The forex market is the largest investment market the world, and there are a number of different ways to trade it—spot transactions, currency swaps, options, foreign exchange swaps, and more. But, as with any kind of trading, there are risks to be wary of when you dip your toes into the game. To help you understand these risks, here are three things to consider before you start forex trading.
If global geopolitics were stable, currency trading would be a much safer bet—to the point where everyone would do it. The reality is that political risks are rampant within the forex market. Just when you think things have settled into a nice rhythm, politically turbulent countries turn the market on its head. Currencies are not directly affected by the political climate in their countries of origin, but politics at home certainly influence their value in more subtle ways. For this reason, you should be aware of the economic and political implications of the currency you wish to trade.
You'll want to assess the issuing country's past and present political stability thoroughly before committing to any kind of trade. This is especially true if the currency is not fixed to a larger nation's currency in value, such as the USD. If the country in question has a history of weak central banks, high inflation, and inadequate reserves, its currency is likely to be a high-risk bet. Should the country experience a sudden currency crisis due to high debts and trade deficits, the value of its currency could rapidly erode.
If traders are convinced that a country is going to default on its debts or begin issuing new currency, they might sell their assets quickly to try and save their initial investments. If enough people do this, it can quickly plunge a country into an economic spiral that results in its currency's value being totally wiped out. Traders who remember the Asian financial crisis know this all too well.
Margin and Leverage Risks
When engaging in forex trading, you'll often have to put down a “margin” in order to begin trading. A margin is a form of collateral that ensures your ability to pay for the currencies you are trading. If the value of your trades changes by a large amount, you may receive what is known as a margin call, and you'll be expected to pay an extra margin. This can be quite dangerous under turbulent market conditions, as trading risks will often skyrocket as a result.
The size of your margin directly correlates with how much of a shift in prices you can handle. If you have put down a small margin, you'll be afforded a high degree of leverage, with the understanding that even small price fluctuations can trigger a margin call. A large enough movement can cause you to lose a substantial amount of money if your contract gets closed out. Conversely, large margins make it difficult for newer traders to “play the game,” but with a large margin you are able to withstand far greater price variations without necessarily losing your margin deposit. Professional traders generally put down large margins prior to trading, as the use of high leverage is generally considered to be too risky.
Being emotional is part of what it means to be human, but your feelings have no place in the forex market, as they can seriously damage your trading performance. If you allow bias and emotions to cloud your judgment, you'll find yourself placing disadvantageous trades and conjuring up hare-brained excuses to justify them. This is especially true with traders who keep thinking that their fast-sinking positions will suddenly make a miraculous comeback; they frequently fall victim to the “sunk cost” fallacy and wind up losing all of their money. Stick to the facts, base your decisions on logic, and you'll come out ahead in the long run. Always remember that acting on emotion within the markets is extremely risky and seldom results in anything but damage to your bottom line.
Currency trading is risky if you don't know what you are doing. Aggressive leveraging, emotion-based decision making, and ignorance of world affairs makes trading on the forex markets harder than it needs to be. Don't fall prey to the many pitfalls that plague currency traders around the world. Keep the above tips in mind and know what to watch out for, and your trades can prove to be very profitable in both the short term and the long term.
The information provided herein is for general informational and educational purposes only. It is not intended and should not be construed to constitute advice. If such information is acted upon by you then this should be solely at your discretion and Valutrades will not be held accountable in any way.