How to exchange money for traders and webmasters without risks

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7 Risks in Foreign Exchange Market

Foreign exchange market (Forex) is the biggest challenge a market can offer you. With its average traded value of approximately $383 billion per day, Forex market surpasses by far any other market out there, including the stock market.

There are many opportunities Forex puts at your disposal, but there is also a great deal of responsibility whenever you play this game. Assets are volatile 24 hours a day, so certainty has no place in this world. However, there are seven main currency risks that you can avoid. Let’s see the stages of your Forex activity requires more caution from your side.

1. Interest Rate Risks

Your main focus in dealing with the Forex risks should be the interest rate. The interest rate is influenced by the 8 global central banks, which base their decisions on external economic indicators (The Consumer Price Index, Consumer Spending, Employment Activity, Subprime Market or Real Estate Sales). Follow Economic Calendar .

The higher the interest rate, the higher the profit. However, currency fluctuation has a volatile nature, and this is your risk point. Predictions are not equal to certainties, and your large bet can be lost by dramatically weakened currency.

2. Country Risk

Currency risks depends a lot on the economic phenomena a country goes through. Before investing in your chosen currencies, you should research the level of stability of the country in question. Any feeble rumor which concerns the economic aspect of a country has great power. The investors can withdraw their assets whenever they want from the Forex market under the pressure of even the thought of losing them, triggering a domino effect. More and more investors will consider retreating a safe strategy, hence a rapid decrease in currency value.

3. Transaction Risk

Due to the unpredictable fluctuation of the Forex market, the currency values can experience a sudden change any moment of the day, and it won’t take your contract regulations into account. As long as the exchange market has a capricious nature, you won’t be safe from risks. Individuals and companies must assume the risk of paying substantial transaction costs that are likely to occur between the moment their contract is decided and the moment their contract is activated.

4. The Risk of Ruin

The risk of ruin can become a reality whenever there is risk-reward ratio bigger than 3:1. That is, however, a too limited safety measure, but beyond this ratio you are hunted by great risks. For the binary options it means that if income percent goes lower 50%, you are taking big risks. The risk of ruin intervenes in any emotional activity. Thus, this makes the risk of ruin a reality in the foreign exchange market.

In order to minimize this risk, it is recommended to resort to diversification. Don’t place your assets on a single bet. This strategy allows you to cross some boundaries, but only on educated guesses also.

5. Settlement Risks

As the rules of Forex market depend on the 8 global central banks, the settlement risk plays an important role in your trading activity. The settlement risk is a side effect of the time zones of different continents. During the same trading day, the same currencies can be found at different prices. So, your success does not depend only on choosing a good day for your chosen currencies, but also a specific moment of that day.

6. Dictatorship Risk

This is when a government uses its influence to interfere directly in the Forex marketplace. It’s why it is important to also have a strong cultural knowledge of the world’s history. Even though this risk is the least probable one from this list due to the fact that all major currency markets are located in U.S., you should still pay great attention to worldwide events.

7. Technical risks

Most of the trading platforms nowadays are online to facilitate the access to anyone to the Forex market. However, no matter how many benefits the Internet provides us, we shouldn’t rely 100% on it. A low Internet disconnection or a website maintenance procedure might be the difference between winning and losing your assets.

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All in all, these are the seven main risks of trading that you should take into account in your decision-making process. Once you strike a balanced connection between the risks you are facing and the opportunities you can take advantage of, you are ready to start your investment.

Author Bio

Charles Leworthy is a Denver-based financial analyst and contributing editor at ForexBinary101. He is passionate about economics, and after studying the great works of Adam Smith, John Maynard Keynes or Milton Friedman, he decided to pursue a career in the field. He is now focused on the capital market, stocks, bonds, and other types of investments.

NOTE: This article is not an investment advice. Any references to historical price movements or levels is informational and based on external analysis and we do not warranty that any such movements or levels are likely to reoccur in the future.
In accordance with European Securities and Markets Authority’s (ESMA) requirements, binary and digital options trading is only available to clients categorized as professional clients.

GENERAL RISK WARNING

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage.
87% of retail investor accounts lose money when trading CFDs with this provider.
You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

Risks And Benefits Of Foreign Exchange Trading

While foreign currency trading has the potential to make a lot of money, it also has some inherent risks like other asset classes. This section will take you through various benefits of forex trading as well as various risks associated with it. In addition, we are also going to discuss various differences between equity and forex market to help you understand the inner workings of forex market.

Pros and Cons of Forex Trading

In the previous sections, we have already covered various factors including volatility, global structure as well as size of the forex market that have all contributed to its popularity. The highly liquid nature of foreign exchange market allows investors to trade extremely large amounts without affecting the underlying exchange rate. Most of the brokers in this industry allow traders to trade at a low margin and this is the reason that traders can take big positions in this market.

For instance, a trader can create a position of US$100,000 by making a deposit of only US$1000 up front as the rest is lent to him or her by the forex broker. Easy availability of huge leverage has made this market extremely attractive for speculators. However, huge leverage offered by forex brokers should be used judiciously. It is a double-edged sword as it allows investors to make big gains while investing a small amount but it also has the potential of massive losses when the market moves against the trader.

Another advantage of foreign exchange market is that it is open 24 hours a day and there is decent liquidity for major currency pairs throughout the day. In fact, it is the only market that operates at all times. This makes it an optimal market for traders who have a busy schedule or a day job. The major trading hubs in the currency trading market are spread across various time zones which mean that a trader does not need to wait for opening or closing to trade. When markets in the east are closing, the US market opens allowing traders to transact throughout the day.

Huge leverage and 24-hour operations make forex market exciting for investors but it is also risky when compared to trading in equities. Ultra high leverage in the foreign currency trading market also means that big profits can quickly turn into huge losses and your account may be completely wiped out within a matter of minutes.

New traders in the forex market need to understand that there are a lot of players in this market and those players bring huge money with them. Huge liquidity in the forex market also means that the currency prices move sharply whenever any new information is released into the market as serious players react quickly to any significant news.

As far as the movement in currencies is concerned, these do not tend to move quickly when compared to equities but the availability of huge leverage in the spot trading market results in volatility. On the other hand, bad news can lead to huge loss of valuation in case of equities.

For instance, if you invest $1000 in the forex market and have a leverage of 100:1, you have a trading capital of $100,000. If the market moves against you by just 1%, the value of the trade will decrease to $99,000 which means that you will lose $1000. In other words, your investment is completely wiped out or you have lost 100% of your capital.

Equities market work in a different manner as most of the traders in that market do not use leverage. So, when they make a bet of $1000 in the equity market and the market moves 1% against them, they will lose only $10. Therefore, it is extremely important for beginners to understand the risks involved in the forex trading before they decide to begin.

Differences in the Forex and Equity Market

One of the biggest differences between equities and forex market is the availability of traded instruments. For instance, there are thousands of stocks available for trading in the equities market whereas only a few currency pairs are regularly traded on the forex market. Most of the forex traders trade in seven different currency pairs of which four are labeled majors including USDJPY, USD/CHF, GBP/USD and EUR/USD. The three others are labeled commodity pairs and these include USD/CAD, NZD/USD and AUD/USD. Other currency pairs are also available for trading but they are just different combinations of these currencies and are known as cross currencies. Limited number of traded instruments in the forex market makes it easier to follow as compared to choosing gems in equities with more than 10,000 options. The only thing forex traders need to do is to keep up to date on political and economic news of eight countries.

Another major difference between these markets is that there is often a lull in the equities market that leads to low volumes and activity. This makes it hard for traders to open and close positions when they desire. Also, it is extremely difficult for an equities investor to make money in a declining market. Short selling equities in the US equities market is a difficult process as there are a number of strict rules and regulations governing this process.

On the other hand, a trader can easily make money in the forex market with both rising and declining currencies. In forex, buying and selling happens simultaneously which means that short selling is an inherent feature of forex trading. Also, huge liquidity in the forex market means that traders do not need to wait for the rates to move up before shorting as is the case with equities market.

Extreme liquidity in the forex market also ensures high leverage and low margins. On the other hand, equities market cannot offer such low margin rates. In fact, investors typically need to deposit at least 50% of the value of the trade with their broker before they are allowed to trade on margin. Most of the forex traders can trade up to 100 times their investment.

Forex market also has much lower commissions as compared to the equities market. In case of equities, traders often need to pay a commission fees to the brokers in addition to the spread along with the fees to the exchange. On the other hand, brokers make their money only from the spread in the spot forex trading market and there are no other fees.

Top Reasons Forex Traders Fail

The forex market is the largest and most accessible financial market in the world, but although there are many forex investors, few are truly successful ones. Many traders fail for the same reasons that investors fail in other asset classes. In addition, the extreme amount of leverage – the use of borrowed capital to increase the potential return of investments – provided by the market, and the relatively small amounts of margin required when trading currencies, deny traders the opportunity to make numerous low-risk mistakes. Factors specific to trading currencies can cause some traders to expect greater investment returns than the market can consistently offer, or to take more risk than they would when trading in other markets.

Forex Market Trading Hazards

Certain mistakes can keep traders from achieving their investment goals. Following are some of the common pitfalls that can plague forex traders:

  • Not Maintaining Trading Discipline: The largest mistake any trader can make is to let emotions control trading decisions. Becoming a successful forex trader means achieving a few big wins while suffering many smaller losses. Experiencing many consecutive losses is difficult to handle emotionally and can test a trader’s patience and confidence. Trying to beat the market or giving in to fear and greed can lead to cutting winners short and letting losing trades run out of control. Conquering emotion is achieved by trading within a well-constructed trading plan that assists in maintaining trading discipline.
  • Trading Without a Plan: Whether one trades forex or any other asset class, the first step in achieving success is to create and follow a trading plan. “Failing to plan is planning to fail” is an adage that holds true for any type of trading. The successful trader works within a documented plan that includes risk management rules and specifies the expected return on investment (ROI). Adhering to a strategic trading plan can help investors evade some of the most common trading pitfalls; if you don’t have a plan, you’re selling yourself short in what you can accomplish in the forex market.
  • Failing to Adapt to the Market: Before the market even opens, you should create a plan for every trade. Conducting scenario analysis and planning the moves and countermoves for every potential market situation can significantly reduce the risk of large, unexpected losses. As the market changes, it presents new opportunities and risks. No panacea or foolproof “system” can persistently prevail over the long term. The most successful traders adapt to market changes and modify their strategies to conform to them. Successful traders plan for low probability events and are rarely surprised if they occur. Through an education and adaptation process, they stay ahead of the pack and continuously find new and creative ways to profit from the evolving market.
  • Learning Through Trial and Error: Without a doubt, the most expensive way to learn to trade the currency markets is through trial and error. Discovering the appropriate trading strategies by learning from your mistakes is not an efficient way to trade any market. Since forex is considerably different from the equity market, the probability of new traders sustaining account-crippling losses is high. The most efficient way to become a successful currency trader is to access the experience of successful traders. This can be done through a formal trading education or through a mentor relationship with someone who has a notable track record. One of the best ways to perfect your skills is to shadow a successful trader, especially when you add hours of practice on your own.
  • Having Unrealistic Expectations: No matter what anyone says, trading forex is not a get-rich-quick scheme. Becoming proficient enough to accumulate profits is not a sprint – it’s a marathon. Success requires recurrent efforts to master the strategies involved. Swinging for the fences or trying to force the market to provide abnormal returns usually results in traders risking more capital than warranted by the potential profits. Foregoing trade discipline to gamble on unrealistic gains means abandoning risk and money management rules that are designed to prevent market remorse.
  • Poor Risk and Money Management: Traders should put as much focus on risk management as they do on developing strategy. Some naive individuals will trade without protection and abstain from using stop losses and similar tactics in fear of being stopped out too early. At any given time, successful traders know exactly how much of their investment capital is at risk and are satisfied that it is appropriate in relation to the projected benefits. As the trading account becomes larger, capital preservation becomes more important. Diversification among trading strategies and currency pairs, in concert with the appropriate position sizing, can insulate a trading account from unfixable losses. Superior traders will segment their accounts into separate risk/return tranches, where only a small portion of their account is used for high-risk trades, and the balance is traded conservatively. This type of asset allocation strategy will also ensure that low-probability events and broken trades cannot devastate one’s trading account.

Managing Leverage

Although these mistakes can afflict all types of traders and investors, issues inherent in the forex market can significantly increase trading risks. The significant amount of financial leverage afforded forex traders presents additional risks that must be managed.

Leverage provides traders with an opportunity to enhance returns. But leverage and the commensurate financial risk is a double-edged sword that amplifies the downside as much as it adds to potential gains. The forex market allows traders to leverage their accounts as much as 400:1, which can lead to massive trading gains in some cases – and account for crippling losses in others. The market allows traders to use vast amounts of financial risk, but in many cases, it is in a trader’s best interest to limit the amount of leverage used.

Most professional traders use about 2:1 leverage by trading one standard lot ($100,000) for every $50,000 in their trading accounts. This coincides with one mini lot ($10,000) for every $5,000 and one micro lot ($1,000) for every $500 of the account value. The amount of leverage available comes from the amount of margin that brokers require for each trade. Margin is simply a good faith deposit that you make to insulate the broker from potential losses on a trade. The bank pools the margin deposits into one very large margin deposit that it uses to make trades with the interbank market. Anyone that has ever had a trade go horribly wrong knows about the dreadful margin call, where brokers demand additional cash deposits; if they don’t get them, they will sell the position at a loss to mitigate further losses or recoup their capital.

Many forex brokers require various amounts of margin, which translates into the following popular leverage ratios:

Margin Maximum Leverage
5% 20:1
3% 33:1
2% 50:1
1% 100:1
0.5% 200:1
0.25% 400:1

The reason many forex traders fail is that they are undercapitalized in relation to the size of the trades they make. It is either greed or the prospect of controlling vast amounts of money with only a small amount of capital that coerces forex traders to take on such huge and fragile financial risk. For example, at a 100:1 leverage (a rather common leverage ratio), it only takes a -1% change in price to result in a 100% loss. And every loss, even the small ones taken by being stopped out of a trade early, only exacerbates the problem by reducing the overall account balance and further increasing the leverage ratio.

Not only does leverage magnify losses, but it also increases transaction costs as a percent of the account value. For example, if a trader with a mini account of $500 uses 100:1 leverage by buying five mini lots ($10,000) of a currency pair with a five-pip spread, the trader also incurs $25 in transaction costs [(1/pip x 5 pip spread) x 5 lots]. Before the trade even begins, he or she has to catch up, since the $25 in transaction costs represents 5% of the account value. The higher the leverage, the higher the transaction costs as a percentage of the account value, and these costs increase as the account value drops.

While the forex market is expected to be less volatile in the long term than the equity market, it is obvious that the inability to withstand periodic losses and the negative effect of those periodic losses through high leverage levels are a disaster waiting to happen. These issues are compounded by the fact that the forex market contains a significant level of macroeconomic and political risks that can create short-term pricing inefficiencies and play havoc with the value of certain currency pairs.

Conclusion

Many of the factors that cause forex traders to fail are similar to those that plague investors in other asset classes. The simplest way to avoid some of these pitfalls is to build a relationship with other successful forex traders who can teach you the trading disciplines required by the asset class, including the risk and money management rules required to trade the forex market. Only then will you be able to plan appropriately and trade with the return expectations that keep you from taking an excessive risk for the potential benefits.

While understanding the macroeconomic, technical and fundamental analysis necessary for trading forex is as important as the requisite trading psychology, one of the largest factors that separates success from failure is a trader’s ability to manage a trading account. The keys to account management include making sure to be sufficiently capitalized, using appropriate trade sizing and limiting financial risk by using smart leverage levels.

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