Traders and non-traders alike are afraid of bad investments and wary of risk. This is a rule for all of us; those who aren’t afraid of risk or losses at all don’t last very long in the business. The extent of your fear may vary, of course, and some trading assets make more traders more nervous than others.
Online forex investments form one example of an asset class that – fairly or not – is often accused of being too risky, or prone to “bad investments”. While I disagree with that broad characterization, I think people are right to question any investment class, particularly one that is relatively young and almost entirely online, with plenty of seedy, discount brokers tainting the market for trustworthy brokers.
I don’t think forex is a bad investment, or even that it lends itself to more bad investments than other asset classes. But, I understand that an explanation is in order, so this article will provide precisely that – my analysis of the risk involved in forex.
How Hard Is It to Make Money With Forex?
The first question I like to ask when evaluating an asset class is this: How hard is it to make money in this asset class for a typical trader?
After all, if it’s really hard to actually turn a profit, there is a higher chance of making a bad investment. It’s that simple.
Derivatives, for example, are far more complicated than, say, stocks (which are, in and of themselves, more complicated than trading commodities).
I look at a few factors:
- The learning curve involved;
- How technical one has to be to analyze the asset class properly;
- How much in-depth knowledge of an asset or market is needed; and
- How many factors influence price (and how complicated they are to follow).
Based on this criteria, foreign currency exchange isn’t any more difficult than most mainstream assets. Forex does have a bit of a learning curve in that you have to learn different terminology and approach buying and selling currencies differently than buying or selling stocks or commodities. For example, you have to know what a trading pair is; how to read a forex quote; what price factors are in play; and how you can navigate around spreads and pips and all that other stuff.
You don’t have to be uber-technical to analyze forex, though. You also don’t have to understand everything about a currency. In some ways, currencies are easier to predict than stocks because there are less major moving parts that impact a currency’s value. In many cases, if you can predict what a central bank will say at its next meeting and whether or not it’ll be good for the currency, you can probably provide an educated guess as to what the currency will do.
How Much Risk Is Involved?
One additional area that makes some assets more capable of bad investments than others is innate risk. How much money do you have to invest? What kind of leverage can be used? Do you lose everything if you are wrong – like with binary options – or can you cut your losses? How liquid are assets?
In terms of liquidity, forex is near the top (unless you’re buying an exotic currency that simply isn’t traded very highly in the market). This means you won’t have much of a problem getting away from a bad investment. You can also make sure you don’t lose everything, too; currencies rarely devalue themselves to the point where you are eating a 90-95% loss (and by the time it happens, you should have plenty of time to get out).
One potential problem, if used incorrectly, is leverage. You can leverage your funds with 25:1 and 50:1 buying power (meaning one dollar controls $25 and $50 worth of currency, respectively), and sometimes can gain access to even higher leverage ratios. This means big profits can be had – but so can big losses.
One note about one possible solution many traders think of when it comes to mitigating risk: managed forex trading accounts. Managed accounts are when you basically entrust your capital to a professional trader who makes all the currency trades for you. You may think it’s a good solution; after all, what’s better than having a pro do all the legwork for you? Many times, though, this ends in failure. Either the trader is trying to trade for too many people at once, turns over trading to an automated system, has a per-trade fee schedule that rewards him or her for the more trades that are made, or has a monthly quota that also encourages more trades.If you want to cut down on risk, going with a managed trading account may not be the best idea.
Forex does have a bit of a learning curve, and currencies can go through high volatility. Leverage can wreck you, too, and your knowledge has to shift from microeconomic trends and patterns and events with trading stocks to macroeconomic factors.
But, forex is far from gambling. A smart, savvy, and disciplined forex investor is a far cry from a riverboat gambler. Moving forward with careful analysis and prudence can net you a profit just as easily as stock trading or commodities or bonds can – and in some ways, forex trading is actually easier.
In short, getting into forex can be the beginning of a successful investing career – and, in the right hands, isn’t a bad investment at all.