Differences between Forex and Gambling [Main Reasons why it's not gambling]
Looking up various websites about Forex for beginners, a lot of novice traders might ask themselves if it is even real to make that much money while trading on Forex? So they start to consider Forex as gambling at some point. In this blog post, we will explain all the differences between these two.
Why do some people still consider Forex as Gambling?
We can assume that the principle behind Forex trades is similar to betting in a casino: you are betting on some assumption you have made. For example, you open a trade (USD/EUR) because you assume that the dollar will rise and the euro will fall. And wait to see if it finally happens or not. That is basically the only similarity we can find between those two.
Also, another reason why people think Forex is gambling is that when people start trading Forex, their main goal is to gain as much money as possible. This leads to greed. And as we said about it in one of our blog posts (LINK) greed is one of the main enemies of traders. They make quick decisions, without calculating all the possible outcomes. Forex trading is mainly about calculating and building your own strategies. This is the main reason why people compare Forex to Gambling.
Another thing is that there are gambling traders, who treat Forex as a casino and open deals guided by intuition, luck or chance. But this is a personal decision of everyone.
Read more about the differences between Forex and Gambling on Is Forex Trading Haram?
Main Reasons why Forex is NOT Gambling
Some people say that trading is a game of chance, this is an unclear statement that makes no sense, because, by definition, gambling is when its outcome does not depend on the skill or ability of the players, but exclusively on luck, while the result in trading, depend on the skills, abilities, discipline and strategies that a trader has.
Of course, when you start a trade no one knows where the price will go, but there are many tools that help determine the trend and narrow down the range of results.
Fundamental analysis helps determine the nature of price fluctuations, while technical analysis reveals price ranges, the boundaries of which are support and resistance levels.
By learning all the tools, a trader can protect his or her deposit and avoid bankruptcy. Meanwhile, when playing roulette one can only count on luck.
If you compare the results of several traders, you can see that they are different from each other. In contrast, the monthly results of a consistent trader over two years show similar results over the course of the months, which is consistent with the fact that these are directly related to the skill, ability and discipline of the trader.
There are many differences between gambling and trading, one of the most important is that a professional trader finds a statistical advantage over the market, a situation that is unlikely to be achieved in gambling.
If we go to more technical comparisons, we also find differences. For example, the probability of success in a gambling game depends on the number of possible results that it might have, while the probability of the success of a professional trader depends on the statistical effectiveness of the trading strategy that a trader is using.
Generally, gambling games are designed to have a relationship between the probability of success and the profit/loss ratio, which statistically ensures profits for the casino and of course losses for the player in the long run. An example of this is American roulette, which gives a hit probability on a full number of only 2.63% and has an attractive ratio of 36 to 1. If we take this ratio to the long term, statistically the casino will have the advantage, as it is a game with a positive mathematical expectation for the casino and a negative one for the player.
A trader who has the skills and abilities to beat the market, and who has a trading system that gives him a statistical advantage, can achieve consistently good results.
Guide to Managing Risk in Forex
Risk management for trading in any financial market such as Forex is one of the keys for any trader who wishes to be successful in the long term.
Risk management along with money management and a good trading strategy are the three pillars on which any successful trading strategy is built, which every experienced trader should know very well.
Let's start by explaining what risk management even means?
Risk management is the part of the strategy that specifies position size, leverage size and Stop loss and take profit levels. Good money management is a vital part of successful long-term trading.
One of the most important rules in trading is not to risk more than you can lose. However, many novice traders make the mistake of investing much more than is advisable.
A trader can have an excellent trading strategy and still end up losing money if they don't employ proper risk management.
The lack of experience is possibly the main reason why novice traders lose capital in Forex trading. Being diligent with your risk and money management principles will increase your success as a trader and decrease your risk.
Basically, risk management is a combination of multiple ideas that serve to control risk in trading and include the following principles:
- Define lot sizes
- Trade at the time of the day with the major volume
- Decide in advance where to position your stop loss and profit.
Why is it so important to control risk in trading?
Risk management is one of the key concepts that every trader must apply if he wants to survive in the market. It is an easy concept for most traders to learn, although it is not always easy to apply.
In the trading industry, brokers like to advertise the benefits of leverage and rarely mention clearly the potential losses a trader can suffer if he misuses leverage.
A very effective form of risk management is loss control. Every trader should know when to cut his losses on any trade. In this case, the trader can use a stop-loss order which the broker's trading platform will automatically execute. Thus limiting his losses.
It is also important to use the right lot size for your account. A trader who wants to survive and be profitable in the long term must control very well the size of the lots he trades with, especially if his account has few funds.
5 Trading Risk Management Tips
If analysing the market is important, maintaining proper risk management is just as important, if not even more important. Risk management in the Forex Market can be easier to follow, because of the numerous tools and instruments that you can use to help keep your trading losses in check while maximising your profits.
This is the standard method of limiting losses. A properly placed stop-loss generally reacts faster than a trader would manually. This makes stop losses a great risk management tool.
Every trade is different, so it is necessary to choose the right stop loss level depending on the volatility of the price that day. If the price is not very volatile you can adjust it more, and if the price is more volatile you should extend your stop a little.
First of all, you must define the percentage of risk you want to take on each trade. Generally, it should be between 1-3%. This means that if we have a 10.000$ account and we set the risk per trade at 1%, our stop loss will assume a maximum loss per trade of 100$.
The risk/reward ratio is a ratio that is used in trading to measure the amount of risk you have to take in order to receive a reward.
The risk would be the price where you would apply your stop loss, and the reward would be where you would place profit.
When using this form of risk management, there is no cheating involved. This is very easy, you can place your stop wherever you want, and also your profit target.
You have to be realistic, and decide where you would actually exist, and what is the most likely target to take profit. Not the one you would like, but the one the chart is telling you.
If you see an entry where the stop loss is too far away and the price is unlikely to travel that distance to make the same proportion of profit, you should discard that trade outright.
The breakeven point, or moving a stop loss to a break-even point. This is a protection technique, which is commonly used by traders. It is a way of protecting a position, once it has moved in our favour.
What we are trying to do is that if the trade goes against us, we don´t lose more money than we are willing to risk.
Choosing the right leverage
Choosing too high leverage will increase your risk, so a few negative trades can ruin your trading result.
Since August 2018 FCA regulated brokers offer two types of leverage:
- 1:30 for retail clients
- Up to 1:500 for professional clients
Other regulations such as AISC (Australia) allow leverage of 1:500 for all clients. However, they are not subject to the guarantee fund for accounts up to 85.000 pounds which is offered by the FCA regulation.
Books to learn about risk management
5 Books about risk management in investment and trading
- Against the Gods: The Remarkable Story of Risk
- Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets
- Market Wizards: Interview with Top Traders
- Deep Risk: How History Informs Portfolio Design: Volume 3 (Investing for Adults)
- Risk Management in Trading: Techniques to Drive Profitability of Hedge Funds and Trading Desks