What are the risks to trading in forex?
The two distinguishing factors of forex trading are the unregulated nature of the exchange and the high degree of leverage. These two factors contribute to the risk of forex trading in different ways. First of all, the fact that the market is mostly unregulated means that finding a legitimate broker is an additional barrier. The futures market is usually regulated, because futures contracts trade on open exchanges, but these are less useful to individuals than the spot and forwards markets. So it is critical to examine different brokers and make sure that they do not appear to be scams and that they have good reputations. Otherwise, traders run the risk of losing their money to a scam or just poor management of the brokerage.
The second risk is more important. Finding a trustworthy broker is not that hard- it just requires some time investment. On the other hand, being able to manage highly leveraged positions is a skill in itself. Wagering on a position with a ratio of 250:1 means that if you are wrong, you will owe someone else two hundred and fifty times your original bet. You can never lose more than your margin, which is the total money that you have invested in your brokerage account, but it is very possible for a single bad bet to wipe out an entire account. For that reason, it is good practice to set stop limits or loss limits on your account. Most brokers have an easy way to set these up. You pick a set level of losses, and if your losses reach that amount, the broker will close your positions. That way, you effectively limit what you can lose on any single position, even taking into account leverage.
How much money should I invest in forex?
The combination of the high degree of uncertainty in returns from forex, along with the large leverage ratios, means that until you know the market well and understand how to trade without taking on too much risk, it is a good idea to limit initial investment in forex. This is particularly true for people who are not working in finance and are just trying out foreign exchange as a side job, secondary to a main career. The exact amount depends on the brokerage options. Some brokers offer different kinds of benefits based on how much money you put into your account. This might take the form of additional chart tools or more detailed information about trading strategies, or a reduction in trading fees.
Think carefully, though. For a beginner, taking even small positions in a highly leveraged environment can lead to potentially large losses as a percentage of your total investment. There is no point depositing thousands of dollars into a brokerage account, only to lose it on a few bad trades. So start small, both with individual bets and with the total amount of money in the brokerage account. On the other hand, it is a good idea to take advantage of some of the brokerage account benefits for depositing certain amounts when those benefits are significant. One way to get started without risking real money is a demo account- this is a trial account that some brokerages offer, which lets you see the trade interface and experiment with some trading without risking any real money. You won’t be able to make any gains, but you won’t have any losses, either. It’s a good way to get the feel of how forex brokers and forex trading works without having any skin in the game.
How does investing in forex differ from other kinds of financial markets?
Aside from size, one of the major differences between forex and other markets is that forex runs for five days straight every week. This is because the forex market operates according to which major financial exchanges are open, and the variation in time zones means that there is always trading happening somewhere. Second of all, forex trading, at least for individuals, happens faster and with more intensity. Most people and institutions adopt some variation of buy and hold in markets like stocks or bonds. They just want a relatively safe investment that they can count on, whether it be for retirement savings or a low-risk flow of income. Occasionally, institutions devise complicated financial products like special derivatives.
These are obscure and complicated, and often few people in the world really understand them. A notable example is the credit default swaps and mortgage-backed securities that contributed to the financial collapse of the late 2000s. The forex market has no such complicated products. The closest to a complex product forex gets is an options contract, and that is simple relative to the mysteries of proprietary trading products at big banks.
That makes forex much more accessible than individuals who want to take an active role in day trading. It is also easier to build a relationship with a broker. Many brokers in other markets prefer to deal with banks and other large clients, but forex brokers are used to having individuals as their clients, so they are welcoming of individuals and expect them to constitute a large proportion of their customer base.
How is forex similar to other markets?
First of all, day trading on forex and day trading in other markets, like binary options or equities, are similar in the sense that they are based on trying to make rapid gains on short-term price movements. In forex, as in other markets, the price of an asset is the most important statistic. The basic means of analysis between different markets are remarkably similar. For example, the methods of technical analysis apply just as well to stocks as they do to currency pairs. Of course, the techniques need a little bit of tweaking and adaptation to apply to different assets, but that applies to bonds and other markets as well.
It is to be expected that different assets need different approaches. Yet the basic ideas and motivation for technical analysis works for any asset. Fundamental analysis does not work quite as well in the area of forex, because the assets are less likely to react in price to underlying changes in economic conditions. Changes that are significant enough to shift a currency’s price dramatically and for a prolonged period are also hard to anticipate- they signal a large and unexpected event. While the forex spot market does not have an open exchange, that is also true of many bonds. Bonds and related financial products are not traded on open exchanges the way stocks are. Similarly, bonds operate on informal networks of telephone connections between traders and brokers, just like the forex market.
Finally, foreign exchange is a confluence of all different kinds of financial entities, from individuals to banks and governments. That is true of all financial markets- people, businesses, and governments with a stake in finance are all heavily involved in all kinds of financial markets in one way or another. They could be buyers, sellers, facilitators, or regulators, but no financial market is completely dominated by just one type of trader. The possible exception is the forex futures market, where few individual traders bother to exchange currency.
Why is the forex market so large?
One of the most striking aspects of the forex market is its size. With about five trillion dollars in value changing hands daily, it dwarfs any other financial market. The reason for this size is twofold- first of all, the importance of the forex market means that the largest players in finance, big banks and governments, are heavily invested in currency exchange. On top of that, the fact that forex is truly international means that those major players from every nation large enough to have its own financial industry gets into forex. For banks, forex is less about trying to make money and more about foreign investments.
Whenever a bank or other financial institution, like a hedge fund, wants to make an investment in a different country, it needs to first convert its money to the currency of that country, and then make the investment. For example, suppose that an American hedge fund wants to invest in a German healthcare firm. It has to first buy some euros, then use those euros to purchase stock in the German company. Therefore, the hedge fund’s bet on the German company’s stock is also a bet on the euro. Banks use the futures market to set up contracts to protect themselves against the risk that devaluation of the euro will hurt their investment. Governments often try to manipulate the price of their own currency. That requires a lot of transactions in the forex market- either buying their own currency using foreign ones, or selling their currency for foreign cash. Either way, the presence of big governments and banks from all over the world means there is always a lot of money flowing through forex at ay one time.
How is George Soros connected to forex?
George Soros is a famous financier who made quite a lot of money in foreign exchange. He has used his money to influence national governments to change their economic policies just by threatening to short their currency. In fact, he was partly responsible for damaging the Bank of England and the British pound in the early 1990s. During that time, the euro did not yet exist. However, the countries of Europe were trying to find a way to integrate their national currencies to ease trading across countries. They created the Exchange Rate Mechanism, a collection of currencies that would have fixed exchange rates.
- The British pound and the German mark had been roughly equal in value prior to the creation of the ERM. However, George Soros and other forex investors realized that England’s high level of spending and high inflation meant their currency was too weak to survive a fixed exchange rate with other European currencies, and Germany’s difficulty in post-Cold War reunification would make it hard to use the mark as a reference currency for the Exchange Rate Mechanism.
- So Soros and smaller currency traders began to short the British pound, despite the British government’s desire to keep the price of the currency stable.
- After enough pressure, the British government became unable to support the pound’s price in relation to the mark, and they were forced to withdraw it from the ERM.
- This is because the government needed to buy pounds in order to keep the price up, and eventually this became unaffordable. Soros made about a billion dollars when the price of the pound collapsed, and the British government was forced to rein in inflation and spending to keep its economy under control.
What is the best way to find a good forex broker?
The best guide to whether a broker is both legitimate and a good deal is reputation, especially for a beginner trader. Early on, you might not know enough to decide whether a certain bonus or fee structure is truly a good deal. The best source of information about forex brokers is online communities of traders. Some websites do reviews of brokers, but these may be biased. Be careful that the review site is not affiliated with a particular broker. Likewise, some review sites just write positive reviews for every broker out there, because they want to get credit for referring people to those brokers. So try to find honest reviews who do not ask you to click on a certain link to register for a reviewed broker, sprinkle lots of links in their review, and sound like an advertisement.
- Forums are good places, because they are less likely to have fake reviews and information. This is because it takes more effort to fake forums posts and profiles than simple reviews. Forums also have the advantage of numbers- there can be many people who support a review with their own personal experience with a broker.
- It takes seconds to make a blog and fill it with fake reviews, but it is harder to fake a discussion. One good feature to keep an eye out for is a demo account.
- This will let you get an inside look at the trading interface as well as experience forex trading itself without risk. Be sure not to hand over any money or bank account information to a broker until you are absolutely sure that they are legitimate. Having a trustworthy broker is much more important than getting a slightly larger bonus or slightly lower fees.
Is investing in forex worth it?
It’s hard to predict if forex is a good idea for any individual person. Certainly it is true that investing household money in traditional retirement funds is usually a safer road to returns. However, stocks are currently overvalued. Many leading financial analysts expect that the next several years will not have the same gains in the stock market as there have been in the past. That makes forex relatively more attractive.
Despite the risks, it might be easier to extract profits from the forex market than by hoping the stock market continues to make record-breaking returns. Stock markets never last forever. On the other hand, with forex, it is always possible to make money, because that market does not depend on any underlying trend in corporate profits or the economic situation of one country. To the contrary, there is always money to be made in forex, no matter what the news is or whether the global economy is doing well or poorly. There is always an angle in forex. On the other hand, that comes with increased risk as a result of the large leverage ratios.
It might be worth the time and effort to get to know forex and then decide whether it merits more investment. After all, while it is a risky venture, it is impossible to get any return without some risk. At least the forex market doesn’t change very much. The basic principles of working forex are constant. In stocks and bonds, economic changes can always upset the apply cart and turn winners into losers. On the other hand, forex is beyond the reach of any one government or regulating body. Governments can regulate parts like the futures markets that take place on exchanges, but the rest is neutral territory.