Trading the forex market and the risks involved
The forex market has advanced substantially the past few years and brokers have found way to provide retail traders with tools that used to be exclusively used by major banks and financial institutions. In fact, even a complete beginner can open an account and start trading within a few minutes.
A forex trading account usually gives you access to a treasure trove of educational materials and resources to familiarize yourself with the forex market and your broker’s offering of trading platforms and other market analysis tools.
However, while starting out might be considered easy, developing a consistent trading strategy is where most forex traders give up. Because even if you find the most favorable currency pairs to trade and a way to achieve short-term profitability, the market suffers from unpredictable bouts of volatility which presents a significant amount of risk.
If you can’t find ways to manage your risk exposure and mitigate your losses, no amount of winning trades will save your account from being wiped out eventually. A successful trader is determined by the number of losses he can sustain and not the percentage of his profits.
Forex market benefits
Online forex trading refers to the exchange of a currency for another at the predetermined market price. Due to the large number of participators in these daily currency exchanges, the forex market is the largest financial market in the world. This huge trading volume provides its own set of advantages for forex traders because there’s so much liquidity in the market that trades are executed in milliseconds and the trading costs are fairly competitive.
If you are wondering why so many traders prefer trading forex, it’s probably a combination of the reasons listed below:
- Around-the-clock trading: Since trading in the forex market is facilitated through major international banks, you can essentially trade around the clock except during the weekend and certain bank holidays. Of course, there are specific times when the market is much more active and some currencies are traded more than others. Put simply, each region has its own trading session (London, New York, Sydney, Tokyo) which indicates when traders in the region are more active. Higher activity means larger price movements and better market opportunities. Therefore, knowing the times these trading sessions open and close is essential in identifying which currencies are more widely traded in each region.
- No hidden fees or commissions: When you are trading forex, you speculate on the movements of exchange rates between currencies in a network of other buyers and sellers. Due to the decentralized nature of the market, you don’t need to pay any fees or commissions for your trades besides a minor upfront spread which is paid to your broker as compensation for facilitating each trade.
- Competitive terms: Transaction costs remain extremely low because of the huge trading volume and number of participators in the market. However, each forex broker offers different trading terms and conditions, and some may be more beneficial than others. Also, forex can be traded on leverage which can increase your buying power. For example, a deposit of $1.000 can be used to buy $100.000 unites of currency – depending on the leverage ratio provided by your broker. Using leverage can magnify your profits but it also increases your risk exposure since small price movements can translate to heavy losses as well.
Why managing risk is so effective
A large percentage of forex traders give up in their first year simply because they don’t take into account that the market changes its rhythm quite frequently. There are prolonged periods of time where a currency pair may increase in value but then it suddenly may start sinking for no apparent reason.
If you don’t develop your trading strategy around the fact that some or most of your trades might end up failing to predict the market, you are going to start running out of money sooner rather than later. Therefore, veteran traders focus on minimizing their losses instead of increasing their profit margins. Following a set of clearly defined risk management rules might not deliver the profits you aim for in a month’s time, but it will guarantee that you don’t run out of capital within your first year of trading.
Risk management tips
One of the best methods in mitigating risk when trading forex is to calculate the size of your position or how many lots you are willing to trade beforehand, as well as the leverage amount you are comfortable with undertaking. Trading with smaller lot sizes and lower leverage significantly reduces your risk exposure in the market which is much more important than risking your entire capital for extra profit.
Another way you can prepare for increased volatility in the market – a particularly risky time to trade – is to forfeit trading during important economic announcements. While most traders anticipate important market events in order to profit from the increased movements in the market, the volatility created by the uncertainty instigated by these events is extreme enough to move the price of currencies significantly. In turn, the market may move in the opposite direction of your position and wipe out your trade within seconds.
Trading during extreme market events is favorable for experienced traders who can expect how the market will react, but beginner and conservative traders are highly advised to refrain from trading completely. If you are wondering how you can anticipate for these important announcements and other key market events, you can consult an economic calendar which you can find on your broker’s website and third-party providers such as FXStreet or Investing.com.