5 Risks That The Novice Forex Trader Should Be Aware Of
Just like many other forms of trading, foreign currency trading carries risks and the novice foreign currency trader needs to be aware of these before dipping a toe into the foreign exchange pond. Here we look at the 5 most common risks of foreign currency trading.
1. Forex scams. In recent years the industry has done a great deal to put its house in order and today Forex scams are unquestionably a lot less common than they used to be. However, they do still happen.
It is relatively easy to open a Forex trading account, particularly using the Internet, and a Forex scam is simply a case of a crook setting up a website pretending to be a broker, inviting you to create an account and deposit money into it and then disappearing without a trace.
To ensure that you are not caught out you need to check out any broker very carefully before opening an account. Select a broker who is associated with a major financial institution (like a bank or insurance company) and who is also registered as a broker. In the US brokers will be either registered with the Commodities Futures Trading Commission (CFTC) or will be a member of the National Futures Association (NFA).
2. Exchange Rates. One of the appeals of the foreign exchange market is that it can be tremendously volatile with currencies moving a lot against one another in very short time periods leading to fast and considerable gains. However, the other side of the coin is that the volatility in the market also produces sizeable and rapid losses.
Luckily there are tools available to the trader to help to limit this risk and novice traders should familiarize themselves with these tools and ensure that they make full use of them whenever they enter a trade.
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3. Credit Risk. As there are two parties (a buyer and a seller) taking part in every transaction there is a chance that one party will fail to honor his commitment once a deal is closed. Usually this happens where a bank or financial institution declares insolvency.
It is possible to reduce any credit risk considerably by trading only on regulated exchanges which require members to be monitored to ensure their credit worthiness.
4. Interest Rate Risk. Whenever trading any pair of currencies you need to look for discrepancies between the underlying interest rates in the two countries involved because a discrepancy can result in a difference between the profit predicted and the profit which is actually received.
5. Country Risk. Occasionally a government will intervene in the Forex markets to limit the flow of its country’s currency. It is unlikely that this will take place for a major world currency but might occur in the case of minor and less often traded currencies.
Of course, these are merely some of the risks involved in foreign exchange trading and novice traders will have to acquaint themselves with the others as they go along. Nonetheless, a sound understanding of the risks explained here is essential before you begin trading.
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