Forex trading, or trading in the foreign exchange market, is a rather recent market for individual investors compared to the stock and bond market. In the forex market, you trade foreign currencies. Trading in the forex market has become very popular with investing.
The forex market is incredibly liquid, and currency almost always has value, but you can still lose all your money. Luckily, there are many ways to avoid losing money in forex trading:
- Find a good brokerage
- Only trade with money you can lose
- Use a stop-loss order
- Respond to the news, do not try to predict the trends
- Embrace being wrong frequently.
Find A Good Brokerage
Forex trading normally happens only between banks and financial institutions. However, it is possible for typical consumers to trade in the forex market either through these institutions or a brokerage.
If you’re interested in finding a brokerage, check out the 5 best trading platforms.
Forex trading is entirely over-the-counter meaning that all currencies are traded among individuals and institutions. It is not traded through any central exchange. That means that forex trading is unregulated and that each trade is risky.
More importantly, trading through foreign exchanges means that you must have firm standards for the brokerage you choose. Many brokerages can be anything from financial trouble to a scam. If you chose the wrong brokerage you could easily lose all the money you deposited and even all your gains in trading within a single moment.
You should read as many reviews for each brokerage so you can try to determine if they are legitimate. But that is not enough. Whenever you first try a forex brokerage you should “practice” with the brokerage. Deposit money you would be more than ok with losing (a few hundred to a thousand) and try some trades. If the trades go through with few problems, you probably found a brokerage that workers for forex trading.
Note: forex brokerages need to make money too. While many forex brokerages are trying to eliminate trading fees, they will almost always utilize an ask-bid spread collection to make money. The bid price is the highest price the brokerage will pay for your currency while the ask price is the lowest the seller will accept for the security. The difference is the money that a brokerage makes from your trade.
If a forex brokerage does not utilize collections from an ask-bid spread, it is very likely the brokerage will face financial trouble or even be a scam. If you want to do forex trading take the loss in money from the ask-bid spread or the loss of money from the shutdown of the brokerage, your choice.
Only Trade with Money You Can Lose
Forex trading like any other form of trading involves risk. You could lose all your money in a single instant if you are not careful.
Therefore, you should never trade any money you cannot afford to lose. Make sure your forex trading account only has a balance you will not panic about if it suddenly turns to zero dollars.
Furthermore, if you want to do forex trading, you have options to leverage or borrow money. This could even be from your brokerage. Never borrow more than you can handle for forex trading.
Only Risk 1 Percent of Your Account on A Single Trade
One of the best ways to prevent yourself from losing all your money while forex trading is to only risk a limited amount in a single trade. It is recommended that you only trade at most 1 percent of your brokerage account on a single trade. This way if the trade is terrible and you lose everything in this trade, you only lost a limited amount.
This also forces a trader to diversify because a trade may be good only for a short amount of time. If you make a trade with only 1 percent of your account, it will all but force you to look at other potential trades instead of doubling down more on the trade you made.
To make money trading forex this way, you should have a sizable balance. Let us say you have a brokerage account of $1,000. A 1 percent trade with this account would be a $10 trade. Now let us say that the trade was excellent, and you doubled your money, the trade is now worth $20, and you made $10 minus the fees and the ask-bid spread collection. Exciting, right?
You will not make much, probably not even any money trading with that type of account. There technically is no minimum balance required to do forex trading, but that does not mean it is ok to start with little money. For trading, experts recommend you have an account balance with a minimum of $5,000, some even say $10,000 is better. This way you can make money from your good trades.
Use A Stop-Loss Order
A stop-loss order is an order an investor makes to a brokerage firm to sell an asset at a certain price. Stop-loss orders are commonly used in forex trading to sell a currency at a certain price. This helps lower the risk of losing too much from a certain trade.
The opposite is where you want to sell your currency at a higher price. While they are technically the same thing, many call this type of order a take-profit order. It allows you to profit off a currency as soon as profits are reached and prevent sudden losses. After all, as the law of gravity (and financial investing) frequently say: “what comes up must go down.”
However, it should be noted that stop-loss orders can lead to a sale of a currency very suddenly and not always at the price you want. Sometimes a currency price can rise or fall at a very sharp rate leading to a sudden purchase or sale you did not plan for. Maybe in some situations, you would want to hold onto the currency or wait for a better price depending on your position.
Furthermore, the stop-order loss will sell the currency after the threshold is crossed. For instance, if you buy a currency at a certain price a good way to mitigate risk is to make a stop-loss order to sell the currency at 50 percent, that way you only lose 50 percent. However, let us say that the currency does not drop at 50 percent but instead drops by 85 percent suddenly, you will sell the currency for 15 percent of what you bought it for. While stop-loss orders can mitigate risk if something drastic happens you will still take a drastic loss.
Always Trade in Pairs
Now for the rules specific to forex trading. When you forex trade, you are trading currencies, you are not actually buying anything as much as trading values. This sets the forex market apart from the stock and bond market where you buy and sell ownership and debt.
Every time you forex trade, you are buying a certain amount of one currency by selling a certain amount of another. Even if you are just starting in forex trading you are selling your currency to buy another.
The basics for trading in pairs is to determine your position and the risks. If your position is bullish (anticipating an increase in value) for one currency you should buy that currency. If your position is bearish (anticipating a decrease in value) you should sell that currency.
Risk is unique in the situation with forex trading. Risk depends on how well accepted and global certain currencies are. Some of the most global currencies include:
- US dollar (USD)
- European euro (EUR)
- Japanese yen (JPY)
- British pound (GBP)
- Swiss franc (CHF)
- Canadian dollar (CAD)
- Australian/New Zealand dollar (AUD/NZD)
- South African rand (ZAR).
These global(ish) currencies are generally low risk. They are generally accepted when it comes to international trade, international equities, and bond markets. However, they are not accepted everywhere.
In general, the value of these currencies is driven by supply and demand. Since global currencies are in high demand many of them are not prone to much growth.
There are more local currencies that are generally higher risk. The more local currencies are a less used form of currency. They are more likely to be overcome by a more global currency, but there is always a chance for them to grow strongly.
Know How Markets Will Affect the Value Of Currency
The concept of supply and demand may appear simple in many circumstances, but it is not always simple when it comes to currency.
Many local currencies have varying degrees to how their currency is accepted in international markets. However, the local people are generally paid with this local currency so products/services cannot be sold to them with global currencies. For instance, a Japanese carmaker could make a car for 3 million yen and try to sell it for 5 million yen. They could do that in Japan and other regions where the Japanese yen is readily accepted, but not others.
If the Japanese carmaker tried to sell the car in the US for 5 million yen there would hardly be any American that would exchange their US dollars for yen to buy that car, and these are two countries each which use a currency that is in the top 3 global currencies and have strong trade agreements.
Imagine if the Japanese carmaker tried to sell their car in Chad (I chose a random country as an example, any relation to past, current, or future events is coincidental). There would be more trouble with exchanging currencies. Chad’s national currency, the Central African franc (CFA) may or may not be readily accepted in the Japanese market.
But if Japan wants to sell cars in Chad and Chad would like access to some Japanese cars, they will need to make a trade agreement with each other. Note: I am assuming that such a trade agreement has not happened yet.
Usually, there would be a trade agreement involving the import of Japanese cars to Chad and an export of a Chad product/service to Japan. This way Japan gets something it wants from Chad and Chad gets the cars it wants from Japan.
However, let’s say that neither Chad nor Japan come to an agreement for an import/export yet they still want to market Japanese cars in Chad, Chad could buy those cars by exchanging some Central African franc for Japanese yen to buy their cars. Or let us say Japan wants Chad’s export, Japan could exchange some Japanese yen for Central African franc.
This exchange in currency causes a shift in supply and demand for the currency. For instance, if Japan exchanges some Japanese yen for Central African franc the exchange causes a rise in demand for Central African franc. This shift causes the value of the Central African franc to increase while the yen value decreases. If Chad exchanges some Central African franc for Japanese yen the opposite happens, the value of the Japanese yen increases while the value of the Central African franc decreases.
Know How Policies Control the Value Of Certain Currencies
What was just mentioned about supply and demand is assuming the rules of a free market are followed. There are many international policies that help to negate these swings including the fixing of a value of one currency to another that you need to account for. If you plan on trading in foreign currencies, you must understand the laws and policies that were made with those two currencies.
Sometimes the addition or removal of currency price-fixing can lead to drastic changes in price. For instance, the removal of the price-fixing between the Swiss franc and the European euro in 2015 led to the illiquidity of the Swiss franc and a drastic change in people’s investment portfolios.
Balance Liquid Currencies and Illiquid Currencies
One of the keys to forex trading is to understand that liquid currencies can rather easily be exchanged. There tends to be high supply and demand for these currencies. However, illiquid currencies may not be readily available to buy nor sell, there will not always be a buyer nor a seller, much less both.
You can invest in illiquid currencies, but you should hedge the currencies with more liquid ones including the more global currencies.
Respond to News, Do Not Try to Predict The Trends
Investing always requires you to know the markets you are trying to invest in. However, trading is on a different level altogether, especially with forex trading. You will need to know more about what is happening in those markets and that will be a full-time job in and of itself.
Some traders try to anticipate the news for certain markets including news about trade agreements and emerging markets. They are frequently wrong, and the markets are very volatile either way. Sometimes the news will affect the price of these currencies very sharply and in either direction. It usually takes time for the value of the currency to find a trend.
Note: the ask-bid prices right after news related to the currencies you are trading. If you trade promptly after some news you may lose more money.
Embrace Being Wrong Frequently
Forex trading is full of risks, they are called bets for a reason. You will frequently be wrong about the direction some of your holdings will take.
Sometimes you will trade a currency that is about to take a dive. Other times you will sell a currency just before it explodes in value. The key to successful forex trading is to keep a level head as you trade.
Be incredibly happy with the wins you make even if you sold the currency just before a sharp climb. Also, as a forex trader, you will have to embrace the fact that you will likely buy currencies that will force you to lose money. That is a part of forex trading. If you cannot embrace being less than perfect forex trading is not for you.
Many forex traders have tried to win back losses or doubled down of assets more for their pride than for their winnings. You need to embrace the small victories even if you could have done better or even if you are losing. There are many guidelines to control your emotions when you forex trade:
- Do not try to reverse damage in your portfolio
- Do not try to bet more money than you were willing to lose just because of a series of losses
- Sharp swings happen when forex trading, but they are not always the best indicators of a valuable currency.
Can You Lose All of Your Money In Forex Trading?
Trading always has risk, but currency provides an interesting situation. Currency by literal definition is a system of money accepted by a community so every active currency must have value. Currencies do not become worthless; they are taken out of circulation.
How much are these currencies worth? Ask someone if they would take:
- French francs
- Zimbabwean dollars
- Deutsche marks.
At best these would be taken as collector’s items or historical artifacts. These currencies cannot be used in markets because they are no longer recognized by the markets.
The reasons for their removal from circulation include:
- Multiple re-denominations (new types of currency notes printed such as a $1 bill becoming the new $1,000 bill)
- Adoption of a new currency.
These can happen at any moment and eventually make your held currencies worthless.
Forex trading will involve the rise and fall of money in many situations. However, if you want to become a forex trader there are many ways to minimize your losses.
Some people who go into trading believe forex trading is a quick way to make money, it is not. In fact, many experts claim that the best traders try to trade with the market instead of beating it, which requires time, patience, and observation.
At least at the start of forex trading, you should aim to keep your balance where it is to avoid losing money instead of trying to make money.