Foreign exchange trading
Foreign exchange (FX or forex) trading is when you buy and sell
foreign currencies to try to make a profit. This webpage outlines
the risks of this strategy.
Before you put your money on the line, you should find out how
forex markets and trading works, do extensive research and consider
getting professional financial advice.
What is forex trading?
Foreign exchange trading is when you attempt to generate a
profit by speculating on the value of one currency compared to
another. Foreign currencies can be traded because the value of a
currency will fluctuate, or its exchange rate value will change,
when compared to other currencies.
FX trading is normally conducted through 'margin trading', where
a small collateral
deposit worth a percentage of a total trade's value, is required to
Foreign exchange trading is complex and risky. Even the most
skilled and experienced traders have difficulty predicting
movements in currencies. Trading in international currencies
requires a huge amount of knowledge, research and monitoring.
Risks of foreign exchange
Most FX trading products are highly leveraged. This means you
only have to pay a fraction (for example, 0.5%) of the value of
your trade up-front, but you are still responsible for the full
amount of the trade.
Case study: John loses $2,800 in an FX trade
wanted to trade in forex and so he deposited $A3,500 with a margin
FX provider. John decided to buy $100,000 Australian dollars (AUD)
against US dollars (USD) at 0.9100, which was a contract worth
$US91,000. He paid a 0.5% margin of $A500.
Unfortunately the value of AUD against USD fell to 0.8850 and
John closed out his position, losing about $A2,825 (including the
margin of $A500 he paid). So out of his original $A3,500 he was
left with about $A675, less any transaction costs.
If John had not closed out this trade and the value of the AUD
against USD continued to fall, he may have had to meet a margin call and lose many times his
If John had arranged a guaranteed stop loss order with his
provider, this would have cost him a fee. The guaranteed stop loss
order would have closed him out of the trade at a certain price to
prevent further losses if the market moved against him. This may
have capped his losses but would not have covered them
Foreign exchange trading is also very risky because:
- There are significant investment risks as currency
fluctuations may move against you, causing you to lose
money. Exchange rates are very volatile - they tend to move
around a lot even within very short periods of time.
- Markets are open 24 hours a day 6 days a week (due to time
zones), so you need to devote a lot of time to tracking your
- Currency markets are extremely difficult to predict because so
many factors affect exchange rates
- Because most FX products are highly leveraged, even small
market movements can have a big impact
- Risk management systems such as stop loss orders, will only
give you limited protection by capping your losses. You may
have to pay a premium price to guarantee your stop loss order.
Read what the US Commodity Futures Trading Commission has to say
about foreign currency trading
Forex trading raises the stakes further by letting you trade
with borrowed money (leverage), but you'll be responsible for all
losses, which may exceed your initial investment. Margin FX trading
is one of the riskiest investments you can make.
Dealing with FX
Here are the risks you will take when dealing with foreign
exchange trading providers:
- You may take on 'counterparty' risks - the risk that the
provider won't be able to fulfil its obligations to you if
something goes wrong. For example, if your FX provider became
insolvent, you may be ranked as an unsecured creditor and have
difficulty getting your money back.
- You may not be able to make trades when you'd like to, because
of a lack of liquidity in the market, execution
risk, or other trading delays (this is explained in more
detail in the ASIC publication Thinking
of trading contracts for difference (CFDs)?
- The provider may advertise low or even zero fees and
commissions, but there is generally a profit margin or 'spread'
built into the exchange rates you'll trade at
- Promotional offers for 'free' and 'no loss' trades often have
strings attached. The offers may not be as good as they first
appear, so examine their terms and conditions closely before
committing your money.
- Technological problems may hamper your ability to trade
successfully. For example, there could be problems with your FX
provider's computer system or your computer system, or there could
be delays in information feeds.
Do your own checks
Different types of foreign exchange trading products involve
different risks so you should read the product disclosure statement carefully
You should also check that the forex provider you are thinking
of dealing with has an Australian Financial Services Licence. ASIC
Registers will tell you if they do. Find out what an AFS
If the provider does not have an AFS licence, make sure it is
regulated by an appropriate overseas authority (trading with these
providers may not give you recourse to Australian laws). See check an investment
company or scheme for more details.
Read ASIC media release warning about a fake
Is forex trading right for
To successfully trade you will need to have good knowledge of
foreign exchange, leverage, volatility and the conditions of each
country whose currency you are trading.
You will also need to predict how these conditions affect the
relative value of those currencies. This is extremely difficult as
so many factors come into play, including politics, economics and
market confidence, and these are unexpected, random events.
You will also need to:
- Know how FX works in detail
- Have lots of time to do research and monitor your trades
- Understand the online platforms used for trading and their
- Read the product disclosure statement and discuss the risks
with your financial adviser
- Be able to afford to lose more than the amount you
Foreign exchange trading
software programs, seminars and courses
There are also many software programs available for this type of
trading. They may claim their programs can let you know when to
make trades. Remember that no person or program can ever accurately
predict movements in foreign currencies.
Be wary of companies that say if you use a particular product
you will get access to better exchange rates or easy money. They
may let you trial their trading platform for free at first, but
this is usually just a teaser for you to buy the software or
A basic FX trading course or seminar will not give you
enough information to start trading. You should also do your own
research and consider getting separate financial advice from a
Foreign exchange trading is very risky even if
you have years of skill and experience in this type of trading. You
will need plenty of spare money if you have to cover a margin
Last updated: 07 Sep 2016