This is the reverse-engineering method to break away from losing trades! (Part 1)

- The truth behind the figure that “about 90% of people lose in FX trading”

Recently, a leading FX company conducted a survey for its clients, and in the first half of 2016 (1-6 months), the percentage of investors who made a profit in FX was30% or less, which, compared to roughly50% in the same period the previous year, indicates a substantial decrease in profitability, according to an article on Nikkei Asian Review’s website.

It is often said in FX trading that “about one-tenth of people win,” but in reality more investors are making profits. However, how much those who lose are losing, and by how much, is known by few, isn’t it?

In Japan, FX brokers must register with the General Incorporated Association Financial Futures Association (hereinafter “the Association”). As of the end of July 2016, the number of registered members was52 firms (※1).52※1).

Those52 firms must report their monthly trading statuses of their clients to the Association, a process called monitoring reporting, and the reported contents are compiled and disclosed on the Association’s website.

Reviewing those materials,2015 year8 month from2016 year7 month, the total confirmed profits and losses for the year amounted to about6,899 billion yen (※2).6,899 billion yen. Of course, there are months with profits, but over the year the total is a loss of this magnitude.

By the way,2015 year5 month to2016 year7 month, for 15 months in total, the loss was about7,183 billion yen. This shows that the average monthly loss during this period was over478 billion yen, which is striking.

- Is FX not suitable as an investment?

If such large amounts are being lost almost every month, one might wonder whether FX is unsuitable as an investment. But that is not the case.

Because FX is a zero-sum game (※3※3), the sum of investors’ profits (+) and losses (−) tends toward zero. Therefore, there are investors who gain approximately the same amount as the losses described above. In other words,from 2015 year7 month to2016 year6 month, the total profits by investors (including corporations) who earned profits are about6,8616,861 billion yen.

Also, the total number of active trading accounts for the year is about2.859 million accounts (※4), so if we take the simplified ratio of 3:7 as mentioned at the beginning, the approximate profit per winning investor (including corporations) per account would be about80 million yen, while the loss per losing investor per account would be about34 million yen. Of course, some investors have near-equal amounts of profit and loss, so those who are winning may be larger, and those who are losing may be larger as well.

From these aspects, if you can join the ranks of those who win, FX can be a very attractive financial product.

- Why FX loses to such a high ratio

Now that the preface is long, this is the main point. If about seven-tenths of all investors lose, why is the loss rate so high?

There are various reasons many individual investors lose, but the leading keyword is probably “cutting losses.” “Cannot cut losses,” “cutting losses late, leading to larger losses,” and “almost all capital is wiped out by stop-out losses after holding on too long”—these are common themes among losing individual investors, who end up overall losing more because losses outweigh profits.

- A method to avoid overall losses: how to set effective stop-losses

So, what kind of trades (stop-loss methods) should one use to avoid overall losses?

There are many courses and products that claim you can become a winning investor by never cutting losses, but in my view you cannot win in trading without cutting losses. Therefore, here I would like to share my personal opinion on what kind of stop-loss approach to use.

First, the meaning of “stop-loss”: it is to lock in losses by taking an opposite trade when a position is in a loss, i.e., turning an unrealized loss into an actual loss.

Many traders who fail to win cannot cut losses, but for space reasons here I will not focus on “how to cut losses” and instead will discuss for those who can cut losses but still cannot win, “what kind of stop-loss strategy leads to winning.”

- “Being able to trade anytime is important”

Before getting into concrete methods, the most important thing in trading is to keep going for a long time. Because if you can stay in a state where you can trade at any time, there will always be opportunities to win. Conversely, not being able to trade when those opportunities arise is the biggest opportunity cost.

Ultimately, I believe in preserving capital rather than chasing large gains; this approach will, in the long run, grow your assets.

Next time, in the middle chapter, I would like to introduce specific figures on how to avoid a large decrease in assets.

※1Source: Association of the Financial Futures Association of Japan materials “OTC FX Monthly Briefing”

※2Source: Association of the Financial Futures Association of Japan materials “Custody Amount Information”

※3A zero-sum game is a game in which the total winnings and losses of all participants sum to zero (±0). Mahjong is also a zero-sum game.

※4Source: Association of the Financial Futures Association of Japan materials “Quarterly Overview”