By Daniel Van Niekerk
Forex trading is not something I would get into purely because of the risks associated with it. Of course, every investment carries risk, but the risks of loss in forex trading contracts are bigger.
Once you decide to be a player in this market; you had better realise the risks involved to make informed decisions.
In forex, you are operating big sums of money and it is always possible that a trade may not go as expected.
The forex trader should know the tools of advantageous and careful trading to minimise losses. The only funds that should be used for speculating in foreign currency trading are funds that you can afford to risk without affecting your situation.
There are reasons why forex trading may or may not be a suitable investment for you as an entrepreneur.
The fraud and scams in forex market
It is wise to be cautious and to check a broker’s background before signing any documents with them. Reliable forex brokers work with big financial institutions.
In Uganda, forex traders should be licensed by Bank of Uganda and registered as a member of the Uganda Forex Bureau and Money Remittance Association.
The association, which currently has 106 members, disseminates information and enforces discipline and standards in the forex bureau and money transfer market.
There is risk of losing your whole investment!
You deposit an amount of money, called the “security deposit” or “margin”, with your forex dealer in order to buy or sell an off-exchange forex contract.
A small amount of money can let you hold a forex position many times bigger than the value of your account.
If the price moves in a non-preferable direction, this can bring you large losses compared to your first deposit. If noted in the contract with your dealer, you may also be required to pay extra-losses.
The market sometimes moves against you!
You will not 100% guarantee how exchange rates will move because the forex market is quite unsteady. Changes in the foreign exchange rate between the time you place the trade and the time you close it out influence the price of your forex contract and the future profit and losses.
There is no major marketplace
The forex dealer determines the execution price, so you are relying on the dealer’s honesty for a fair price. Unlike adjusted futures exchanges, in the retail off-exchange forex market, there is no main marketplace with lots of buyers and sellers.
You are relying on the dealer’s credit reliability. Funds deposited for trading forex contracts are not insured and never get a priority in case of bankruptcy.
There is a risk of the trading system break down!
Sometimes the system fails. If you are using Internet or any electronic system for executing trades. The result of a system failure may be a loss of orders or order priority.
There are risks with forex trading even if you work with a reliable broker. Transactions are vulnerable to unsteady markets and political events.
Interest Rate Risk is based on differences between the interest rates in the two countries represented by the currency pair in a forex quote.
Credit Risk is a possibility that one party in a forex transaction may not honor their indebtedness when the deal is closed. This can occur if a bank goes bankrupt.
Country Risk is connected with governments that take part in foreign exchange markets by limiting the currency flow. It is higher with “rare” currencies than with currencies of big countries allow free trading of their currency.
Exchange Rate Risk depend on the changes in prices of the currency during a trading period. Prices can go down quickly if stop loss orders are not used. There are several ways of minimising risks. Each dealer should have a trading scheme. For example, one should know when to enter and exit the market, what kind of fluctuations to expect.
The main rule for every trader is: “Don’t use money you can’t afford to lose.”
Every forex trader should know at least the main things about technical analysis and reading financial charts. He should also know chart movements and indicators and understand the schemes of chart interpretation.
Even the most experienced traders cannot foresee with absolute certainty how the market is going to change. Therefore, one should use these tools to limit losses during each forex transaction.
The simplest way of limiting risk is to use stop-loss orders.
A stop-loss order consists of instructions how to exit your position if the price comes to a definite point. If one takes a long position and expects the price to go up, he or she puts a stop loss order below the current market price. If one takes a short position and expects the price to go down, he or she puts a stop loss order over the running market price.
There are other, much safer investment options out there that can yield a good steady return. Unless forex really excites you and you have money you can afford to lose, I’d advise you to think about more sustainable options.
The writer is a private client adviser
AES International, Global Wealth Management