What are the Risks Involved in Forex Trading?

What are the Risks Involved in Forex Trading

 

There seems to be some confusion about the risks involved in trading currencies. There has been a lot of conversation about the interbank market being unregulated and therefore very risky because of the lack of oversight. This statement isn’t completely true.

 

A better approach to the discussion of risk would be to understand the differences between a decentralized market versus a centralized market and then determine where regulation would be appropriate.

 

The interbank market is made up of several banks trading with each other around the world. The banks themselves have to determine and accept sovereign risk and credit risk. This is why there are several internal auditing processes that keep them as safe as possible. The regulations are industry-imposed for the sake and protection of each participating bank.

 

Since the market is created by each of the participating banks which provide offers and bids for a particular currency, the pricing mechanism of the market is created by supply and demand. Due to the huge flows within the system it is almost impossible for a rogue trader to influence the price of a currency.

 

Because of the high volume of trading in the market today, with between two and three trillion dollars being traded every day, even the central banks can’t move the market for any length of time without the full coordination and cooperation of other central banks.

 

An ECN (Electronic Communication Network) is currently in the works which will bring buyers and sellers into a centralized exchange so that pricing can be more transparent. This will be a positive move for retail traders who will gain a benefit by seeing more competitive pricing and centralized liquidity.

 

This issue of course doesn’t apply to banks which is why they can remain decentralized without it creating any issues for them. Traders with direct access to the forex banks are also less exposed than those retail traders who deal with relatively small and unregulated forex brokers, who can and sometimes do re-quote prices and even trade against their own customers.

 

The discussion of regulation has come up because of the need to protect the unsophisticated retail trader who has been led to believe that trading forex is a surefire profit-making market.

 

For the serious and educated retail trader, there is now the opportunity to open accounts at many of the major banks or the larger more liquid brokers. As is the case with any financial investment, it pays to remember that nothing is guaranteed so that is why education, caution and common sense needs to be applied when trading in the forex market.

 

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10 thoughts on “What are the Risks Involved in Forex Trading?

  1. The “risks” you referring to are mainly advantages, as liquidity is not such a serious issue as it is on stocks, money always moving, but if you try to sell back a stock to the market which nobody wants to buy, you in a very bad situation.

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  2. It’s funny how the NFA has tinkered with the rules like no hedging for US accounts, lowered the leverage significantly from back in the day. I remember 400:1 and 1000:1 leverage. It’s more of an inconvenience than anything for US traders. The risks are going to be there. There’s a role for regulation, but at the end of the day, it’s the trader driving the car.

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    1. I totally agree with you. We can get to the point where there are too many regulations. I don’t really want the government telling me how I should think or what I should do. Now, I’m not a “non-government, government bad” sort of person but it does get ridiculous. My favorite example is smoking. I was a smoker for many years and I quit 6 years ago for health reasons but my belief always was, I’m a grown man I should be able to make my own decisions whether good or bad. As long as I know the risks involved, it’s my choice.

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      1. Same here, I don’t want to bash the govt and nit pick at stuff I don’t agree with , but like the no hedging in the same account. I mean traders will just open 2 different accounts. Hedging one time saved a big account I had when the Eur/$ was rocketing up and I was short. It’s weird how when you sign up with a new broker, every country is listed but the US, we’re not the third worlders. I tried the Options markets, I always end up going back to Forex, it’s crazy at times but it’s just fun.

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      2. I agree with your comment that FOREX is fun. If you’re not careful, like anything else that’s “fun” it can get away from you. But yes, it is fun. I also tried options but I couldn’t ever really get into it. Just not my bag I guess. But no, I’m also not one of these government “let’s live in a rural area and claim we are a country” sort of guy, even though I do live in Michigan home of the militia freaks lol. I really enjoy trying out my trading plans on a virtual trading site. Do you do the same? If so which site do you like best?

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