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Forex Trading: Risky Business
By: Ron King
You can see the claims on some FOREX web sites, implying that FOREX is a
risk-free pastime. No investment is risk-free.
In FOREX you are trading substantial sums of money, and there is always a
possibility that a trade will go against you. There are several trading tools
that can minimize your risk, yes, but eliminate it, no. With caution, and above
all education, the FOREX trader can learn how to trade profitably and minimize
loss.
The Scams
FOREX scams were fairly common a few years ago. The industry has cleaned up
considerably since then. Still, you should exercise caution before signing up
with a FOREX broker by checking their background.
Reputable FOREX brokers will be associated with large financial institutions
like banks or insurance companies, and they will be registered with the proper
government agencies. In the United States, brokers should be registered with the
Commodities Futures Trading Commission or a member of the National Futures
Association. You can also check with your local Consumer Protection Bureau and
the Better Business Bureau.
The Risks
Assuming you are dealing with a reputable broker, there are still risks to FOREX
trading. Transactions are subject to unexpected rate changes, volatile markets
and political events.
Exchange Rate Risk: refers to the fluctuations in currency prices over a trading
period. Prices can fall rapidly, resulting in substantial losses unless stop
loss orders are used (see below).
Interest Rate Risk: can result from discrepancies between the interest rates in
the 2 countries represented by the currency pair in a FOREX quote. This
discrepancy can result in variations from the expected profit or loss of a
particular FOREX transaction.
Credit Risk: is the possibility that 1 party in a FOREX transaction may not
honor their debt when the deal is closed. This may happen when a bank or
financial institution declares insolvency. Credit risk can be minimized by
dealing on regulated exchanges, which require members to be monitored for credit
worthiness.
Country Risk: is associated with governments that may become involved in foreign
exchange markets by limiting the flow of currency. There is more country risk
associated with "exotic" currencies than with major countries that allow the
free trading of their currency.
Limiting Your Risk
FOREX trading can be risky, but there are ways to limit risk and financial
exposure. Every trader should have a trading strategy; i.e., knowing when to
enter and exit the market, and what kind of movements to expect. Developing
strategies requires education, which is the key to limiting risk. At all times
follow the basic rule: Never use money that you cannot afford to lose.
Every FOREX trader needs to know at least the basics about technical analysis
and how to read financial charts. He should study chart movements and indicators
and understand how charts are interpreted. There is a vast amount of information
on FOREX trading available both on the Internet and in print. If you want to be
successful at FOREX, then educate yourself.
Stop-Loss Orders
Even the most knowledgeable traders, however, can't predict with absolute
certainty how the market will behave. For this reason, every FOREX transaction
should take advantage of available tools designed to minimize loss.
Stop-loss orders are the most common way to minimizing risk. A stop-loss order
contains instructions to exit your position if the price reaches a certain
point. If you take a long position (expecting the price to rise) you would place
a stop loss order below the current market price. If you take a short position
(expecting the price to fall) you would place a stop loss order above the
current market price.
Stop loss orders can be used in conjunction with limit orders to automate FOREX
trading. Limit orders specify that an open position should be closed at a
specified profit target.
About the Author:
Ron King is a full-time researcher, writer, and web developer. Visit
http://www.forex4u-now.com to learn more about this fascinating trading vehicle.
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