You may be eager to try Forex trading because you’ve heard of Forex traders making huge profits by trading currencies. And you’re right – some people are able to make lots of money Forex trading. In fact, there are hedge funds and institutions that rely heavily on Forex currency trading to make money, and they do very well at it. However, it has only been in the last few years that Forex trading has become popular with individual investors.
Forex Trading Risks
Margin and Leverage
The biggest risk of Forex trading is the leverage involved. If you are leveraged 1:100, or required to have a 1% margin requirement, you can have a $10,000 investment with only $100 actually in your account.
This can be great if you are riding a winner, but if interest rates change, or news events break, you could find your position underwater very quickly.
There are ways to avoid or minimize this risk. First, you can use a stop loss order to ensure that your position closes out if a certain value is hit. This can be especially useful in Forex trading since the markets are open almost 24 hours. You could find yourself with a profit at bedtime, and wakeup to see yourself underwater. A stop loss would prevent this.
Second, some Forex brokers allow instant margin calls. To prevent you from ever owing more than your account balance, if your loss reaches your margin amount, your position will be automatically closed to prevent further loss. While not as ideal as a stop loss, it can prevent huge losses.
Another risk is interest rate risk. If you are short a currency, you will be debited the overnight rate on that money. If you are long a currency, you will get a credit for the interest rate. Many traders invest solely in interest rates – called the carry trade. This can be highly profitable, but sometimes it can be risky. Governments could intervene, and you could find your trade to be a loss.