While foreign exchange (forex) investing is a legitimate endeavor and not a scam, plenty of scams have been associated with trading forex. As with many industries, plenty of predators exist out there, looking to take advantage of newcomers. Regulators have put protections in place over the years and the market has improved significantly, making such scams increasingly rare.
- While foreign exchange (forex) investing is a legitimate endeavor, there are plenty of scams to watch out for.
- Some common examples of scams include churning and brokers who simply underestimate risk.
- Churning involves brokers who execute unnecessary trades for the sole purpose of generating commissions.
- Check the location of the brokerage's headquarters, and research how long it has been in business and its regulations.
What Is Forex Trading?
Foreign exchange trading involves the trading of pairs of currencies. For example, someone might exchange euros for U.S. dollars. In September of 2019, 1 euro ranged in value from about $1.09 to about $1.12. So, a trader who exchanged 100 euros for $112 when the value of the dollar is high could profit by exchanging those $112 for euros when the value of the dollar drops back to $1.09 per euro. Such a transaction would result in a net profit of less than 3%, which likely would be wiped out by the broker's commission.
Forex is a legitimate endeavor. You can engage in forex trading as a real business and make real profits, but you must treat it as such. Don't look at forex trading as a get-rich-overnight business, no matter what you may read in hyped-up forex trading guides.
Exchange rates are volatile and can go up or down unpredictably. When accounting for commissions brokers take from transactions, making money requires significant changes in exchange rates in favor of the trader. High profits are possible, but it's not a market where anyone should expect quick and easy cash.
What Makes a Scam?
Forex trading first became available to retail traders in the late 1990s. The first handful of years was wrought with overnight brokers that seemed to pop up and then close down shop without notice.
The common denominator was that these brokers were based in nonregulated countries. While some did take place in the United States, the majority seemed to originate overseas where the only requirement to set up a brokerage was a few thousand dollars in fees.
A distinct difference exists between a poorly-run brokerage, which isn't necessarily a scam, and a fraudulent one. Even a poorly run brokerage can run for a long time before something takes it out of the game.
Some common examples of scams investors should look for include churning and brokers who simply underestimate risk. Churning involves brokers who execute unnecessary trades for the sole purpose of generating commissions.
Additionally, some brokers often overestimate the ability of investors to make a lot of money quickly and easily through the forex market. They typically prey on new investors who don't understand that forex trading is what is known as a zero-sum game. When a currency's value against another currency gets stronger, the other currency must get proportionally weaker.
How to Avoid Being Scammed
The first step to take is to check the location of the brokerage's headquarters and research how long it has been in business and where they are regulated. The more the better.
If you feel you are being scammed, contact the U.S. Commodity Futures Trading Commission.
The simple act of finding out who you should call if you feel that you've been scammed, before investing with a brokerage, can save you a lot of potential heartache down the road. If you can't find someone to call because the brokerage is located in a non-regulated jurisdiction, this is usually a red flag and a sign that it's best to find more regulated alternatives.