The ads keep popping up online, even on reputable business news websites. “Ex-teacher makes $15 000 a week,” says one; “Supplement your income as a forex trader,” says another. Click on the ad and you are taken to an online trading site that explains how you can earn an income by trading in foreign exchange (forex) or derivatives such as binary options.
The sites appear to make it as easy as possible for you to make money by, typically, giving you the tools you need, such as educational material and trading tips, and even sophisticated software, or an app for your smartphone, by which to monitor your “investments” and carry out your trades.
It looks easy. But you must be very, very careful.
First of all, the legitimacy of the operation may be questionable, and it may operate in a slack regulatory jurisdiction. Many trading sites are based in exotic island locations (a popular one has its head office in Vanuatu, a group of small islands in the southern Pacific), so you have little recourse if you don’t get back money you are owed.
Second, even if it is legitimate and works in a well-regulated environment – a number of operators are registered financial services providers with the Financial Services Board – the chances of you scraping a living, let alone acquiring fabulous wealth, are slim, and the chances of you losing your money are enormous. These risks are spelt out in small print on the site, but they are deliberately understated.
It is no easy life being a full-time trader. To begin with, you need to have built up trading and financial market experience over many years; you need more start-up capital than you think; and the right type of personality, among other things (see “What it takes to be a trader”, below). And the types of derivative instruments offered on these sites are normally used by professional traders only under certain controlled circumstances, often to hedge positions on assets such as shares. Few professional traders use binary options as their instrument of choice for their own accounts.
Simon Shear, a founder of financial education website MyTreasury, takes a dim view of binary option trading, saying it is not investing at all, and is much more akin to gambling. In a blog on the site, “Binary options and forex trading: a 21st-century scam”, he says: “As the word ‘binary’ implies, a binary option is an option in which two outcomes are possible: based on a given outcome, either you get a designated amount back or you receive nothing.”
If that sounds more like a round of roulette than a sound investment strategy, well, there’s the reason binary options have become such a common way to con investors.
“Of course, that could simply make binary options a high-risk, high-reward method of investing. Sure, you risk everything you place on the ‘investment’, but you stand to make serious cash in return.
“In reality, the odds are deliberately stacked against investors, who are manipulated in very sophisticated ways by binary options providers. An investigation [by The Times of Israel] revealed that these companies manipulate pricing data, and even refuse to pay investors who try to withdraw their money.”
For these reasons, Shear says, it is important to state categorically that binary options are not legitimate investment products and binary options providers are not reliable financial services providers.
Regarding forex trading sites, these essentially operate in the same way.
“Foreign exchange trading is a legitimate investment practice, but that is not what these companies are offering,” Shear says. “Instead, they offer the same binary model on currency bets … This is not how real trading on foreign exchange markets works.”
What it takes to be a trader
In a blog on his Traders Corner website, professional share trader Garth Mackenzie, a popular figure on radio and television, says he is often approached by people, who may have about R100 000 to invest, wanting advice on how to make a living out of trading.
Mackenzie says: “This is the equivalent of me going to the local golfing pro at a golf course and saying, ‘I’ve saved up some money to buy some clubs. Can you help me out with a few lessons so I can learn to play the game, as I’d like to start playing professional golf for a living.’”
It’s not simple to trade successfully and the statistics back this up, he says. “The generally accepted statistic is that around 95% of people who attempt to trade [derivative] instruments for their own account will destroy their account within a year or two of starting. That means one in 20 people can make a success of trading, or should I say that one in 20 can stay the course. Far less than one in 20 are actually successful as traders. I can vouch for that statistic, having worked as a broker in the retail derivatives trading space since 2001.”
Mackenzie says a colleague of his who works for a well-known international forex and CFD provider told him that the average lifespan of a retail client at their firm is 18 months.
He says not only do you need many years’ experience in the markets before you have any hope of trading for a living, but you need a substantial amount of start-up capital – R100 000 won’t cut it.
After 18 years of trading, he says, he targets an average return on capital of not more than about four percent a month – so if you are targeting an income of R40 000 a month, you need R1 million at least, and that doesn’t include your “school fees”: the amount you lose as you’re learning the ropes.
The entire article, “What does it really take to make a career as a trader?”, is worthwhile reading for anyone entertaining such ideas. Go to traderscorner.co.za and click on “Blog”.
What are derivatives?
Derivatives allow you to “take a bet” on the price of an asset going up or down, without actually buying the asset. The leveraging can be high, which means that for a small amount “invested” you can earn a high return, but you can also make a large loss. With binary options, unlike some other derivatives, you cannot lose more than you put in (for more information, read "Derivatives for beginners").
Wikipedia explains binary options thus: “Binary options are based on a simple ‘yes’ or ‘no’ proposition: will an underlying asset be above a certain price at a certain time? Traders place wagers as to whether that will or will not happen. If a customer believes the price of a commodity or currency will be above a certain price at a set time, he buys the binary option. If he believes it will be below that price, he sells the option.”
Before you jump in
If, after considering the risks, you are still keen to try your luck, keep the following in mind:
• Trading is not investing. Trading is buying and selling assets in the short term (from intra-day trades to trades over a few weeks) in order to make small profits frequently. Investing is buying an asset that you expect will increase in value over the long term (months to years) and from which you may also receive dividends.
• You should never gamble with money that you cannot afford to lose, particularly your long-term savings.
• Deal only with a provider that is registered with the Financial Services Board (FSB) as a financial services provider authorised to deal in forex and derivative instruments. Check on the FSB’s website (www.fsb.co.za) whether the company in question is registered.
Under the Financial Advisory and Intermediary Services (FAIS) Act, the Registrar of Financial Services Providers determines the requirements with which financial services providers, key individuals and representatives of providers must comply to be granted a licence by the Financial Services Board. These are termed the Fit and Proper Requirements for financial services providers.
The requirements were updated in 2008, and there have been several amendments since. Further amendments are in the pipeline.
The requirements set criteria regarding the honesty and integrity, competency, operational ability and solvency levels for providers. Among other things, they require providers and their representatives to have qualifications and experience that are appropriate for the products the offer. There are different categories for different types of products. The companies must be financially sound, and must have certain solvency reserves.
Once registered, financial services providers are required to uphold the Code of Conduct under the FAIS Act regulations.