What Role Does Luck Play in Forex Trading?

The saying ‘The harder I practice, the luckier I get’ is usually attributed to golfing legend Gary Player, although this is open to dispute.

What can’t be disputed, however, is the sense which the phrase contains. While luck is, by its very nature, intangible and impossible to quantify (although you know it when it happens to you), any endeavour can become easier and carried out more successfully through simple repetition and the honing of the key skills required. This applies to forex trading as much as it does to playing tennis or cracking an egg one-handed, and in this case ‘practice’ often amounts to finding a broker offering a free demo whch allows you to develop your skills without risking real money. This isn’t to deny, however, that luck sometimes plays a part.

It’s impossible to deny this because of the huge degree to which probability plays a part in forex trading. Putting the probability of trade down purely to luck, however, is not something even the most novice trader would think of doing, since the best trades are always based on a strong strategy drawn from in-depth research, analysis and not a little experience.

The flip-side to this is to trust your intuition when trading, playing a ‘hunch’ or feeling that a certain currency is going to rise or fall in a way which you can profit from. The problem with this approach is that the human mind’s ability to analyse and calculate probability is not quite as cut and dried as we might like to think it is. The ability of the average mind to analyse risk, for example, was something which was examined and shown to be much less certain and rational than might be assumed by Daniel Kahneman and Amos Tversky. They came up with something which they called ‘Prospect Theory’ which can be illustrated in the following way:

– You’re given a choice between a 75% chance of winning £100 and a 25% of getting nothing OR
– A definite win of £70

The other choice which helps to define the theory was:

– A 75% chance of losing £100 and a 25% chance of losing nothing OR
– A definite loss of £70

In both cases, logic would dictate that the second option is the one to go for if you are averse to risk, since it offers either a limited risk of loss or just a limited win. In reality, however, most people when given the choices will go for option two in the first and option one in the second, despite this demonstrating two opposing approaches to the issue of risk. This shows that the prospect of losing money has more of a psychological effect on people than the chance of winning money. Another example of prospect theory shows that people are far more likely to accept a direct offer of £25 than to accept being given £50 and then having £25 taken away. There is no logic to this of course, since they end up with £25 in both cases, but it illustrates the ways in which our thinking around gains and losses is often anything but logical.

All of which is to say that relying solely on your instincts and emotions when trading forex reduces the process from a strategic investment to something more akin to buying a lottery ticket or tossing a coin. Thinking that a run of bad luck is bound to change if you just wait long enough is what leads traders to hold on to losing positions for far too long, ultimately losing much more than they might otherwise have done. Similarly, the same instincts will kick in when a trade is successful, persuading individuals to close out sooner than they need to have done in the desire to quite before their luck changes.

Judgement

The way in which the human mind misjudges probability can probably be best illustrated by the example of tossing a coin. If you toss a coin, it comes up heads five times in a row and you’re then asked to place a bet on how the next toss will land it’s extremely difficult, using your instinct, to stop yourself betting on tails, purely because it must be ‘due’ a turn. The truth of the matter, of course, is that each coin toss is an individual event, and the chances of head or tails are exactly 50% each and every time. If you’re relying on good luck and instinct to shape your trading strategy, then the fact that a currency has been strong for a set period of time could lead you to assume that it must be ‘due’ a period of weakness. If you’ve developed a coherent trading strategy, on the other hand, then you’ll make a choice based on that strategy and not on what may or may not seem like the ‘lucky’ option. Having developed a strategy of this kind, you can then stress-test against the past performance of markets, carrying out dry runs of how the strategy – with its stop losses, entry points and profit targets – would have performed in various previous conditions.

In many ways, what might be referred to as ‘luck’ when considering forex trading is actually the ability to recognise an opportunity when it comes along, the temperament to make the trades that will take advantage of this opportunity and the risk management to know when things are going wrong and a trade is best closed rather than pursued.

Of course, it would be possible to simply stick a few pins into pieces of paper and find that, completely by chance, you’ve made successful trades. This would purely be luck, but it would teach you nothing whatsoever that you could use going forward, unless you analysed those random choices and tried to get to the bottom of why they worked, to enable you to replicate their success in the future. Sticking with the same lucky pins, on the other hand, is not going to form the basis of a long term investment strategy. Luck can happen, such as when market shifts take place due to unforeseen external factors, but luck of this kind counts for nothing unless you have the skill, experience and ability to take advantage of this. And that’s the kind of ‘luck’ that Gary Player (if it was him) was talking about all along.