The forex trading market has gained a lot of interest in recent months from both traders and non-traders. And this is not surprising. First, it is the market with the highest trading volume. Every day people are engaging in more than five trillion dollars’ worth of transactions. Second, it is open to everyone. Even ordinary traders who have as little as $100 can participate in this market. Third, it is operational 24 hours a day. It is easily accessible to people no matter where you are in the world. A person from the USA can be exchanging currencies to a person from the Philippines in Asia in real-time through online trading platforms.
Also, you may have seen depictions and stories on social media about ordinary people who became millionaires just by trading. Some movies with known actors have painted a fantastic picture of the trading market. A world that centers on gaining millions of dollars, huge houses, and expensive cars. One such movie is The Wolf of Wall Street, starring renowned actor Leonardo di Caprio. In addition, some testimonials on the internet claim that an average person can reach fame and fortune by simply trading forex. They tell of rags to riches stories to entice you to invest your hard-earned money in trading investments. Sadly, this is not the reality.
The forex market is a risky investment asset. There is no guarantee that you will gain profits. And it cannot transform you from an office clerk to a millionaire in just one night. Studies conducted by experts reveal that around 70% of all traders lose money while doing forex trading. And it doesn’t matter if you are a professional trader who has been in this business for years now. Everybody loses in forex. To put it another way, only one out of three traders will see their capital grow while trading currency pairs. We must establish this early on so you can have a more realistic view of forex trading.
How do you make money in forex trading?
Now we have established the facts vs. myths on the forex market. Let us consider next how people can make a profit from trading. Knowing this basic fact will make it easier to explain how much forex traders make.
Forex trading is the exchange of one currency to another country’s currency. For the European Union, this applies to the whole region since the majority of the member countries adopted the Euro as their single currency. In forex trading, you always deal with two different currencies called a currency pair. It is because the concept of trading is that you buy one currency in exchange for another. Today, the currency combinations can reach hundreds. It is not hard to imagine this, considering that every single country in the world has its currency. Of course, there will be currencies that will get more attention from traders. The US dollar is the most traded currency, followed by the Euro.
The goal of forex is to buy and sell currencies to make a profit. The basic principle is to buy a currency when its value is low and sell it when it is high. Let’s look at the EUR/USD as an example. When you take a position in the Euro, and its value goes up against the dollar, you earn some profit. This movement in the price of currencies is called pip. A pip is a small number measured up to four decimal places. But if you add these small gains on multiple currency pairs and for a long time, you can get some profits.
Then brokers introduced leverage. It is the use of funds borrowed from the broker so you can increase your trading volume. It is the ratio of your deposit to the borrowed funds. For example, if you are trading $1,000 worth of Euros against the dollar and your gain is 0.1, your profit is $100. (To get this result, multiply your total trading amount of $1,000 with your gain margin of 0.1. The result will give you $100). If you use a leverage of 50:1, then your profits will increase by 50 times! In our example, your profit will become $5,000 (multiply $100 profit to the leverage of 50). Did you see the huge gap? From $100 at zero leverage to $5,000 at 50:1 leverage. It made your profit bigger in this example. But remember, you can also be in a losing position. If this happens, your loss is also multiplied by 50x. With this amount, you can go bankrupt in a few minutes. It is the reason why some regulators set a limit on the leverage. In the US, the maximum leverage is at 50:1. Imagine a leverage as high as 1,000:1 or 5,000:1!
Why is risk management vital?
At the start of this article, we said that forex trading is risky. And that a large majority of traders lose money in this market. So, a risk management strategy should be in place to protect your hard-earned money from going down the drain.
The first step to minimize the risk is to know how much money you are willing to lose per trade. This amount will be your bet size. As a rule, you must never use your whole deposit on a single trade. Doing this is a sure-fire way to lose your money fast. Experienced traders and mentors recommend allocating only 1% to 2% of your total money in a trading account for every transaction. For example, you have a $5,000 deposit account with your broker. Getting 1% of $5,000 is $50. It is the maximum trading amount that you should place for each currency pair trading that you do. It will allow you to keep a substantial amount in your deposit even if you lose on a few trading positions.
Another vital risk management strategy is the stop-loss order. It is an exit plan that forces you to sell a losing trade. Only when it reaches a specific value. It helps to cut further losses on a currency pair if the trend continues to go down. So, if you bought the EUR at $0.48 to the USD and it continues to go down, you will also lose your money continuously. But if you put a stop-loss order at $0.45, the moment the Euro reaches this value, the broker will sell your position. Your loss is effectively limited to $0.03. Imagine how much money you will lose if the Euro loses $1.5 and you don’t have a stop-loss order! If your total bet size is $100, then you can say goodbye to your $150.
How can I estimate my profits in forex trading?
By now, we have established how to make money in forex and how to manage the risks. Next, we can discuss the three ways to estimate your profits in forex trading. Notice that we used the word estimate since it is not an exact science. The amount of money you can make from trading is different from person to person. And it is affected by many factors. It includes your amount of capital, risk management strategy, and trading volume.
- Win rate. It is the number of winning trades you performed out of all the trading activities you have done. It takes on a percentage symbol. For example, you just started trading in August 2021 and made a total of 100 trades. Out of the 100, you gained profit in 60 trading positions and lost in the other 40. Using the formula 60 winning trades divided by 100 total trades, you will get 60%. In this example, your win rate is 60%. Most traders will get a 50%-win rate. And this is acceptable. Aiming for 55% to 60% is not impossible, especially for advanced traders.
- Risk/Reward ratio. It shows how much a trader is willing to risk in reaching the desired profit number. In other words, it is the expected reward earned for every dollar at risk. So, trading in a currency pair with a 1:5 risk to reward ratio means that he is investing $1, intending to reach a profit of $5. It is also called the profit to loss ratio. The standard risk/reward ratio is 1:3, but you can aim for a higher number.
- Expectancy. It is a combination of the first two methods. It is defined as the predicted profit in the long run for each dollar you risk. Expectancy is like the risk/reward ratio but considers more factors to come up with the result. It is a principle that uses both the win rate and risk/reward ratio. A win rate alone is not always a good representation of profits. And neither is the risk/reward ratio a reliable standard on its own. Expectancy is expressed as this equation: E= [1+ (W/L)] x P-1. The values of the formula are:
- E is the expectancy score.
- W is the size of wins on average.
- L is the size of losses on average.
- P is the winning rate.
Let’s look at an example to understand it better. You started trading in April, but you are not a full-time forex trader. You only completed 20 trades and won in 12 instances but lost in 8 trading positions. Your winning rate is at 60% (computed by dividing 12 wins with 20 total trades). In your 12 wins, you managed to get $5,000 in profit that gives you an average win of $416.67 (computed as $5,000 profit divided by 12 trades). But you lost $2,000 for an average loss of $250 (computed as $2,000 loss divided by eight losing trades). So going back to the formula,
- W= $416.67
- L= $250
- P= 60% or .06
By using the expectancy formula, of E= [1+ (W/L)] x P-1, we will arrive at [1+ (416.67/250)] x .06-1 = 60%. The expectancy rate is 60% which means that for every dollar you spend on trading, you will get a 60 cents profit.
What other factors should you consider in estimating your profits?
Now that you know how to get your win rate, risk/reward ratio, and expectancy, let us discuss two more factors that can affect your projected profits. The first is your trading volume. Each forex trader will have a trading plan and strategy. Whether you use scalping, hedging, or swing trading, you must remember that these strategies will only work if you put them to actual use. And these strategies are not for one-time use only. You need to make several trades in a day and on several currency pairs. The name of the game is the frequency or the number of times you are trading. The more times you trade, the more chances you have of winning. Also, if you choose the major currency pairs where the pips are tighter, the potential profits will be small. But when you trade more, you will get higher profits when you combine all your small wins.
The other factor to consider is your total investment amount. The bigger your money, the higher the potential profit will be. Your investment is proportionally related to profit gained. If, for example, your profit expectancy is 15%, with a $100 account, your profit will be around $15. But if your account is worth $1,000, the profit increases by $150. For a $1 million account balance, this profit blows up to $150,000! So, the amount of capital that you have in your account directly affects your profit margins.
How much do forex traders make a day?
The forex market is trading trillions of dollars per day. But as individual traders, you cannot expect to get billions, millions, or thousands of dollars per day in profits. The amount of profit you can get depends on a lot of factors. And it varies from trader to trader. And profit is not guaranteed in forex trading as most traders will lose their money. Instead of focusing on gains, work on your trading strategy and risk management tactics.
Can you get rich by trading forex?
Yes, but forex trading is not a get-rich-quick fix. And it is not the same as gambling. It is an investment activity that requires skill, discipline, and substantial capital. Only a few traders make it big in forex, and the risks are high. So, if you want to get rich, look for other investment opportunities elsewhere.
How much does a forex trader make per year?
The profits that a forex trader makes per year are dependent on many things. It includes the amount of his starting capital, his trading strategy, and his trading volume. His skills, discipline, and time spent, also matters. In addition, market forces can swing the value of forex up or down. So, predicting the gains per year is difficult. But by using the three methods discussed above: the win rate, risk/reward ratio, and expectancy, you can have an estimation of your profits per year.