They key difference among these market participants is their level of
sophistication, where the elements of sophistication include:
ƒ Money management techniques
ƒ Profit objectives
ƒ Level of computerization
ƒ Quantitative abilities
ƒ Research abilities
ƒ Level of discipline
Of course there are sophisticated and non-sophisticated banks,
governments, corporations, investment funds, and traders. But among
these segments it is the individual trader who has the least amount of
external governance. Whereas governments, banks, corporations, and
investment funds adhere to regulations and restrictions (to a certain
extent), traders are only restricted by their level of capital.
In the absence of these external restrictions, traders fall into two groups:
those who can impose internal restrictions – discipline - on their trading
strategies and those who cannot: the fence-swingers, et al.
Those who can impose this discipline we will call the sophisticated
investor. In the zero-sum game of forex trading, the sophisticated investor
uses tools and strategies that emulate those of the highly sophisticated
institutional participants to extract profits from the novice participant. It
is only the sophisticated investor who has the ability to extract positive
returns from the forex markets.
WHY
Forex trading has surged in recent years, as more individuals earn their
living trading and the popularity of riskier investment vehicles like hedge
funds has increased. The bottom line for these investors is superior
returns, and in foreign exchange four major factors create a unique
investment environment:
ƒ Liquidity
ƒ Leverage
ƒ Convenience
ƒ Cost
In no other market can you find a playing field that is so biased to the
investor, at least on the surface. But to take advantage of these factors you
have to be constantly aware of their downside.
Liquidity
In a liquid market there is a high degree of transparency, even when large
transactions change hands. The sophisticated investor understands what
this means: forex attracts huge players. As a trader grows in
sophistication, they understand that these huge players have significant
price impact, and watch for their market entry.
Leverage
The low margin requirements in the forex markets make everyone’s whatif analysis yield forecasts with 1000% growth annually. What those
forecasts fail to account for is the multiplying effect of leverage during
periods of consecutive losses
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