By SARAH MORGAN
Retail investors have> gotten increasingly interested in trading foreign currency, but until now, there's been no way to see how well they're succeeding. New disclosures are required to reveal the success and there's not much of it.
SmartMoney.com examined the recent disclosures of the four biggest retail forex brokerages, representing 95,000 accounts and the majority of the retail forex universe: Of the 16 firms registered with the National Futures Association, only five have more than 10,000 accounts. In the fourth quarter of 2010, only 33,000 accounts at the four firms examined made money 35% of the total. The results vary widely: Oanda, one of the five biggest brokerages, had the highest winning percentage, with 43% of its 48,866 accounts making money. FXCM had the lowest, with 23% of its 18,000 investors making money.
Oanda suggested its customers may be more successful for a number of reasons: The brokerage pays interest on account balances, it charges no inactivity fees, it believes its spreads are tighter. But they don't really know, says CEO Michael Stumm: "Maybe we just have better traders."
FXCM spokeswoman Jacyln Sales said: "Until recently, the calculation methods used weren't uniform and FXCM used a more conservative method than others. We think next quarter's numbers will be more reflective of the truer picture."
This information has only recently become available, as part of financial reform legislation passed in July. Each quarter, dealers must disclose how many retail accounts they have, and how many of those accounts are profitable. (That information has been added to each firm's risk disclosure statement; see an annotated version of one of those documents.) The regulations also limited how much leverage customers can access: The industry used to commonly allow retail customers to leverage themselves as much as 200-to-1; the new limit is 50-to-1.
Critics say the low success rates prove that individual traders are at a huge disadvantage in a round-the-clock, volatile currency markets. Currency "trades 24 hours a day, 7 days a week, and most people sleep," says Mike Savage, founder of East Stroudsburg, Penn.-based Savage Financial Group. The market's also characterized by small, rapid price movements, and even if an individual trader were able to move fast enough to keep up, when transaction costs are taken into account, "the math just doesn't make sense," says Oliver Pursche, the president of Gary Goldberg Financial Services. "It's probably not much different than sitting down at the blackjack table in Atlantic City or Vegas and expecting to beat the house."
Forex firms say the success rates for retail traders are comparable to active traders in other markets. The returns of stock traders have not been studied in recent years, but a small body of older research seems to support that argument. One 2003 study found that only about 20% of day traders were "more than marginally profitable," and almost twice as many day traders lost money as made it. Another study, in 2004, focused on active traders in Taiwan, and found that 80% lost money. Some very active traders appeared to execute successful trades, but very few were sophisticated enough to make a net profit after transaction costs were taken into account.
The Taiwan study identified a small group of equity day traders who consistently made money, and that's essentially how retail forex firms describe their customer base. "There is a segment that has really figured out how to trade and be successful," says Todd Crosland, the CEO of Interbank FX, where 28% of 13,669 accounts were profitable in the fourth quarter. About 25% of their customers stay with the firm for seven years or longer, Crosland says.
Many individual traders are drawn to volatile markets, but they can be difficult to navigate, acknowledges Stumm: "When you get strong winds, sailing becomes a lot more fun. But it can become dangerous very quickly," Stumm says.
Of course, choosing a dealer with a higher percentage of profitable accounts doesn't guarantee success. But aspiring traders can make other moves to limit losses, like taking advantage of the educational materials and demo or practice accounts that most dealers offer. At Interbank FX, clients who practice -- either through a practice account or by making very small trades -- appear to be more profitable when they up their stakes, Crosland says.
Traders can also watch out for common pitfalls that can deepen losses, such as holding on to losing positions for too long. For example, in 2010, Oanda's clients exited 55% of their positions profitably, but many still lost money overall: They held losing positions for too long, and exited winning positions too quickly, Stumm says, with deeper losses as a result.
Another way to stem losses is to limit the amount of leverage you take on. As dealers' risk disclosure statements note, trading with borrowed money means that you could lose more money than you started with, which means you'd end up having to pay the brokerage for the privilege of your ill-timed investments.