Is Forex Trading Right For You?

Is Forex Trading Right For YouLike that perfect pair of shoes beckoning from the shop window, sometimes you just know when something’s right for you. It’s instinctual and human, and we have all experienced the certainty of knowing something without the need for further investigation. Unfortunately, however, even if you’ve got the financial savvy to have had a measure of success in other investment arenas (whether in stocks, bonds or derivatives, for example), that’s no guarantee that your skill set will easily translate into forex trading success: whether forex trading is right for you is something that can’t just know, but rather must first thoroughly research before you commit to jumping in.

As a means of generating capital growth, foreign exchange trading is unique in its concepts, methodologies and risks. In order to determine whether trading in forex is a good fit for you, you must first become aware of these unique aspects so that you are better-qualified to predict whether your forex trading efforts are likely to bear fruit.

When experienced investors take stock of their portfolio, they’re reviewing the group of assets that they own.  It’s natural to think of assets and investments in terms of ownership, and the oversight and sale or retention of these assets is a key component of sound portfolio management. Conceptually, forex trading is very different, and does not fit the typical investment paradigm, because when trading forex, you’re not actually buying anything. If you’re used to trading stocks, whether small-cap or large-cap, you’re used to owning the shares and to enjoying all the resultant benefits of ownership (such as quarterly dividend checks or the contractual payments attached to preferred shares), and if benefitting from such perks is important to you as an investor, then trading forex may not be the right vehicle for you.  Forex trading involves taking a position in a pair of currencies, so that you can take advantage of movements in the exchange rates between the currencies in your chosen pair. As such, you are not actually buying the currencies, but rather are betting that the currencies in your pair will move in a particular direction against each other. Forex trading thus does not involve the purchase of an asset that can be counted as part of your investment portfolio but instead is a form of arbitrage—the taking advantage of price differentials to make a profit—simple enough for even the beginning trader to grasp.

It works like this: at today’s exchange rate of US $1.22 for 1 euro, it would take $1,220 to receive 1,000 euro; if the euro appreciates in value against the dollar to $1.34, and are turned back into dollars, it would pay $1,340, for a profit of 10% (prior to fees, commissions and the like). In actuality, however, when you place your forex order through a dealer, you’re not physically shorting the dollar and going long in the euro, rather, you’re committing your capital to entering into a contract for the purchase of euro and the sale of dollars, which you then hold until you change or liquidate your position. Your liquid assets—dollars—are converted into a contractual obligation. It’s that simple in theory, yet in practice, it takes a great deal of discipline, research and planning to know where to place your stop loss orders (the point below which your dealer is alerted to sell your position in order to minimize your losses) and, correspondingly, where to place your take profit points (at which your dealer implements your instructions to take your gains, turning your contract back into cash—hopefully, at a profit).

The fundamental methodologies utilized in forex trading also differ from those to which a forex newcomer may be used. Retail Forex traders must Is Forex Trading Right For Youplace their orders through a Forex broker who, in actuality, is not a broker per se (in the sense that he is neither regulated by any external authority nor licensed) but rather is a dealer. While this in itself is not necessarily cause for concern (indeed, despite their licensed status, we all are aware of unscrupulous or unethical bankers and stockbrokers), it may make a potential forex trader sufficiently uncomfortable to reject the notion of getting started in forex. Further, because profits are made through trading and not through ownership, a forex investor can only keep profits moving through continued trading, which because of the associated fees may wind up enriching the broker as much as the trader, if not more.  Another methodological distinction unique to forex trading is the position purchase function: in forex, you both buy and sell your position simultaneously, having no opportunity to separate the buy and sell functions into two discrete transactions. In this respect forex trading is not intended for the faint of heart.

While all forms of investing are by definition associated with a certain degree of risk, the risks associated with forex trading are also somewhat unique. Forex firms offer their retail clients an extremely high degree of leverage, and the lure of availing themselves of this easy leverage can be difficult for many investors to resist. In fact, while US forex firms are limited to offering a maximum leverage ratio of 50:1, many foreign forex providers offer their retail clients enormous leveraging opportunities, and it is not unusual to find firms willing to provide ratios as high as 500:1. Too many forex traders fail to recognize until it is perhaps too late that if your trade goes against you, you’re in it for the full leveraged amount; at such high ratios, then, a novice forex trader runs the risk of losing everything they’ve staked, and more.

A further risk unique to forex trading is the lack of price transparency. Unlike almost every other financial market, where prices are available to the retail investor through independent means, forex traders are dependent on their dealers for pricing information. This is true because foreign exchange prices are set by banks, who quote their prices to dealers; the dealers, in turn, quote the prices further down the line to their forex trading clients. Because the trader has no direct access to the bank, they have no insight into whether the price quoted by the dealer has been manipulated to increase the dealer’s spread, which serves as the fundamental source of his profits. The practice of increasing the spread quoted to the client is known as “leaning”, and while it is highly unethical, it is not illegal. This is one reason that forex traders have an extra burden to develop a relationship with a dealer based on trust and respect. Another reason that the dealer-trader relationship is of the utmost importance in forex is because forex brokers are not regulated by any agency and correspondingly, there is no investor protection akin to the sort made available by the SIPC or FINRA to victims of unscrupulous stockbrokers or stock brokerage firms. In forex, it’s all pure risk, making it critical that the forex trader feels completely comfortable with his choice of forex service firm.

It’s important to mention that many aspects of forex trading remain strikingly similar to investors who have a certain familiarity with trading in the stock markets. The performing of thorough research is critical to success in both, as is the ability to read charts and utilize tools and indicators as a means to predict price movements. In both kinds of trading, the retail client should be careful to only risk what they can afford to lose, and risk management is a crucial function that must be performed and considered on a daily basis. The importance of remaining emotionally detached and the ability to take a certain amount of losses in stride while simultaneously controlling the natural urge toward greed that might cause one to remain in a position for too long is identical whether one is trading forex or stock, as is the need to treat your on-going trading activities as a legitimate business venture, with concomitant levels of earnestness and professionalism. Indeed, for all of the differences, there are as many similarities between trading forex and trading in the stock markets and if you can shift your paradigm to include the unique nuances and aspects associated with forex trading, if you’re up for the challenge and game to delve into something familiar-yet-new, forex trading just may be right for you.

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