The foreign exchange market accounts for about 1.8 trillion dollars in trading a day. Only individual investors do a very small part of this. Banks, Corporations and Governments do most of the trading. The retail Forex market, a market aimed at the individual investor, has only been around since the mid 1990s. This article will look at the retail forex market, as well as describe the risks that individual investors may face in the forex market.
Forex currencies are traded in pairs; one currency is contrasted with another. For example, the British pound and the American dollar. The stronger currency at the time goes first in the listing scheme. In this case it would be listed as GBP / USD. When you invest in this particular pair, you would be anticipating that either the British pound would become stronger than the US dollar and go up, or the alternative; that the GBP would become weaker than the USD and go down.
Risk and your particular risk tolerance are both factors to consider when deciding to enter the forex market. The risk in forex arises from two sources. The first is that as in any other market, no one knows what will happen in the future.
The two major approaches to predicting the possible moves of the forex market are Fundamental and Technical analysis. Fundamental analysis is based on issues like the state of a country's economy, it's government fiscal policy and it's political stability. Technical analysis is based on past movement of the market and the likely hood of those movements repeating themselves.
The second source of risk in the forex market is the availability of leverage to a degree that is not seen in any other markets. Although leverage of 1: 100 or 1: 200 is normal, there are brokers offering 1: 400 leverage. With this kind of leverage, sizable profits are possible if you predict the market's movements correctly and large losses if you're wrong.
What your broker will likely do is to allow you to risk only part of your account. Stops will be placed in the opposing direction to the direction that you expect the currency to go in, at the point where your account will cover the losses if the market goes the other way. This way if you're wrong, your gamble will be covered by your account. Of course it will probably use up your entire account.
Some people may advise taking positions going in both directions, however this undermines the idea of trying to learn to predict the likely moves of the market. Furthermore, if the forex market swings up and then down, one position may not necessarily cancel out the other. Your account may be wiped out anyway. Generally speaking, the more positions you take, the greater the risk.
So how do you manage risk in forex trading? Some advisors suggest setting stops in the opposite direction that you're betting the market will go in. These stops will hopefully close out your trade before the market wipes out your entire account. Stops can also be used to capture and hold profits if the market is going up and down again, assuming that you've chosen up as your prediction. Other advisors add the caution that placing stops too close can limit profits when the market does go consistently in the direction you want it to go in.
Another way of managing risk is to risk money that you can afford to lose. If you're using your rent money, then do not invest in forex. Yet another useful concept is money management. Money management is based on the idea that you will lose sometimes and if you control the amount that you invest in each position, you will be able to weather the storm of losses. To make money management work, both fear and greed need to be kept in check.
For the individual who temperament will allow them to tolerates ups and downs in the market, forex may be a worthy opportunity. Just remember to manage your risk and your money. That way, you'll be around to trade long after others have walked away.