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What South Africans should consider before investing in the forex market?

The forex market is the most liquid market in the world with over $6tn daily traded volume that makes it attractive for South African investors. Many South Africans are now trading in forex and leveraged CFDs as some figures suggest there could be as high as 190,000 forex traders in South Africa.
What South Africans should consider before investing in the forex market?

But most investors and traders don't know the risks associated with forex trading or even the basics like choosing a good broker. Here are some important points that new investors must consider and know before putting any money in the forex market.

The forex market is very volatile

The forex market is very volatile and there can be sudden movements in a split second. Traders can’t keep up with unexpected movements that could suddenly wipe out their accounts within few minutes. These unexpected movements might be triggered by economic events such as with the Swiss Franc crisis when Swiss National Bank (SNB) removed the peg/ceiling on the currency to let the currency rate float. This caught the market off guard as many investors didn’t expect this move by the Swiss central bank. Many investors who were wrong side of the trade lost their money, and many brokerages went bankrupt due to this sudden news.

It is very important for traders to understand the risk of market volatility while trading in the forex market, and always use a definite stop loss.

Using high leverage can be risky

Leverage allows you to open bigger positions in the currency pair than the actual amount in your account. Most retail forex brokers offer leverage to their clients under margin trading and CFDs by keeping margin amount aside based on your selected leverage to let you trade on the currency pair.

The leverage offered varies from broker to broker based on the regulation they are providing service under and the currency pair you are trading in. Some brokers even offer 1:1000 leverage on the major currency pairs.

Using very high leverage can bring quick profits to the traders using little capital. But it can also bring huge magnified losses to the traders which is the case at most times for the retail traders. Market regulators like ESMA and FCA understand this risk, that is why they have recently put the cap on leverages to 1:20.

So, it is very important to use low leverage for each trade, somewhere between 1:10 to 1:20.

Always trade with a regulated broker

It is very important to choose a well reputed and regulated forex broker to trade forex and CFDs. Trading with a regulated broker offers protection and safety of your funds. Regulation also ensures that proper trading conditions and environment is maintained by the broker like leverage caps, direct market access, no malpractices by the broker, proper grievance redressal.

South Africa has a local regulatory body FSCA, and it is recommended for South African traders to trade only with forex brokers regulated with FSCA as it ensures safety of funds.

Unregulated brokers have no oversight or obligation to maintain proper trading conditions for the clients. There have been cases when some unregulated brokers have not provided withdrawals to their clients or they didn’t send the client orders to the market.

So, it is very important to choose a broker based on their regulation and online reviews. More regulations the broker has, the better trading condition it will provide to you as a client.

Importance of volume and liquidity

The trading volume and liquidity is a very important factor in forex trading. The forex market is popular because it is very liquid and has global participants like government, corporations, banks, institutional investors and retail investors all at one place. This creates huge demand and liquidity in the market. Liquidity ensures that your order is fulfilled as soon as it is placed, no matter if you are buying or selling the currency pair.

But if there is less liquidity in the market, even small events or sudden influx of capital in the market could move the currency pair. This case is true for some exotic currency pairs and cryptos where demand and volume is very low so there can be sudden movements in such pairs when there is any influx of capital or sudden surge in demand. Bitcoin and some African currencies are very volatile due to this nature.

More than 70% retail forex traders lose money

This is a tough fact about the retail forex industry; no matter how experienced a trader you are, you are bound to lose.

The forex market is very volatile and unpredictable, and it can be impossible for the retail traders to track the unexpected fluctuations of the market or keep track of every important event in the market that could affect their trade; unlike large institutional investors and banks who are well informed of such events in most cases.

Moreover, retail traders often bring their emotions into trading as it is said in the trading community, “Emotion is the number one enemy of successful trading.” Traders often tend to close their trade too soon or too late due to their emotions that come in between their strategy. Most of the cases there is nothing wrong with the strategy they are following except for bad money management.

Unlike institutional investors who normally use very low or no leverage at all, retail traders normally trade leveraged products with very high leverage, which can magnify their profits, but it can also bring huge losses for them. And most of the times, new traders have bigger losses than profits, which wipes out their entire accounts.

As per market research by various independent bodies and market regulators it has been proven that more than 70% retail traders lose their money. Such that regulators like FCA, ESMA and ASIC have made it mandatory for the regulated brokers to carry a warning related to CFDs on their website like: “CFDs are a leveraged product and can result in losses that exceed deposits,” and “% of retail investor accounts lose money when trading CFDs with this provider.” These warnings vary from broker to broker, depending on the region of their clients, but the base message is the same that retail traders can lose their money.

Forex is risky for new investors, so right education is a must

Forex is risky for new and old investors alike, but new investors are more likely lose to their money as they lack the experience, sound trading strategy or knowledge of the market.

Beginner traders need to educate themselves about investment and market basics before entering the forex market. Once they are ready, they need to demo trade for the first six months to devise a sound trading strategy before entering any actual trade with their real money.

There are many resources online like Forexbrokers.co.za’s forex trading guide for South African traders, and Investopedia for general investor education. You can also start learning about currency trading from books by popular authors like Jim Brown and Kathy Lien.

11 Dec 2019 13:06

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