Many of you travel the world through your deployments and personal travel and are probably very experienced at managing foreign currencies. What you might not realise is trading foreign currencies, or forex trading, is a very risky form of investing. In one trade your investment can turn into thousands of dollars of debt .
What is Forex?
Foreign exchange trading is the practice of buying and selling foreign currencies to make a profit. It is possible to trade in this way because foreign currency exchange rates move in value when compared to each other. Foreign Exchange is also known as Forex or FX trading.
An example of the simplest form of foreign exchange is when you’re deployed overseas and sell Australian dollars to buy foreign currency. When you return home, if the value of the Australian dollar has gone down relative to the currency of the country you came from, then you will get more money back per dollar, less any fees, commissions and profit margins applied by the bank or foreign exchange provider.
Foreign exchange markets work in a similar way but on a larger scale.
The dangers of leverage
Most forex trading products are highly leveraged. This means you only have to pay a fraction (for example, 0.5%) of the value of your trade up front, but you are still responsible for the full amount of the trade.
For example, a $50 investment could let you place a $10,000 forex trade. If the value of the trade dropped by 0.5% to $9,950, you could lose the original $50 that you invested. If it fell further, you may have to pay much more than your original investment.
You could even be liable for the entire $10,000 – that’s 200 times your original investment – unless you close out the trade sooner before the losses become so extreme.
Risks of forex trading
To successfully trade in forex you need to understand the economic conditions of each country whose currency you are trading, and how those conditions affect the relative value of those currencies. This is extremely difficult because so many factors come into play including politics, economics and market forces.
Forex markets are very risky because:
- you could lose more money than you put in, when the trade is leveraged;
- there is a huge volume of trading ;
- you’re dealing with foreign traders, laws and cultures;
- markets are open 24 hours a day 5 days a week, making it hard to track your investment; and
- markets are impossible to predict because so many factors affect exchange rates.
In order to trade forex successfully you need:
- extensive trading experience in shares and other investments for a long period of time;
- to know how forex works in detail;
- to read the product disclosure statement and discussed the risks with your financial adviser; and
- the financial capability to afford to lose more than the amount you invested.
There are many providers and types of forex trading products. Some that you may see advertised are:
- Forex contracts for difference (CFDs)
- Margin forex trading
- Spot forex contracts
- Forex options.
Different types of forex trading products involve different risks. If you are looking at Forex CFDs download our investor guide, Thinking of trading contracts for difference (CFDs)? from www.fido.gov.au.
There are also many software programs available which claim their programs can let you know when to make trades or let you manage your forex trades online in an easy and simple way. Remember, forex trading is never simple so don’t rely on a trading system that tells you it is.
Also be wary of marketing promises that suggest that by using a particular product you will get access to better exchange rates or that say it is easy to make money trading forex. Some providers let you trial their trading platform for free initially – but it is always different when your money is on the line.
Trading in international currencies is never easy and requires a huge amount of research and monitoring if you are to be successful. Even the most skilled and experienced investors cannot reasonably predict currency movements. So before investing in forex or any other investment, always consider our six steps to investing between the flags.
- Understand some key things about yourself
- Understand some key things about investments
- Develop an investment plan
- Decide how to invest
- Implement your plan
- Monitor your investments
For more information on investing visit ASIC’s consumer website, FIDO at www.fido.gov.au or call 1300 300 630.
E-mail ASIC with topics that interest you at ADFcolumn@asic.gov.au.
Tony D’Aloisio BA LLB (Hons)
Australian Securities and Investments Commission