Mechanical Forex

If you’re like most retail traders out there then one of the first things you might have heard about retail trading is that between 90 and 95% of all retail traders lose all their money. Sure, this figure isn’t always the same and some books/people will take it as high as 99% of retail traders and some as low as 85%, however there seems to be a tacit agreement in the community which implies that the probability of long term success is somewhere in the 1:10 to 1:100 region. One of the things I have always wondered is where this number came from and if there is any actual evidence that backs up this figure. Is there any study that explores retail trading success? Is there any evidence that tells us that the probability of having a long term edge is so low? On today’s post I am going to walk you through some of the evidence I have found on the subject and what it tells us about trading and the success of retail traders.

First of all, let us remember that the above statistics – although used to a very large extent in forex trading – is actually older than this (I found books using it in futures printed in the early 90s) so most likely the above number was derived from observations across markets different than Forex. However was unable to find the precise original source of this quote – since it is only cited without reference – and therefore I decided to do a bibliographical search to see if I could find some “modern evidence” that the above is actually true.

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Searching for academic articles dealing with retail trading performance is not easy, despite the fact that the topic is rather interesting it is observational at best and therefore not in the interest of most people dedicated to math, trading or statistics. My first piece of evidence comes from the Journal of Financial Analysis in an article by D.J Jordan (2003) where the profitability of stock day traders is studied and the conclusion is that about 20% of the day traders studied had profitable outcomes. It is interesting to note that stocks are a market with inherently less leverage and therefore “safer” so we would in fact expect the profitability of retail traders there to be a little bit higher.

However this is not always the case. A study made by B.M Barber around Taiwan traders published in SSNR in 2004 shows us that the performance of day traders can even be less than that. In the Taiwan scenario a little bit of further analysis is conducted and the authors conclude that only about 1% of traders have at least 2 years of profitability while the rest of traders go into a prolonged losing streak that ends up with an account wipeout. The evidence we have from these two articles strongly suggests that most day traders in stocks lose money. Since Forex is a market with higher leverage we would expect the figures to be – as a best case – of the same magnitude.

Of course it becomes important to also search for information in this regard about Forex. However since Forex is not traded through a central exchange but through retail brokers, it becomes very difficult to get access to any data (and hence there are no studies in this regard) because this data is kept private by the brokers. Although the NFA forced brokers to show the number of profitable and losing retail traders per quarter they are not obliged to say what the turnover is and therefore there is no way of knowing what the long term (2 year for example) success rate of forex traders is. We merely know that in the very short term (quarter) about 50-70% are unprofitable but this is most likely increased to a figure between 95-99% after a two year period.

After searching for a while I could find some sources which back this theory up. The first true piece of evidence comes from Reuters on an article that talks about the banning of retail Forex trading in China. The Chinese government found out that more than 90% of participants lost their deposits, meaning that this was a highly risky endeavor for the general population, much more in line with a casino than an investment vehicle. This is the first piece of evidence that shows us that the success rate in retail Forex trading is in line with the “rumored” amount, although the exact values found out by the Chinese are not detailed (merely that more than 90% lost their money).

My final piece of evidence comes from the Los Angeles Times on an article published a little bit more than a week ago. On this article journalist Nathaniel Popper goes into some depth into the current Forex business in the United States, showing that brokers are indeed playing a game of massive turnover in which they are mainly interested in “burning and cycling” rather than keeping customers for long term periods. The author goes into some of the data provided by US Forex brokers and how this leads to the conclusion that most retail traders lose all their money in the Forex market. The article makes a good point, highlighting the fact that people usually get into trading with the aims of making large amounts of money (with an average starting capital of 3K) but the bast majority lose all their deposit.

Certainly we will probably never have a decent academic study on retail Forex trader profitability because brokers will never give the information needed to carry it out. Unless the government forces brokers to reveal account turnover number and make a difference between inactive, active and margined accounts the actual figure of how many retail traders are profitable will remain obscure. However it is true that the evidence in stock and futures points to a success rate of between 10-1% and information from the Chinese government does tell us that retail success is actually – at the very most – below 10%. Now as a piece of rogue information (more like gossip) I can tell you that a friend of mine – working at a large European broker – told me that their 5 year account success rate is less than 0.5%.

In the end it seems that the old trader saying is right for the large majority of retail traders: If you want to make a small fortune trading… Start with a big fortune :o)

If you would like to learn more about my work in automated trading and how you to can learn how to create and evaluate trading systems using sound trading tactics and evaluation methods please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach towards automated trading in general . I hope you enjoyed this article ! :o)