In the late 90’s, a new type of investment became available to consumers. For the first time, anyone could make money on the currency markets with only an internet connection. Since that time, huge numbers of consumers have flocked to foreign exchange brokers, making it one of the fastest growing types of investments.

Most of these brokerages offer free accounts with minimal opening deposits. Traders can make money when the market shifts either direction, and they can trade with various levels of leverage or risk. Best of all, forex demo accounts let customers try out the system with a hypothetical amount of money and no risk of a real loss.

But all is not as good as it initially appears. According to experts, the number of traders that are profitable is probably lower than 15%, and the average trader suffers a $15,000 loss.

Rates like this are hardly tempting to someone thinking about the market. How are such terrible losses possible? There are several reasons, but one of the most significant is unrealistic expectations from people without trading knowledge or experience.

The forex market is considered a zero-sum game, simply meaning that one trader gains only if another loses. Worse, every forex broker charges commissions and transaction costs, so that overall, everyone loses (a negative-sum game).

Simply stated, this means that you must be a lot better than everyone else, if you expect to make a profit. This is where things become even more challenging. The biggest players in the market by far are the banks and full-time investors. These traders are backed by the best information, the fastest access with the most opportunities, plenty of technical, financial education, and years of experience. When consumers enter the market, they can succeed only if they somehow manage to outsmart these traders, and very few can.

Add another component to this discouraging picture, and things turn darker. Even though they know these facts, brokerages and investment funds seek to convince consumers that they are missing out on the biggest investment opportunity of their lives. Visit one of many brokerage websites, and you’ll get the impression that anyone can make lots of money in a little time with no education. Increasingly, “third-wave” brokerages offer simplified platforms with free education courses that make the process easy for beginners. The education they provide is certainly positive, but the way that many forex brokers represent themselves in their marketing is quite inaccurate.

Finally, brokerages hand consumers a rope to hang themselves with when they provide high amounts of leverage and exotic currency pairs. Leverage allows any trader to multiply their gains many times over—a very tempting prospect. The problem is that it also multiplies losses by the same factor. A bad trade can turn into a catastrophe very quickly. Similarly, many exotic currencies are quite volatile, and beginners are often tempted to profit from the constant change. Once again, these changes often turn negative faster than beginners realize.

Why would brokers allow this to happen? Quite simply, they have every motivation to increase their consumer base by whatever means necessary. Every broker takes a small percentage from each trade or uses some other commission structure. This is only natural, since he bears the transaction costs. Many brokerages also having a dealing desk, where they trade with or against their customers. At some point, however, this breaks down and becomes managed gambling where the house always wins. In extreme examples, brokerages have been nothing more than legal forex fraud. This is more common than most people realize, and it is the subject of our next article.

The retail forex market continues to grow at an explosive pace, in spite of the fact that most consumers lose significant money every year. What is even more astonishing is the fact that instances of significant fraud haven’t stopped this growth.

Most people have heard of Bernard Madoff—the financier that shocked Wall Street with the biggest financial scheme in modern history. Madoff’s fraud was technically known as a Ponzi scheme—a system where old clients are paid with the investment from new clients, while no real growth of the capital is happening. In the end, investors lost between $12 and $20 billion.

This received lots of press, and helped the public become more discriminating about hedge funds. But fewer people realize that similar things have been happening in forex, albeit on a smaller scale. In only five years, the agency commissioned with monitoring the forex markets prosecuted more than 80 cases of fraud against 23,000 customers, with net losses of $350 million. The next year, the losses totaled another $110 million.
Some of these frauds were very clear. In 2008, the website for WinCapita suddenly vanished. For several years, the company had been offered as an invitation-only investment club for forex trading. Quite simply, the company worked as a pyramid scheme. New members were required to invest several thousand euros, with the promise that they would receive 4-fold returns. The people at the top of the pyramid received their money and encouraged new members to wait for their returns. In the end, more than 10,000 investors lost a total of 100 million euros.

There are many more examples of forex fraud that are even clearer. Russel Cline, Russel Erxleben, Richard Matthews Jr., and Joel ward are just a few of the more significant names that have run scams and been prosecuted. All of them demonstrate the important principle that money isn’t secure, even if invested in a government regulated industry. FDIC insurance is one of the few guarantees that money will actually be retrievable. But forex accounts are never under this program, and if the money is gone, there is simply no way to get it back.

What makes things worse is the fact that most forex frauds are far more subtle. In fact, registered cases of fraud are probably only the tip of the iceberg. Most cases go unreported, because consumers don’t realize that they’ve been cheated. This might be as simple as opening an account with a forex broker and suffering consistent losses. In most cases, the consumers made bad trades and there’s nothing fraudulent. But in some other cases, the brokerage deals against its own customers to make their trading unprofitable. Such cases never get reported because they are almost impossible to detect.

Good, honest brokerages do exist. There is legitimate money to be made in the forex market. But this industry has largely grown on the unrealistic expectations of customers that don’t understand the risks they are taking. The fact that forex isn’t monitored nearly as closely as other investments, opens up the possibilities for fraud. Worse, it hides the fact that the overwhelming majority of investors actually suffer consistent losses.
Brokers have no reason to let people know about the risks and every reason to exaggerate the potential profits. Consumers don’t understand sophisticated trading practices, and are tempted by the hope of large financial profits. But if more people knew the facts before getting into the market, they would either stay away from forex trading entirely, or be a lot more careful than they are.

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