Foreign exchange trading

FX trades

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 trade. 

Warning

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 trading

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

""John 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 original investment.

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 entirely.

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 investment
  • 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 fraud.

Warning

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 providers

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 before investing.

You should also check that the forex provider you are thinking of dealing with has an Australian Financial Services Licence. ASIC Connect's Professional Registers will tell you if they do. Find out what an AFS Licence means.

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 forex website.

Is forex trading right for you?

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 functionality
  • Read the product disclosure statement and discuss the risks with your financial adviser
  • Be able to afford to lose more than the amount you invested 

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 platform.

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 licensed adviser.

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 call.


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Last updated: 07 Sep 2016