for yen and euros, she said, her $3,000 of borrowed money was gone.

She made two mistakes: investing on credit and trying to make a buck by predicting changes in currency exchange rates, something best left to professionals, according to personal finance experts. But she has plenty of company.

An estimated 615,000 Americans are dabbling in foreign currency trading, encouraged by advertising from the two biggest U.S. brokers, FXCM Inc. and Gain Capital Holdings Inc., both based in New York.

These customers are losing money in spectacular fashion.

At FXCM, 75% to 77% of customers lost money each quarter last year. At Gain, the number of unprofitable customers hovered between 72% and 79% every quarter last year.

As if those statistics weren’t scary enough, the rules of currency trading allow 50 to 1 leverage.

The losses have triggered recent lawsuits and regulatory scrutiny — but haven’t stopped the swift growth of the industry, which barely existed a decade ago. Gain and FXCM went public on the New York Stock Exchange last December.

Executives with both firms say that they simply provide a conduit for people who want to trade currency, and that customers are given full disclosure of the risk. [MDW: If you believe this, you are as gullible as their customers]

“The majority of people today are not doing well,” said FXCM’s chief executive. “There’s lots of education: ‘Here’s how to do it right.’ … Do most people heed the advice? No, of course not.”

It’s a bit ludicrous to suggest that the novice can ‘Do it right.’ For individual traders, forex represents gambling and speculation, and it’s the strongest reason that I have for recommending options as a trading vehicle.

Options allow the trader to measure risk (using the greeks). They allow the trader to understand reward and loss potential. The vast majority of traders have a basic understanding of how a stock market works. That cannot be said for the currency markets.

I have a (biased) opinion that options afford risk management techniques simply not available with stocks, futures, currencies, bonds…The ability to measure and manage risk represents a huge difference between trading options and other stuff. However, when opitons are used for speculation, those advantages disappear.

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2 Responses to What you trade matters

  1. Robert 04/26/2011 at 12:58 PM #

    Mark,

    Those statistics are truly staggering. Last year I read an introductory book about forex trading, and although it was well-written, I was astonished at how much information a person would have to know merely to understand how these markets work. It’s really sad to hear about so many people losing money because they just didn’t know better.

    I’m intrigued by the last sentence in your post. Could you give an example of the kind of speculative play you’re referring to? Wouldn’t many people consider a short-term iron condor, for example, to be a speculative play?

    Thanks much,
    Robert

    • Mark D Wolfinger 04/26/2011 at 1:52 PM #

      Robert,

      There’s a sucker born every minute.
      I hate that the trading industry loves to take advantage of them.

      I’m truly a lost soul. Looking for honesty and integrity in a world that has no use for either.

      By my definition, speculation is the making of a trade that is known to be especially risky because the potential payoff is so large. That includes buying a lottery ticket or buying a boatload of $0.10 calls/puts and hoping something spectacular happens. I don’t consider buying individual stocks or trading iron condors to be speculations. All stock market investments include risk – but when the reward is commensurate with the risk; when the reward is earned with sufficient frequency that the investor has a reasonable chance to profit – to me that is investing. It may fall under the gambling umbrella, but it is not speculation.

      As I said: those are how I use the terms.