Main Risks in Forex Trading
Trading in the foreign exchange market carries a high degree of risk and may not suit all investors. Past performance is no guarantee of future results. Any trading strategies that have a 100% success rate are either lying or illegal.
People who have been involved in forex may know that the market is a 24-hour market. That means that there is no set time during the day where all traders go home and stop trading, unlike traditional stock markets, which close at night and on weekends. The result of this is increased volatility because the market has increased liquidity from all these different players worldwide.
It can make it easier for prices to change quickly by a few ticks. In normal times, this would be a positive thing as it will increase liquidity and make prices more accurate, but there are times when volatility can increase quickly. In this kind of situation, the market is less liquid (fewer players trading) due to downtime or time of day, which can rapidly cause large price swings.
One risk in forex trading is payment risk as it is not a get rich quick scheme. All trades on the forex market are between two different currencies; you cannot trade multiple currencies at once as you might with stocks (where you may buy/sell stock in Microsoft and Google at once). You must convert your currency into another currency before entering a trade. There are fees associated with these conversions that fluctuate based on how much money is in the market and which currencies you are trading.
These fees can quickly add up and eat into your profits, so it is essential to be aware of them and how they may affect your trades before taking a position. Have a look at Saxo Bank to get an idea of the fees charged for conversions.
Leverage can be a handy tool when used correctly in forex trading, but it can lead to massive losses very quickly if not used carefully. Leverage, simply put, is borrowing money from the broker (depending on your contract with them) to take more significant positions than you would be able to purchase yourself based on the amount of money you have in your account.
You do not need all the money immediately or even at any set time; this “margin” will sit in your account, and you only need to pay it back when you close out a trade at a loss. You can take larger positions with leverage, but your losses will be much greater if your position loses money because the value of the losing trade is now multiplied by how much leverage was used.
Currency risk (also referred to as cross-currency risk) is not specific to trading forex in the UK, but it does apply here and anywhere else.
As mentioned before, all trades on the forex market are between 2 different currencies; if those currencies move against each other (one appreciates/rises while another depreciates/falls), your trade may begin to make or lose money based on which currencies you are trading. Sometimes you can mitigate this risk by using a hedging strategy, but it is something to pay attention to when entering trades.
Forex fraud includes everything from getting scammed out of your money to more complicated issues like market manipulation or insider trading. Many federal laws help protect traders in the case of fraud; if you violate any of these laws, then the trader has the opportunity to take legal action against the broker.
Even though governmental agencies now watch over this kind of thing, it is still important to avoid scams and trade with reputable brokers for the safest trading environment.
There are several risks involved with forex trading, and understanding these risks is vital to be a successful trader. You will also find the risks associated with leverage and currency risk in many other forms of trading. Still, it’s essential to be aware that they can have a very negative impact on your trades if you’re not careful.