Retail traders outsmart conventional wisdom

There is a common perception (among regulators and policy makers, the press, and some forex professionals) that forex traders in the “retail” category really have no idea what they’re doing.

 Hence, the conventional wisdom goes, they probably should not be trading forex in the first place. But because online market makers like OANDA have opened forex to the general public, these retail traders must be carefully protected from making mistakes.

OANDA’s market data tells a very different story. Retail forex traders are actually much better at trading than people think. For example, in reviewing all retail trades executed during the year 2010, 55% of these trades were closed profitably. Which is really quite amazing. Our clients are far smarter and better at identifying trends than they are given credit for.

Nevertheless, our clients collectively lose money overall. This may seem like a contradiction, but it actually makes sense when you examine their trading behavior. While the retail trader more often than not identifies trends correctly, he or she closes out profitable trades relatively quickly but allows unprofitable trades to run, hoping for a trend reversal. As a result, the losses realized on unprofitable trades tend to be greater than the profits realized on profitable trades.

In other words, the retail trader gets the direction mostly right but fails at risk management. The behavioral pattern of retail traders tends to be the opposite of that of professional traders, who cut losses short but let profits run.

Risk management 101

Fortunately, risk management is a skill that can be taught. Understanding risk management, together with discipline, could well make retail traders profitable overall. One of our primary challenges as a company is to do a better job of educating our clients on effective risk management when trading forex.

We’ve always believed that the more we can do to help our customers trade profitably, the better it is for us as a company—especially in the long term. As a result, we’ve always done things to help clients realize their potential, including (i) no misleading marketing, (ii) limited maximum leverage, (iii) allowing the use of a practice account for as long as needed, and (iv) supporting small accounts and trade sizes without penalty.

It seems to me that other forex brokers can do traders a service by:

• Stop saying that forex trading is easy. On the surface it may be easy, but trading forex profitably is hard—it takes much practice and requires discipline.

• Stop limiting the time a client can use a practice account and stop putting sales pressure on clients to open real accounts. Give customers the time to practice so they can develop their techniques with proper discipline.

• Stop insisting on set minimum deposits to open accounts and set minimum trade sizes. Trading real money is vastly different than trading play (or virtual) money. Allow clients to open accounts with only $10 or $100 and trade as little as a single unit, so they can further develop their techniques.

• Stop offering high leverage. Regulators in some jurisdictions, like the United States and Japan, have rightly reduced the maximum leverage that can be offered to clients. Unfortunately, most brokers still offer 100:1, 200:1 or even 400:1 leverage in jurisdictions that allow it. This is unfortunate because the higher the leverage, the harder it is for traders to be profitable over the long term.