Trading the forex market can be highly profitable for the disciplined and determined trader. However, there are dangers in trading Forex. In this article we explain what these dangers are and how you can side step them.
The forex market offers much opportunity to benefit from the fluctuation in prices of currency pairs. Similarly there are some attending dangers in trading the forex market. Among those forex market dangers are: the risk of central bank intervention, trading an un-diversified basket of currencies and getting a margin call as a consequence of using too much leverage.
One of the biggest draws for investing when thinking of trading the forex market is the high leverage that is offered by forex brokers. In some cases, brokers offer leverage (margin facilities) in excess of 200:1. A trader who uses such a centre will be able to write a trade for an amount of up to 200 times the free cash in his or her trading account. For example, with only $1, 000 in a margin account a trader will be able to open a trade for up to $400, 000.
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Using a margin facility allows the trader to maximise the chance of making big profits from small moves in the market. The problem with highly leveraged accounts is that they also magnify trading losses, particularly in the forex market where the market can move quite quickly. Depending on how much leveraging you’re using, your forex broker will enable you to incur a certain amount of unrealized loss, beyond which they’ll close all your trades, leaving you with a huge loss. As an example, using a 50:1 leverage will cause you more than 50% in losses after a margin call, should you not use a stop loss and good money management.
How to side step this risk – Margin calls are among the biggest Forex market dangers that day traders can encounter. However, they can avoid margin calls by keeping their trading leverage below 3:1. If you use higher leverage it may just give the advantage to the marketplace and your forex broker. Fast money has its pitfalls. However, timely growth is tried and true.
Sometimes huge exchange rate moves can be expected or even predicted; in other instances it is not possible to do so. An example of this would represent an instance where a central bank intervenes in the market to affect the exchange rate of its currency. In some cases a central bank may use rhetoric to accomplish its goals, but when talk fails it may take decisive action such as changing its monetary policy and/or directly intervene in the market.
A central bank will not always let the market know what it’s going to go before it actually makes a move, for obvious reasons. The danger to forex traders is that such a step can completely upset the way exhange rates are behaving, including invalidating all technical analysis and previous tendency of the currency pair involved. In a worse case scenario, a central bank’s intervention can result in a trade to go against the trader by a huge margin and without warning. Figure 1 shows a rapid price reversal that occurred when the Swiss Central bank decided to intervene in the Market (March 2009), to halt the unrelenting appreciation of its currency against the Euro.
How to side step this risk – Your best protection against this risk is good money management, I.e. use a stop loss at all times and never over leverage your account.
On the next page we conclude by taking a look at two other forex market dangers, namely: news release surprises, overnight events and trading an un-diversified portfolio of currency pairs.
This article highlights some of the Forex market dangers and risks that day traders will encounter. They include: new release surprises, overnight market events and trading an un-diversified portfolio of currency pairs.
At other times surprises can come by way of better or worse than expected economic data. By and large, market participants will be completely informed as to when economic data is attributed to be released and he’ll be able to plan their trading activities around such events.
Even when new release dates and their times are known, the actual data and rhetoric for the government has a way of surprising the market from time to time. This can be an issue, especially for new traders, who’re often completely unaware of the effects certain news events can have on the price movements of currency pairs. It isn’t uncommon for a new trader to sit before the trading station wondering why the market is suddenly going against the newly entered trade position so quickly and by such a great amount.
How to side step this risk-No serious Forex trader will start a trading day without knowing what economic data is attributed to be released and which market shaker and mover is due to speak and for how long. DailyFX provides a free, and a near comprehensive economic, calendar that shows the scheduled economic release for all the major economies. It also rates each of the news events as having a low, medium or high chance of moving the market.
News events that normally move the market include: employment data (jobless claims and unemployment rates), interest rate changes, GDP numbers, inflation rate, and any modification of fiscal and monetary policy on the portion of the governments and central banks.
One of the things that makes the forex market attractive to the people who trade it, is that it’s a 24-hour market. This translates to more trading opportunities and greater flexibility for choosing what times to trade. This positive is countered by the very fact that any trade position that is left open overnight poses a risk to the trader. No one can know for sure what event will cause the contract to move, and in a direction that does not favor the trader.
How to side step this risk-Don’t leave trades open overnight without a protective stop loss if you find it to your advantage to let the trade open.
Some currency pairs have a level of correlation to other pairs. For example, if the AUD/USD is rallying, it is probable that the EUR/USD and GBP/USD are rallying as well, because they’re both US dollar currency pairs. If your money management strategy dictates that you’ll have no more than one trade on one currency (during the same time), then entering a long trade on either of the two above mentioned pairs will in effect be double your exposure to the USD (the currency that is common in the pairs).
How to side step this risk-When choosing currency pairs, for your trading portfolio, you should identify the correlation between the pairs before you proceed. Avoid trading two pairs that have a high correlation. You may want to see a number of US dollar currencies to help you see, more clearly, the general direction of the US dollar, but trading two similar pairs is asking for trouble.
You can use highly correlated pairs to hedge (offset) another trade, as an exception to this rule. For example, buying the AUD/USD and shorting the GBP/USD is, in theory, taking a neutral position on the US dollar. Of course this is an advanced forex trading strategy for experienced and knowledgeable traders only. You can find a good currency correlation resource at Mataf.net.
There are risks, as with all things in this life. If currency trading had only high rewards and no risk, everyone could become rich trading in this market. However, to succeed in this market you must be aware of the fact the dangers and learn to side step them. We hope that this article has helped you to identify some forex market dangers.