Foreign Exchange Risks and Benefits
When deciding whether or not to make any investment, it’s absolutely critical to have a firm understanding of the risks and benefits that are involved in that investment. While most people are familiar with the basic risks and benefits involved in stock trading, the Forex, or foreign exchange, market is a very different investment environment. Here are the basics of risk and reward in Forex trading.
Trading in the Forex market carries a risk profile that is almost entirely unique. While the fact that national currencies are unlikely to lose all of their value makes it, to some degree, a secured investment, the fluctuations in currency values over time can result in substantial losses. Since Forex is based on the value of one currency relative to another, it is also important to consider how changes in relative value can result in loss, even if neither currency necessarily moves against a given position individually.
Probably the most unique component of the Forex market’s risk is the degree to which many Forex trades are leveraged. With 400:1 leverage not being particularly unusual on Forex brokerage sites, leverage plays an important role in how much money can be lost on any one Forex trade. If a highly-leveraged Forex trade turns against you, it is possible to lose a large amount of money fairly quickly. Also keep in mind that, when a leveraged position doesn’t turn a profit, you will be the one paying for the losses, not the brokerage that helped you to leverage the trade.
Looking at the risks, some of you might be getting a little pessimistic about Forex trading. Don’t decide against it just yet, though, because the benefits of Forex are also very high. To start with, the Forex market is one of the only trading environments in which economic downturns, bad jobs reports or other marketplace occurrences won’t affect the ability of traders to turn a profit. While these will affect how different currencies perform, they will not rob the Forex market of the ability to produce a return for investors. This separates Forex trading from standard equity investment, such as the stock market, in which a sufficiently large downturn can cut or eliminate returns for months or even years at a time.
The largest producer of risk in Forex is also the largest producer of reward. Though leverage can cause you to lose money on unsuccessful trades, it also makes your successful trades vastly more profitable than they could ever be without it. Leverage is the multiplier that makes it possible to realize good earnings in the Forex market. Without it, the typical small fluctuations between currency prices would be hard to turn a reasonable profit on.
Risk vs. Benefit: Is Forex Worth It?
Weighing the risks and the benefits of Forex trading, it is clear that this particular form of investment probably isn’t for the most risk-averse investors out there. For risk-tolerant investors, however, it can produce excellent results over time. The key to success in Forex trading is to learn both economic and technical analysis. If you can predict how economic events will affect currency values and combine that insight with technical analysis of price trends, you will stand a good chance of becoming successful in Forex investment.
At the same time, it’s important to have realistic goals for your Forex trading. Many traders learn about Forex from sites that promise huge gains. Although large returns can be had on individual trades, you need to realize that you will not win on every position, no matter how adept you become as a trader. The losses you will incur need to be a part of your expectation of Forex trading in order for that expectation to be in any way realistic. With that being said, there are Forex traders out there who reliably beat the stock markets by making returns of 20-30 percent or more annually on their investments.
Can You Limit Forex Risk?
Another key part of the risk and reward balance of Forex trading is whether or not any given trader takes adequate steps to limit risk. Some traders, especially those who are less experienced, tend to jump into trades without a risk management plan, especially if they have had good luck early on and seen some very sizeable returns without much in the way of losses. However, no matter how well your first few trades may go, risk management is still crucial to ensure that you make money with Forex in the long run.
There are several different ways to limit your overall risk in the Forex marketplace. The first is using the stop loss trading feature that almost all brokerage sites offer. Using a stop loss, traders can set a point of acceptable loss beyond which the position will automatically close. While this doesn’t eliminate the possibility of loss altogether, it does allow traders to control how much capital they can lose on any given position.
Another good way to limit Forex risk is to only risk small percentages of your total capital in any given trade. As a general rule, 1-2 percent of your overall capital in any one trade is considered a reasonable risk amount, with anything more than 5 percent offering too much risk for capital loss.
Forex as Part of a Portfolio
From its high-risk, high-return nature, it should be fairly obvious that Forex trading is more of an income-producing investment than a long-term growth investment. This is why Forex trading is an excellent option for making up the higher-risk end of a diverse investment portfolio. However, it’s still important to have other investment options in your portfolio that are in a lower risk range. The more you diversify, the better the total results of your investment will be.
Though Forex trading is considered to be one of the higher-risk forms of investment out there, the potential rewards make it more than worth it for investors who are comfortable with risk. Be sure to manage your risk wisely and to diversify your investments, and you’ll be able to make Forex trading work as a profitable part of your overall investment plan.