The post Top Forex Trading Risks by Stjepan Kalinic appeared first on Benzinga. Visit Benzinga to get more great content like this.
Reduce your forex trading risks by opening a brokerage account with eToro.
“No risk, no reward” is the motto of the markets. Sure, you can get a risk-free return from FDIC-insured products like savings accounts and certificates of deposit, or even from noninsured federal debt securities like Treasuries, but the returns you’ll get on these assets are minimal.
If you want to get good returns, you’ll need to take on some risk, regardless of the asset class or market you’re trading in. Now, this doesn’t mean every asset faces the same type of risks. Not only do forex traders have to keep an eye on their trades 24 hours a day, but they have to contend with a host of risks that stock and bond traders do not.
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What is Forex Trading?
Forex trading is the process of buying and selling currencies. Since currencies have floating exchange rates, forex traders can make profits from speculating on currency pairs. Forex is short for foreign exchange, and traders in this market must remain on their toes because currencies are traded 24 hours a day during the week (like stock exchanges, forex markets are closed on weekends).
The foreign exchange market is the largest on the planet with an estimated value of over $6 trillion traded on the average day. To trade currencies, an investor will need a forex trading account with a broker and an idea of which types of currencies they want to trade. Currencies trade in pairs — the investor buys one currency and sells another, hoping to profit when the currency they buy appreciates versus the one they sold.
For example, let’s say a currency trader thinks the U.S. dollar will appreciate versus the price of the Japanese yen. In this scenario, a long USD/short JPY position would be opened. But because currency moves look relatively small compared to the moves made by stocks or commodities, leverage isn’t just encouraged when making a foreign exchange trade — it’s almost required. Leverage of 20/1 is completely normal in the forex markets and many brokers offer leverage as high as 500/1.
If you open a long USD/short JPY trade with $1,000 at 20/1 leverage, you’ll control a $20,000 position with your original $1,000 investment. If your trade gains 20%, you’ll make $4,000 in profit on just a $1,000 investment. But a 20% decline means your original $1,000 is gone and you still owe your broker $3,000. Leverage is a double-edged sword and one of the major risks currency traders face.
7 Common Forex Trading Risks
Forex traders must keep a number of different risks on their radar. Unlike trading individual stocks, currencies aren’t affected by drug trials or earnings reports but by a host of micro and macro-economic factors. This is far from a complete list, but here are the major risks forex traders must consider when dipping their toes into currency markets.
Exchange Rate Risk
One of the most obvious risks facing traders is the currency exchange rates. Exchange rates float, meaning that the amount of currency that can be traded for another varies from day to day. You may be able to get 118 JPY for $1 USD one day, but only 114 JPY the next. While this might seem like a minor fluctuation, moves in exchange rates can drastically influence a trader’s profits since leverage is so often applied to forex trades.
Interest Rate Risk
Interest rates are another major influence on the profits of FX traders. Interest rates don’t fluctuate with the rapidity of exchange rates, but they do determine how profitable it is to trade certain currencies versus others. Countries with high rates allow profits to be earned on their currencies while low-rate countries struggle to provide interest on their money. If you invest in a currency with a high interest rate and the central bank of that country announces a surprise rate cut, your profit margins will be greatly impacted — the currency you own will no longer produce the expected rate of return.
Credit Risk
Credit risk, or counterparty risk, is the risk that the other person, institution or market maker you’re transacting with will be unable to repay due to solvency issues. Since forex trading is done with derivatives contracts and leverage, the risk that the person(s) on the other side of the trade becomes insolvent is a reality that currency traders must live with. Currency markets aren’t as closely regulated as other financial markets. If the counterparty is unable to provide the owed currency, they could default and negate the profits of the trade.
Country Risk
Like all securities, forex contracts can be hit with volatility that exceeds the estimated range. Currencies can be extremely volatile during unprecedented macro events, such as England voting to leave the European Union, which caused a cascade of volatility in the market for the pound sterling. George Soros famously banked more than $1 billion in a single trade by shorting the British pound in 1992 because he believed the currency was being pumped too hard by the Bank of England (which had upped interest rates into the teens).
Low Liquidity Risk
Liquidity is crucial in any market and the foreign exchange market is no different. Trading 24 hours a day during the week provides plenty of liquidity to most corners of the market, but that doesn’t mean instances of low liquidity never occur. Currency traders usually don’t have to worry about completely unexercised trades, but liquidity issues can cause significant slippage in forex contracts. Illiquid contracts will have larger spreads, which can cut deep into the profits of forex trades.
Margins and Leverage
Borrowing money is a way of life in the forex markets, but too much leverage can lead to ruin (as it can in any market). Since currency movements look small in terms of percentage, traders often ramp up the leverage to make big profits. As mentioned above, leverage levels of 500/1 aren’t uncommon with forex brokers. A 500/1 leverage trade means that a $500,000 position can be controlled with just $1,000. If your trade turns against you at 500/1 leverage, you could face a very unpleasant margin call.
Losing Your Money
Just like stock trading, there’s no secret sauce or formula for success in the forex markets. Every trade will have different risk parameters, and each individual will have to determine how much risk makes sense. The risk of losing all your investment is ever-present, even more so than with stocks because leverage is applied to most forex trades. You might not just lose all your money — you could lose more than you initially invested.
Manage Your Risk with These Top Forex Brokers
Currencies can be traded alongside stocks and bonds at many traditional online brokers. However, some of the best brokers for currencies tailor their offerings to the forex asset class, allowing users access to powerful trading platforms like MetaTrader 4. Here are a few of Benzinga’s favorite forex brokers.
FOREX.com is a one-stop shop for forex traders. With a massive range of tradable currencies, low account minimums and an impressive trading platform, FOREX.com is an excellent choice for brokers searching for a home base for their currency trading. New traders and seasoned veterans alike will love FOREX.com’s extensive education and research center that provides free, informative forex trading courses at multiple skill levels. While FOREX.com is impressive, remember that it isn’t a standard broker.
Best For
- MetaTrader 4 users
- Beginner forex traders
- Active forex traders
- Impressive, easy-to-navigate platform
- Wide range of education and research tools
- Access to over 80 currencies to buy and sell
- Leverage available up to 50:1
- Cannot buy and sell other securities (like stocks and bonds)
IG is a comprehensive forex broker that offers full access to the currency market and support for over 80 currency pairs. The broker only offers forex trading to its U.S.-based customers, the brokerage does it spectacularly well. Novice traders will love IG’s intuitive mobile and desktop platforms, while advanced traders will revel in the platform’s selection of indicators and charting tools. Though IG could work on its customer service and fees, the broker is an asset to new forex traders and those who prefer a more streamlined interface.
Best For
- New forex traders who are still learning the ropes
- Traders who prefer a simple, clean interface
- Forex traders who trade primarily on a tablet
- Easy-to-navigate platform is easy for beginners to master
- Mobile and tablet platforms offer full functionality of the desktop version
- Margin rates are easy to understand and affordable
- Access to over 80 currency pairs
- U.S. traders can currently only trade forex
- Customer service options are lacking
- No 2-factor authentication on mobile
86% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you can afford to take the high risk of losing your money.
Plus500 is a European derivatives broker focusing on contracts for difference (CFDs). CFDs are similar to binary options in the U.S. where traders take all-or-nothing speculation on the prices of certain securities like indices, commodities or currencies. While not legal to trade in the U.S., CFDs are legal in many jurisdictions across the globe and Plus500 offers a wide array of tradable markets using these instruments.
Plus500 doesn’t charge commission and only profits off the spread, which is the difference between the buy and sell price of a specific security. But Plus500 is not a broker for beginners — the education materials are sparse and CFDs are risky derivatives capable of sapping out all of an investor’s capital. Only trade these instruments if you understand how they operate and the risks involved with buying them.
Best For
- Traders looking for a smooth mobile experience
- Great mobile app
- Low spreads and commissions
- Unlimited demo account
- Only derivatives are available
- Not open to U.S. residents
Though Australian and British traders might know eToro for its easy stock and mobile trading, the broker is now expanding into the United States with cryptocurrency trading. U.S. traders can begin buying and selling both major cryptocurrencies (like Bitcoin and Ethereum) as well as smaller names (like Tron Coin and Stellar Lumens).
eToro offers traders the opportunity to invest their assets into premade portfolios or cryptocurrencies, similar to services offered by robo-advisors through traditional brokers. Though eToro isn’t a one-stop-shop for everything an investor needs, its easy-to-use platform and low spreads is a great way to enter the cryptocurrency market.
Best For
- International Forex/CFD Traders
- New cryptocurrency traders looking for an easy-to-use platform
- Traders who want to buy and sell cryptocurrencies on-the-go
- Simple platform that is easy to master
- CopyTrader feature that allows new traders to copy the same strategies used by professionals
- Virtual dummy account that gives you $100,000 to practice trades
- U.S. traders currently limited to cryptocurrencies
- Only 15 major coins available to trade
HYCM is 1 of the world’s leading forex brokers, offering investors access to over 69 unique currency pairs. However, forex isn’t the only thing the broker offers — HYCM also offers high rates of leverage, stock and ETF trading, commodity investing and much more. Getting started with HYCM is quick and easy, and most investors can open an account in as little as 10 minutes.
HYCM offers a varying fee structure, which allows investors to choose the spread option that’s best for them. A wide range of educational and investing tools are available, which can be equally beneficial to both experienced and novice traders. Though HYCM isn’t currently available in the United States, it can be a great choice for residents of the other 140 countries where it offers service.
Best For
- Investors who want a customizable fee schedule
- Traders comfortable using the MetaTrader platform
- Islamic traders who need swap-free accounts that don’t build interest
- Mobile app with a simple trading experience
- Wide range of currency pairs available
- Excellent selection of educational tools
- Not currently available to traders based in the U.S.
A fully regulated broker with a presence in Europe, South Africa, the Middle East, British Virgin Islands, Australia and Japan, Avatrade deals with mainly forex and CFDs on stocks, commodities, indexes, forex, cryptocurrencies, etc. This brokerage is headquartered in Dublin, Ireland and began offering its services in 2006. It offers multiple trading platforms and earns mainly through spreads.
Best For
- Beginners
- Advanced traders
- Traders looking for a well-diversified portfolio
- Controlled by regulatory agencies of multiple countries
- Choice offered in terms of trading platforms
- Support available in 14 languages and trading platforms in 20 languages
- Practice/demo account available for trying out
- Breadth of trading assets
- Does not accept customers from the U.S. as it isn’t regulated in the U.S.
- Transferring funds to the account may take up to five days; withdrawals could take up to 10 days
Billing itself as the world’s 1st eco-friendly broker, CedarFX makes it easy to trade and give back to the planet. You can choose a 0% Commission Account or an Eco Account — or open multiple accounts to meet all your needs.
CedarFX offers access to a wide range of tradable securities, including stocks, futures, major and exotic forex pairs, cryptocurrencies and more. Though CedarFX could introduce a few additional educational resources, the broker remains a unique option for traders invested in giving back.
Best For
- Forex investors
- Investors interested in 0% commission or eco conscious trading
- Investors looking for 24/7 customer service
- Allows users to offset their carbon footprint
- 0% commission investing
- Offers demo account access
- 24/7 customer service available through live chat
- Eco Account Option (10 trees planted for each lot traded)
- Fast deposits/withdrawals with Bitcoin
- Limited number of educational resources for new investors
Forex Trading Carries Unique Risk Factors
Forex trading is appealing for many reasons. The markets are open 24 hours on most days, the liquidity is high, and margin requirements are significantly smaller than those demanded from stock investors. Forex trading can provide diversification away from U.S. stocks because currencies carry different risks than equities, but knowing how to evaluate these risks is crucial.
Traders have to keep their eyes peeled for changes in fiscal and monetary policy, geopolitical events and broader economic trends, as well as their own leverage levels and risk tolerances. It’s a balancing act unlike any other, but forex traders who can juggle these all factors at once may have a tremendous source of alpha.
Frequently Asked Questions
Is forex trading high risk?
Forex trading entails many different risks, some of which are often ignored by bond and stock traders. Trading in any market can be high risk if excess leverage is combined with limited knowledge, but forex traders must contend with exchange rates, interest rates, creditworthiness and liquidity levels when executing their trades. A ‘set it and forget it’ strategy doesn’t work as well in currency markets as it does in stocks.
Why is forex dangerous?
Forex can be dangerous for inexperienced investors because leverage is a fundamental part of the process. Traders dealing in stocks can make outsized profits without using a single cent of margin, but forex traders often must borrow money and trade with leverage to score big. If you don’t understand how leverage affects your positions, you could face serious repercussions (like a complete loss of capital and/or margin call).
Is forex riskier than stocks?
The foreign exchange market is far more volatile than the stock market.
The post Top Forex Trading Risks by Stjepan Kalinic appeared first on Benzinga. Visit Benzinga to get more great content like this.
