The Risks of Trading on the Forex Currency Markets

Currency Trading Basics, Including Risks and Rewards

Foreign Currencies
Learn The Basics of Foreign Exchange Including Why Trading FX is Popular. Dimitri Otis/The Image Bank/Getty Images

The Forex, an acronym for "foreign exchange," is the world's largest financial market, trading nearly $2 trillion of world currencies daily. Currencies are traded by individual retail investors, financial institutions, and corporations doing business. Retail investors and banks trade to make profits and corporations often trade in the normal course of conducting business in different world markets.

 

How Is Currency Trading Done?

Retail currency trading is typically done through brokers and market makers. Traders place trades through brokers who, in turn, place corresponding trades on the interbank market.

Why Do Currency Values Change?

Currency values can change for many reasons. Sometimes they react to external political and economic news, such as Great Britain's proposed exit from the European Union.  At other times, value changes are driven by trading in the market itself. Often, both external and internal events drive currency value changes on the Forex.

When, for example, the U.S. Dollar is strong, companies in the United States may increase their purchases of European products, which have become correspondingly less expensive. To pay for these products, they exchange US Dollars for Euros. When large quantities of dollars are exchanged for Euros over a short period, the demand for Euros increases.

Consequently, the value of the Euro increases and the value of the US Dollar decreases. 

Is Currency Trading Risky?

Currency trading is typically highly leveraged. Moreover, the Forex is lightly regulated. Spot trades aren't regulated at all. Both factors increase the risk of Forex trading. The real key to success with currency trading is to trade conservatively while employing some means risk management.

Almost all novice traders should begin trading on a practice trading platform that allows them to make hypothetical trades without risking their investment capital. When and if they see positive results, they can begin trading on the Forex itself. 

Who Trades Currencies?

Currencies are traded by individual retail investors, financial institutions, and corporations doing business. Retail investors and banks are trading to make profits and corporations usually trade in the normal course of the international business process.

How Do Successful Traders Trade Forex?

Typically, traders who make only a few concentrated large trades are more apt to lose money. On the other hand, traders who distribute their trading funds over many different trades diversify their risk and have a better chance of trading profitably. Similarly, traders who leverage their trades aggressively are more likely to have large losses than those who don't. 

Nevertheless, according to a 2014 Bloomberg report, almost 70 percent of Forex traders lost money in each of the preceding four quarters. Unsurprisingly, data compiled by the National Futures Association, a Forex self-regulatory institution similar the stock market's FINRA, shows that most retail Forex traders drop out after about four months.

 

Making money trading on the Forex isn't impossible, but it's difficult. Advisable practices include:

  • begin trading with a practice account
  • diversifying risk by making several small trades in different markets rather than a single trade.
  • using stop loss orders to limit potential losses
  • avoid using the available leverage, which can exceed 50 to 1. At 50 to 1 even a two percent difference going against your trade results in a total loss of all invested funds.