Regardless of the assurances you may read on numerous FOREX web sites claiming that there are no risks, FOREX is not a risk-free endeavor. As is the case whenever you are trading with considerable sums of money, there is always a chance that trades will not go as planned and money will inevitably be lost. The silver lining, however, is that you can diminish your risk by the use of several trading tools. With constant vigilance, and most importantly, education, the FOREX trader can learn to trade profitably and all the while, minimizing their losses.
A few years back FOREX scams were pretty common. The industry has tightened up considerably since then, but you still need to be very careful when signing up with a FOREX broker. Take time for some extensive background checking – as reputable FOREX brokers will be associated with large financial institutions like banks or insurance companies and they will be registered with the proper government agencies. In the United States brokers should be registered with the Commodities Futures Trading Commission (CFTC) or a member of the National Futures Association (NFA). You can also check with your local Consumer Protection Bureau and the Better Business Bureau. You can never be too careful.
There are still risks to FOREX trading no matter how highly regarded or skilled your broker is. Transactions are always subject to unforeseen rate changes, unpredictable markets and political events. A few of the most common dangers that you may encounter deal with exchange rates, interest rates, credit, and countries.
Exchange rate risk refers to money price fluctuations over a trading period. Prices can rapidly decrease resulting in considerable losses unless you trading with FOREX and you employ a stop loss order. Stop loss orders state that the open position should be conveniently closed if money prices drop below a prearranged level. In order to control the amount of money you invest, stop loss orders can be used in conjunction with limit orders thus giving you full command of your FOREX trading – limit orders work in a similar way to stop looses in that it specifies that an open position should be closed at a particular profit target.
Interest rate risks accompany inconsistency between the interest rates in the two countries represented by a FOREX quote’s currency pair. This inconsistency can result in disparities from the expected profit or loss of a particular FOREX business deal.
Credit risk can occur when the FOREX transaction is finalized and it becomes apparent that one of the parties may not be able to pay off their debt. This happens usually when a bank or financial institution declares bankruptcy. Regulated exchanges, which closely supervise members for credit worthiness throughout the entirety of the transaction, can aide in lessening credit risk.
Finally country risk limits the flow of currency and is particularly associated with governments that become involved in foreign exchange markets. There is more country risk associated with ‘exotic’ currencies than with major currencies that allow the free trading of their currency.
Though it is to be expected that FOREX trading is risky, there are precautions to execute that can minimize risk and financial exposure. A trading strategy is essential to have in order to avoid problems down the line. This kind of strategy involves knowing when to enter and exit the market and what kind of trading movements to expect. However in order to form a trading strategy you need the key in limiting FOREX risk – education. Education means knowing the rules and the most important rule of all to observe is to never, in any case, place money in the FOREX that you cannot afford to lose. If one keeps this rule in the forefront of their transactions then when you do encounter risks at least they won’t be too detrimental.
Every FOREX trader needs to know at least the fundamentals about technical analysis and how to comprehend financial charts. This involves studying chart movements and indicators and understanding how charts are analyzed. Education is the key to success. If you want to be successful at FOREX, know what you are doing. There is more than enough information on FOREX trading available both on the Internet and in print so take advantage of it and perhaps it can aid in avoiding some common risks.
However the market is incredibly volatile, and even the most well-informed traders, can’t predict its ways with absolute certainty. So in order to diminish loss, every FOREX transaction should take advantage of the available tools. When initially placing an entry order, stop-loss orders should immediately be put in place to avoid potentially losing a lot of money. A stop-loss order specifies exactly when to exit the market if the money price reaches a certain level. If you take a long position (expecting the price to rise) you would place a stop loss order below current market price. If you take a short position (expecting the price to fall) you would place a stop loss order above current market price.
As an example, if you take a short position on USD/CDN it means you expect the US dollar to fall against the Canadian dollar. The quote is USD/CDN 1.2138/43 – you can sell US$1 for 1.2138 CDN dollars or sell 1.2143 CDN dollars for US$1.
You place an order like this:
Sell USD: 1 standard lot USD/CDN @ 1.2138 = $121,380 CDN
Pip Value: 1 pip = $10
Margin: $1,000 (1%)
You are selling US$100,000 and buying CDN$121,380. Your stop loss order will be executed if the dollar goes above 1.2148, in which case you will lose $100.
However, USD/CDN falls to 1.2118/23. You can now sell $1 US for 1.2118 CDN or sell 1.2123 CDN for $1 US.
Because you entered the transaction by selling US dollars (buying short), you must now buy back US dollars and sell CDN dollars to realize your profit.
You buy back US$100,000 at the current USD/CDN rate of 1.2123 for a cost of 121,223 CDN. Since you originally sold them for CDN$121,380 you made a profit of $157 Canadian dollars or US$129.51 (157 divided by the current exchange rate of 1.2123).