TRADING FOREX can be profitable, in the short-term in the medium-term and in the long-term.We are going to focus in anyone but hedgers, since this type is in the markets to hedge a position, not to make profit.
Short Term Traders
Some traders will focus on the technicals, order flow and sentiment among other factors.
They will calculate moving averages, care about the volume, RSI, stochastic oscillator… those are chartists, they will try to benefit from short-term moves in the currencies. They are able to gauge if a particular pair is overbought or oversold and profit from that situation.
The more crowded a currency pair is, the harder it is to benefit from this type of practice, since other traders will try to eat your lunch by trying to anticipate the moves, by entering a bit earlier than when the indicator tells them. If more and more traders try to front-run each other, at the end the patterns will not work.
This is why charts work better in currency pairs that are less traded. However, these pairs are less traded due to other dangers such as lack of liquidity or high volatility (normally the combination of the two).
Traders in the currency market use options in order to understand wether a particular pair will go up or down. They use what is known as a risk revesal.
The risk reversal is an option in the currency formed by a long out-of-the-money call and a short-out-of-the-money put. They both have to have 25 delta. (To find out what delta is check investopedia, its a great resource!).
This risk reversals are priced in term of their implied volatility spread between the 25 delta call and the put. When the number is positive it means that market participants are willing to pay more to insure themselves against a high appreciation of the currency than against a large depreciation.
Medium Term Traders
Some focus on “arbitraging” what are thought to be market inefficiencies.
For example, those participants that perform what is known as the carry trade.
The carry-trade can be performed when the participant borrows in a currency in which the interest rate is low to invest in another one in which the interest rate is high. If the pair does not adjust (the currency that offers the higher interest rate does not depreciate against the one that offers the lower i.r.) then a profit can be made.
This is not pure arbitrage since the risk exists of a major devaluation of the high interest currency. The distribution of the returns from the carry trade shows why this trade exists.
Those market participants that perform the carry trade and get small excess returns are taking the risk of the higher than normal probability of a high loss. The graph of their returns is clearly skewed to the left. The fundamental reason why the carry trade occurs is a different story.
Long Term Traders
Some traders focus on fundamentals
There are many participants that want to take advantage of the fundamental inefficiencies that the markets display in the short and middle terms in order to make a profit.
This people have excess liquidity and can have their capital tied to the markets a long period. This type of traders would have bought USD against the EUR and against the JPY when there was sufficient cause to believe that their monetary policies were going to diverge. They see that the U.S. is turning hawkish while Japan and Europe are turning dovish, they understand that the currencies need to move accordingly. They won’t care about the volatility between the pairs while the move takes place.
Normally, if you are an average investor you are going to need leverage. FOREX is not as volatile as the stock market so you need to capitalise on your views by borrowing money from your broker. Just to picture the idea of how much they move: The move in currencies are measured in pips, a pip is (for most major pairs) 1/100th of 1%…
So yes, it is possible to be profitable in the FOREX market, not easy, but possible!
Indeed there are some people that are making huge gains in the Forex market, however there are also a lot of people that lose a lot of money in this industry. The most important factor in my opinion, if you want to trade Forex for a living, is to actually learn about Forex and know what you are doing.
Forex isn’t anything about gambling or luck, yes you need a percentage of luck like in any other aspect in life, but if you want to make money don’t put everything on luck, put it on your knowledge.
Learn every aspect of Forex trading before you put huge money into it.