Over the past several years, the popularity of online
currency trading has grown substantially.
Each day, online ForexGen attract new investors -
each of them lining up with a glint in their eye, lured in by promises of easy
money. Most of these companies allow you to sign up for a free demo account
which lets you place mock trades using their trading platform to get a feel for
the excitement of currency trading. In the casual world of free demo accounts -
many young traders find they are able to garner impressive profits without a
significant amount of effort. It almost seems too good to be true. But
transferring this success from a demo account to a real account is far less
common. Why is this? The actual trading platform behaves the exact same way,
the market doesn't care whether you're a demo or real trader - so what is
different? It's you who has changed. Not your personality, not even your
trading style - but the factors that affect you are different.
What is the key factor to trading success?
The search for the "Holy Grail" of trading has
been a common theme throughout the history of markets. There are a variety of
different techniques. Those whom are inclined towards number crunching and
pattern recognition may prefer technical analysis, whereas those more focused
on the big picture, logical macro perspective prefer fundamental analysis. Then
there are specific methodologies like swing trading, trend following or even
more esoteric ideas like the Elliot Wave theory. Which one is best? There are
examples of very successful traders using each methodology.
Since most new traders lose money - perhaps the more
appropriate question to ask is, "What is the key factor to trading
failure?"
Greed and Fear
Trading is an atmosphere rich in the porous emotions of
greed and fear. The current price of a given security or financial instrument
at any point in time can be thought of as the confluence of greed (bulls) and
fear (bears). These two emotions make up the core of humanity itself. When
market information is released, trading can be a high intensity experience.
Sensing danger, your body releases adrenaline that acts to accentuate both your
greed (fight) and your fear (flight). Because these emotions are so strong,
they can cause you to act irrationally, ignore your system, stated set of rules
or trading plan and to act upon impulse. Indeed, this is a genetically
programmed response - but it is often also the trader's downfall, especially
when he's playing with much better capitalized, more sophisticated and
experienced foes that know how to manipulate those emotions.
When you are a trader - you are always under the influence
of at least one of these two emotions, even if you don't have any trades on.
Impact of fear and greed on your trading
If the market's going up and you're in - greed is telling
you to buy more and fear is telling you to take your profits while you still
can. If it's going down, fear of being wrong makes you hold onto a losing
position - and then greed sometimes convinces you to "average down"
your position (and buy more) so it'll be easier for you to come back.
If the market's going up and you're not invested - fear is
telling you that you're missing out on easy money but it's your greed that
causes you to get in just after the greatest increase (just when its about to
reverse course). If the market's going down and you're not invested - greed is
telling you to get in as the price is cheap, while fear reminds you that you'll
miss out on this opportunity if you don't act quickly.
Perhaps if we just felt greed, or just felt fear we would be
able to control our emotions a little better. But when both of these little
devils whisper into our ears at the same time - it is often impossible not to
listen.
The Thrill of Greed
The first time you try FX trading - you will feel the thrill
of greed. It is an ecstatic experience, your brain flush with neurotransmitters
and your mind giddy with visions of untold riches about to be reaped. Greed is
bold, aggressive and incredibly exciting. It can take hold of you both mentally
and physically. Just imagine the possibilities!
This greed is what draws us into FX trading in the first
place - the dream of easy money and 100:1 or 200:1 margin rates. It inspires us
and causes us to forego rational thinking in favour of reckless abandon.
In the movie Wall Street, Gordon Gecko says, "Greed is
good", but it is also very dangerous - especially if you are unable to
recognize when greed is the one doing the talking. Greed is also one of the
most common techniques used to manipulate people. Every get rich quick scheme,
promising untold riches for no money down takes advantage of your natural
predisposition to throw all logic and sense out the window when greed pays a
visit. The argument starts to appear very compelling and you ignore what would
otherwise be clear warning signs. Like drunk goggles, greed can mislead you and
when you eventually wake up you are often in a very precarious position.
The Fear of Losing
Fear can be equally as dangerous. The most potent and easily
manipulated form of fear is your fear of admitting that you are wrong. Fear of
having your precious ego bruised. This fear can cause people to do incredibly
stupid things. The funny thing about this world is that everyone thinks that
they are right. Most people would rather lose thousands of dollars than admit
they are wrong. It is easy to feel ashamed of trading losses and live in denial
but this is self-destructive behaviour. By denying the problem exists, you fail
to take steps address it and only ensure that it will continue in the future.
Demo Trading
Demo trading is a great way to get started in foreign
exchange trading. It is identical to real trading, except that you're using
"pretend" money. Demo trading allows you to get a taste for what type
of events move markets and how they move. It encourages you to learn more about
geopolitics, macroeconomics and global finance and these are all incredibly
positive things.
Demo trading also introduces you to the rapture of greed.
Trading is a means to one of the purest, most raw and potent forms of greed.
The whole point of trading is to make money and the more money you make - the
stronger the pull of your greed becomes. It is intoxicating and can take
complete control of you.
But demo trading does not introduce you to fear. There is no
fear when you are demo trading. It is like you have a perpetual get out of jail
free card. If you start losing badly on a demo account - simply start a new
one. There is no accountability for your trading failures and only recognition
of your trading success.
So your demo account does not teach you how to handle the
emotion of fear. This emotion is most likely going to lead to your downfall.
Greed may get you overextended, but fear will stop you from cutting your
losses. You may think that fear of losing money would cause you to cut your
losses, but the stronger emotion is fear of being wrong and that causes you to
hold on to your losing position - until it's all gone.
There is also the issue of account size. Many demo accounts
give you $50,000 to play with. This type of capitalization allows you to buy 5
lots (500K) of EURUSD pretty easily. If goes up 20 pips you've made $1000. Nice
one. But when you open your real account - it's more likely that you put $5000
or $10000 in there to begin with. Now you're dealing with a 50K lot, which
means you'll take $100 out of a 20-pip movement. But mentally you are used to
getting $1000 for that movement so you usually end up risking more. Next thing
you know - your 200K position has turned against you 50 pips and you've lost
$1000. That's real money you just lost. You can't just start another account.
The capitalization of the demo account is sufficient to
sustain losses and still come out on top. But your real account is likely to be
undercapitalized and if you're trying to achieve returns similar to what you
got on your demo account - you are going to blow up very quickly.
Being honest with yourself
Ultimately, while providing an excellent introduction to FX
trading - demo accounts do not accurately predict whether you'll be successful
trading real money. Markets are dominated by psychology and often go against
what fundamental logic or technical indicators suggest should happen. The
single most critical factor in your trading success will be your ability to
control your emotions of greed and fear. These emotions cloud your judgment and
cause you to trade recklessly. Demo accounts introduce you to the emotion of
greed, but by their very nature they are risk free and therefore there is no
fear involved. They are also likely to be better capitalized than your real
money account, which misleads you with respect to the amount of returns you can
expect to earn.
For all of these reasons, demo accounts allow you to avoid
being honest with yourself and this is perhaps the most important factor of
all. You need to know your edge and your limits and in order to know these -
you must be honest with yourself.
This being said, demo accounts are still very entertaining
and educational and I highly recommend opening one to anyone who's interested
in getting a taste of the exciting world of FX trading. It's a great way to
learn more about economics, global politics and yourself.
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