Forex trading is often perceived as glamorous and exciting since markets trade 24/7 and money exchanges hands around the globe at a high rate. But forex markets are unique among asset classes, and making money in currency trading requires a different skill set than trading stocks or bonds. Forex trading should be approached with caution, not recklessness. Here’s how to get started.
What is Forex Trading?
Forex trading is the trading of different currencies on an international market. Forex is short for foreign exchange, and it’s done by pairing different currencies and betting on the direction of their relative price movements. Currencies have floating values and respond to a variety of different geopolitical and economic factors.
Here’s how a forex trade works — an investor believes the U.S. dollar price will rise in relation to the euro. In this scenario, the investor will open a brokerage account with a forex broker and enter a long USD / short EUR position. All forex trades involve a short and long position depending on where the participants think the market is going. For this particular trade, if USD appreciates compared to EUR, the trade will be profitable. If USD declines in relation to EUR, the trade will lose money.
Forex markets are open 24 hours per day during the trading week (Monday through Friday), and leverage is often used to extract noteworthy profits, which means forex trading carries risks that traders unfamiliar with margin will need to understand before opening positions.
Understanding Forex Trading Risk and Reward
Forex trading can provide profits for traders of all experience levels and time frames, but it’s important to understand the risks that come with currencies. Assets like stocks and bonds don’t make the same types of moves as currencies, nor does a pair need to be involved in opening a position. Here are some of the major risks of forex trading.
Available Capital is Required
Plenty of forex trading is performed with borrowed money, but borrowing money can’t be the main source of capital for your forex strategy, especially if you’re just starting out. You’ll need a base of funds to draw from, and you shouldn’t be risking anything you can’t afford to lose. If you’re deep in debt or have high-interest credit cards needing payment, focus on those areas before diving into forex trading.
Forex is not a Get-Rich-Quick Scheme
Be cautious of anyone offering a path to quick profits through forex trading. Like trading stocks, forex trading requires strategy, experience and good fortune to succeed. It’s not a skill that can be learned overnight. If your plan is to get rich off a few months of trading currencies, you’ll likely be disappointed and searching for a way to recoup your lost capital.
Unexpected Events Affect Trading
When trading stocks, you can narrow your level of concern regarding news and world events and focus on the companies you invest in. For example, a troubled bank in Europe is unlikely to cause problems for an American healthcare company like UnitedHealth. But currencies are affected by all kinds of things happening worldwide. An unexpected shortfall in a wheat harvest, severe weather in an economically important area or a surprise election result in a neighboring country are just a few examples of events that can send shockwaves through currency markets. And unlike stocks, currencies are trading 24 hours a day during the week — losing money while you sleep is never a fun thing to think about.
Excessive Leverage Can Magnify Gains and Losses
If you look at the forex charts on Benzinga, it may seem like currencies frequently make inconsequential moves. Yes, a few fractions of a penny of USD here and there may not look like massive movements, but looks can be deceiving.
First of all, currency markets are massive, even larger than the U.S. stock market. Even a move of just a few fractions of a penny means that massive amounts of capital have changed hands. And secondly, forex traders use leverage to control larger positions than their actual capital allows. No matter how seemingly minor, every move can be devastating to a trader with improperly leveraged positions.
Platform or System Malfunctions
Forex brokers aren’t immune from technological malfunctions and unlike stock brokers, they don’t have the overnight downtime to update and reboot their systems. As seen with crypto brokers like Coinbase and Gemini, forex platforms sometimes enter maintenance or suffer malfunctions during volatile periods, which could leave traders unable to close out positions they wish to exit (or vice versa).
Asymmetric Risk to Reward
Forex traders need a plan of attack and ground rules on when to exit losing positions. One of the pitfalls many new traders suffer is holding onto losing positions too long in an attempt to get back to even. A big loss from an overextended position can wipe away the profits from multiple winning trades, so have strict rules about when to take profits and when to eat a loss on a bad trade.
Currency Market Volatility
Currency markets may look stable on the surface, but volatility does frequently occur, especially in the face of unexpected global events. The British pound suffered a drastic drop when the U.K. voted in favor of Brexit, sending many currency pairs to unexpected levels. When volatility and leverage are both present, traders must be cautious and monitor positions carefully.
Lack of Information Edge
Retail traders will always be at a disadvantage over larger trading firms when it comes to information. The real-time data that sophisticated market participants receive surpasses anything a novice trader will get searching through social media or news sites. Understanding your limitations is a must for new forex traders.
Potential Fraud and Market Manipulation
Unfortunately, market manipulation does happen in forex trading, and the scope in the past has been large. In 2013, Bloomberg reported that five different dealers spoke of large-scale market manipulations in currency trading perpetuated by multiple large banks.
The practice involved frontrunning client orders and cheating the 60-second benchmark windows. According to the dealers, the practice had been ongoing for multiple decades. In response, the British Financial Conduct Authority fined five banks nearly two billion pounds for infractions at their forex trading desks.
Trading OTC stocks is often seen as needlessly risky. Now imagine an entire market operating OTC — that’s the forex market. Despite being the largest financial system in the world, forex markets are largely unregulated and brokers don’t have clearing organizations or the same level of investor protection as regulated stock brokerages. Counterparty risk is something to consider when trading forex, especially in thinly-traded exotic currency pairs.
Compare Forex Brokers
Choosing the best forex broker for your trading style is one of the first steps to take. Some brokers are geared toward more experienced and sophisticated traders; others allow beginners to learn the ropes with simple platforms and limited trading pairs. Here are a few of our favorite forex brokers.
CedarFX is not regulated by any major financial agency. The brokerage is owned by Cedar LLC and based in St. Vincent and the Grenadines.
Frequently Asked Questions
Forex can be tough to learn and master since currencies move differently than traditional assets like stocks and bonds. Successful forex traders understand how to apply leverage and set rules to guide their trading habits.
Can I learn forex on my own?
Plenty of resources are available to teach yourself forex trading, including some right here on Benzinga. But learning forex will take time, and it’s never a bad idea to use a paper trading account to practice before jumping into the real thing.
Whether forex trading is a gamble depends on how a trader uses leverage. Making trades with lots of leverage and limited capital can certainly be considered a gamble, and many traders lose their shirts by taking on too much risk. But if you take the time to learn the market and develop a strategy, forex trading won’t feel like a night out at the casino.