Quantpicker

Why trading FOREX might not be the best idea

Thursday, 13 August 2015

Many novice traders are lured by FOREX and CFD trading platforms. One of the main perceived advantages of FOREX-only brokers is low amount required to establish an account. Yet from the point of view of professional investor, FOREX market is probably the hardest to trade. Novice investors stay away from stocks which they see as dangerous or too difficult to trade because there are so many of them. Who could possibly be able to choose "correct" stocks from the entire sea?

Yet the reality is quite the opposite to what I have described. FOREX accounts which allow leverage in hundreds of percentage points are doomed to failure sooner or later. Put quite simply, if you use small account size and high leverage, you are doomed to trade short-term. This leads to falure sooner or later if you are not a rare exception.

I realized this while talking to a client I am consulting for. If you look at the performance of all the basic asset classes - equities, bonds, commodities and currencies, you can see a big picture. Stocks have risen for centuries - around 70% of the time and 30% have been in the bear market. Stocks will usually rise when the economy does well. There is no upper limit to where the stocks can rise.

Bonds are a nice complement to a stock portfolio. Mostly in history they have been negatively correlated to stocks, at the same time offering positive performance. A lot has been written about the possible end of a bond bull market which I am not arguing against. We will probably see mediocre performance in bonds for the upcoming decade. 

Commodities have been mostly flat, if you take into account storage costs and account for futures rolling costs correctly.

It is hard to see such a long-term trends in currencies, as we have seen in stocks. Currencies are a relative measure and express purchasing power of one country in terms of another. Thus, if the entire world rises, currencies will tend to fluctuate and correct the discrepancies among countries, but you will rarely see a long-term trend in them. Also, they are not a great component to a stock-based portfolio, as currencies tend to plummet at the exact same time the stocks do.

Thus, if I were an aspiring investor, I would look into stock investing first, especially factor investing.