With more technology comes more ways for novice investors to enter the trading arena, whether it’s stocks, bonds, mutual funds, or foreign currencies. However, for those who don’t do their homework and take the time to learn as much as they can, investing can quickly turn into gambling.
Unfortunately, few of us were taught as children about fiscal responsibility and investing. It’s one of those life skills that slips through the education cracks. However, it’s a skill that you could argue is more valuable than a lot of subjects we’re teaching children in school.
The problem with opening up trade markets to beginners is that these inexperienced traders don’t understand the importance of cutting their losses, which is perhaps the greatest reason they lose money. According to some statistics, the number of traders who lose money is over 80 percent.
What is FX Trading?
According to Investopedia, “The foreign exchange market is the place where currencies are traded.” The word “place” is a bit misleading, as one unique aspect of this market is that there is no central marketplace like there are for other markets. Instead, currencies are traded electronically over-the-counter.
The Forex market is also the world’s largest, and it’s not even close. According to the Bank for International Settlements, the trade volume averages around $4.9 trillion per day. The hours that the market is open is also unique. Because it involves currencies from around the world, it’s open 24 hours per day, five and a half days per week.
One reason this market is so big is that many of us engage in foreign exchange trading without realizing it. Let’s say you buy cheese that comes from France. Somewhere along the line, someone had to exchange currency to make that happen, likely the importer. If you’re an American traveling to Thailand, one of the first things you’ll do upon arriving in the country is exchange your American dollars for Thai baht.
Avoid Unnecessary Risk and Mismanagement
There is a lot of volatility in the Forex market, which means there is great opportunity for gains. However, there’s an equally great opportunity for losses.
According to City Index, losses are common for most Forex traders, even the most experienced. They recommend the key to being successful is to understand and manage all the risks. So, what are those risks?
City Index says there are two major risk factors that traders should be aware of: margin and volatility.
Margin simply means that you’re allowed to trade with just a small deposit that would signify a small percentage of the currencies being traded. With just a small capital investment, your gains could be significantly higher than that investment, but so could your losses.
Volatility is easier to understand and simply refers to foreign exchange rates that can move very rapidly. For this reason, profits can be extreme, but again, so can the losses.
City Index recommends two ways to minimize risk: don’t over trade and use stop-loss orders.
The idea of not over trading is simple; don’t risk more than you can afford to lose, and make sure you have sufficient funds in your account to cover your losses.
Stop loss orders are a stop-level when a currency reaches a certain price. You set what that close-out price is, and if that currency drops and reaches that price, you’ll automatically sell. This ensures things don’t get out-of-hand, and doesn’t require you to sit in front of your computer all day waiting to see if it does.
With technology comes innovative new ways to trade, which leads us to a great way to manage risk ― social trading. Think of social trading as copy-trading, in that you simply set up an account in a platform that allows social trading, find someone who’s doing well according to your metrics, and set your account activity up to mimic theirs. There are still some things to consider, such as their risk level, how long their trading success history has been, and so forth.
Best Practices for Investing in FX
There are numerous ways to access the Forex market, and some specific best practices if you do. The first thing you should do is get a broader overview of global financial markets, especially the big ones: the United States, Europe, China, Japan, and India.
While trading online may feel like a video game, it’s not. Besides not risking more than you can afford to lose, you should never risk more than one or two percent of your trading account on one trade. In other words, don’t put all your eggs into one basket.
Also, understand that any kind of trading, Forex included, is a marathon, not a sprint. If you’re looking to get rich quickly, go to Las Vegas. However, for every trade, there’s a risk-reward ratio, and you should find ways to improve that ratio. Obviously, this is something you don’t just stumble into, so learning as much as you can about Forex trading and risk-reward ratios will be in order.
One method to mitigate risk is to use stop losses more effectively. Forexboat.com recommends setting them tighter to your buy price to avoid unnecessary losses. Another good recommendation is to move them up to your buy price if the price moves up, thereby you’ll at least break even if the price comes back down.
Lastly, you can go with a pro. This means using the social trading option we mentioned earlier. However, this also isn’t a sure-thing. There are several layers of risk, and you’ll need to determine your risk threshold. You’ll also have to investigate the longevity of the trader’s success you intend to follow. Keep in mind as well that you’ll want to use the best practices mentioned in this article, namely, don’t risk more than you can comfortably afford to lose.
Bette Davis once famously said, “Getting old ain’t for sissies.” Well, neither is Forex trading. If you discover that you don’t have the constitution for it, maybe you should consider investing in bonds instead, as it’s an investment that carries much less risk.
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