Despite the claims you may see on some FOREX web sites, the FOREX market is not risk-free. You are trading with substantial sums of money and there is always a possibility that trades will go against you. There, however, are several trading tools that can minimize your risk, and with caution, and above all education, the FOREX trader can learn how to trade profitably and while minimizing losses.
ScamsFOREX scams were fairly common a few years ago. The industry has cleaned up considerably since then, but you still need to exercise caution when signing up with a FOREX broker. Do some background checking – reputable FOREX brokers will be associated with large financial institutions like banks or insurance companies and they will be registered with the proper government agencies. In the United States brokers should be registered with the Commodities Futures Trading Commission (CFTC), Financial Industry Regulatory Authority (FINRA) or a member of the National Futures Association (NFA).
Whereas, in the Europe users need to check with various regulators depending from where a broker is operating, Financial Services Authority (FSA) for UK, (BAFIN) for Germany and other European Competent Authorities in the Netherlands, Hungary, Spain, Luxembourg, France, Poland. The resident of other countries must/can check with their local Consumer Protection Bureau, the Better Business Bureau or appropriate Regulatory Authorities.
- Investment opportunities 'too good to be true': Stay away from Forex trading opportunities that claim to make you rich overnight. Do not use your hard-earned savings or your retirement fund, or resort to mortgaging your house, to invest in these types of schemes. Chances are that you may never get your money back.
- Guaranteed profits or claims of unusually high performance: Anybody claiming to give you a regular 30% or 40% return per month is promising something that cannot be delivered. These claims of massive profits are likely to be false and are basically tactics to lure in your money.
- Downplaying of the risks involved with currency trading: Always be wary of statements claiming that a company or individual will recover your loses or that your investment will remain safe. Forex trading involves a high amount of risk, and you may end up losing all or part of your investment.
- Difficulty obtaining background information: Don't deal with anyone who won't readily give you their background information.
- Remittance of monies to a third party: An investor willing to use broker's trading system to trade his monies himself or by way of a money manager or third party must deposit his monies in an account opened in the investor's name with the broker or with one of its Partner Custodian Banks. Alternatively, the investor can ask his bank to issue a bank guarantee in favour of the broker. There is no other possible way.
RisksAssuming you are dealing with a reputable broker, there are still risks to FOREX trading. Transactions are still subject to unexpected rate changes, volatile markets and political events.
Break-Down Risk - is probability of a failure in the system, it can happen when one may not be able to enter new orders, execute running orders, or alter or cancel orders that were entered before. The result of such a failure may be a loss of orders or order priority.
Exchange Rate Risk – refers to the fluctuations in currency prices over a trading period. Prices can fall rapidly resulting in substantial losses unless stop loss orders are used when trading FOREX. Stop loss orders specify that the open position should be closed if currency prices pass a predetermined level. Stop loss orders can be used in conjunction with limit orders to automate FOREX trading – limit orders specify an open position should be closed at a specified profit target.
Interest Rate Risk – can result from discrepancies between the interest rates in the two countries represented by the currency pair in a FOREX quote. This discrepancy can result in variations from the expected profit or loss of a particular FOREX transaction.
Credit Risk – is the possibility that one party in a FOREX transaction may not honor their debt when the deal is closed. This may happen when a bank or financial institution declares insolvency. Credit risk is minimized by dealing on regulated exchanges which require members to be monitored for credit worthiness.
Country Risk – is associated with governments that may become involved in foreign exchange markets by limiting the flow of currency. There is more country risk associated with 'exotic' currencies than with major currencies that allow the free trading of their currency.