Truths about Online Forex Trading that beginners don’t know

Thanks to the internet, online trading has become so popular. People across the globe from big to small investors are involved in various kinds of financial instruments trading using the web and mobile applications.

Among the most popular instrument in online trading is forex with over 1.3 million traders in Africa alone.

Forex market is primarily a currency market where different currency pairs like EUR/USD and USD/NGN are exchanged. The currency prices are determined by demand and supply, economy, and so many other factors.

Unlike other capital markets, the forex market is an over-the-counter 24/5 market. So, one can trade almost any time of the day. Brokers often offer leverage and have barrier to low entry which makes it popular among many investors.

However, first-time investors are unaware of some facts like risks and broker safety. Here we look at the must know facts of forex trading.

1. Forex Market is the World’s largest financial market

With a daily trading volume of $6.6 trillion (2019), the foreign exchange or forex market is currently the king of the financial market.

The forex is even bigger than the worldwide stock market (roughly $200 billion/day). It’s just not that. Forex is a highly liquid 24 hour-market.

Liquidity in the forex market comes from large number of participants from banks, corporations who use it to facilitate trade to retail investors who use it for speculation.

2. Retail Forex Trading has high risks

As with any trade, forex trading has multiple risks. It’s a very volatile market where even expert traders find it hard to register profits consistently.

The main risks associated with forex trading are leverage risk, interest rate risk, credit risk, country risk, and exchange rate risk.

One of the biggest attractions for retail traders of online forex trading is availability of high leverage. But leverage is a double-edged sword.

It requires a very small amount, referred to as margin money, to gain access to voluminous trades in currency pairs; allowing them to enter a bigger trade position with fraction of capital invested.

For example, a broker can offer a 1:100 leverage ratio. That means if you have deposited $100 in your trading account as margin, you can place a trade order worth $10,000.

If the currency value changes as you expected, you would earn a profit. But if it goes southward, it will trigger a margin call where you have to pay additional margin to continue trading. Using leverage during volatile market conditions can result in substantial losses.

Another biggest risk of trading forex is associated with Interest rates.The simple economic concept of interest rate plays an important role in determining the value of a currency.

If a country raises its interest rate, its currency will strengthen because more investors come running to gain higher returns. But when the interest rate gets slashed, investors will often withdraw their money.

Whatever currency pair you are trading, always have an eye on new economic data releases and central bank announcements.

Forex traders are also affected by country’s policies and state of economy also known as country risk. Major economies like the USA, EU, and Japan have a floating exchange rate.

That means their currency values are determined by market forces and demand-supply. On the other hand, weaker economies tend to have fixed exchange rates, or tightly managed by central banks.

A currency crisis can occur in weaker economies due to consistent balance-of-payment deficits that can result in the devaluation of the currency. This can have a major impact on currency pair values.

3. Choosing a Regulated or Licensed Forex Broker is essential
The online world is a wild west. And forex trading like any other investment has been abused by fraud brokers and scammers, who aim to dupe first time investors.

The scammers often promise higher unreal returns which are not possible to achieve and they end up going bust taking your money with them. While, some scammers or fraud brokers pose as genuine brokers promising to invest in markets but in-fact they either won’t invest your money or even bet against you expecting you to fail.

Anyone with knowledge of digital technologies can create a trading website/app these days. Till the time retail investors realize, unregulated brokers, close their shop and run with their hard-earned money. That’s why it becomes important to choose only a well-regulated broker.

Currently, there is no regulation for forex brokers in Nigeria making it prone to scams. So, if you are considering getting started in forex, it is important for traders to only choose from the best forex brokers that are licensed by top tier foreign regulators like FSCA, FCA.

Foreign regulation bodies such as FCA (UK), ASIC (Australia), FSCA (South Africa), and CySEC (Cyprus) ensure that forex brokers follow the standard practices and don’t get involved in fraudulent trading practices, otherwise, their licenses can get canceled.

So, always make sure that your broker has licenses and is regulated by one of these foreign regulators.

4. Not all regulated brokers are the same

There are mainly three types of forex brokers with whom one can trade forex online i.e: ECN, STP, and Hybrid (ECN+STP).

Electronic Communication Network (ECN) brokers provide direct access to the interbank market to its clients. They provide transparent pricing, but trading requires large capital. These are suited for professional traders who trade large volume. Popular Forex Brokers that offer ECN type accounts are Tickmill, Pepperstone etc.

Straight Through Processing (STP) brokers send the traders’ orders to their liquidity providers who are hedge funds, banks, and market makers. The process and the orders fulfillment usually have variable spread models. These are suitable for beginners.

Hybrid brokers provide the best of both worlds, and most brokers use this model to link traders with market participants. These brokers can provide ECN as well as STP account and can be a direct dealing broker.

Direct dealing brokers are also known as Market Makers. For example, Exness which is regulated in South Africa is a market maker forex broker and Avatrade is another popular broker in Africa is a market maker too.  

Whatever type of broker you choose, compare the following fees that can have an impact on your returns:

• Spread – The difference between the sell price and buy price of a currency pair is called a spread. Brokers call it bid-ask spread. It means your broker will offer two prices for the same currency pair. For example, if the EUR/USD bid price is 1.3567 and the ask price is 1.3568. The difference between them is 0.0001 or 1 pip.
• Commission – A broker can also charge a fixed or relative fee on each of the executed trade. In fixed commission, a fixed value is levied irrespective of the size and volume. On the other hand, relative fees, the commission varies according to the size and volume of the executed trades. For instance, $1 if the trade value is $10000, and $10 for $100000.
• Other Fees – Brokers can also charge for unclosed overnight positions, inactive trading account, and data feeds. Although these expenses look inexpensive, they can have an impact on your returns.

One must choose a broker that offers the lowest fees.

4. Different Trading platforms have different features

Trading platforms such as MT4, MT5, cTrader are the most popular software’s that allow you access to forex markets. Almost every broker uses one or multiple trading platforms. Each trading platform offers different tools, features and timeframes. For instance, MT4 is more simplistic and offers 9 timeframes. More advanced, MT5 has 21 timeframes.

Beginner forex traders often use MT4 as it is the most popular platform offered by almost all forex brokers.

5. Currencies are traded in pairs in the Forex Market

Forex trading happens in pairs like EUR/USD and JPY/USD. Some currency pairs are frequently traded and take a majority of the forex volume. They are called major currency pairs.

Major currency pairs include USD/EUR, USD/JPY, GBP/USD, and 4 more. US Dollar is world’s most traded currency as international trade happens in US Dollar. And all major pairs involve USD with another major currency.

Minor currency pairs are those pairs that don’t involve American dollars. For example, GBP/EUR, EUR/AUD, CHF/JPY, etc.

Lastly, an Exotic currency pair consists of one main currency and another from a developing country.  Examples: GBP/ZAR, USD/INR, and others.

Inexperienced traders should stick with major and minor currency pairs. Because they have usually lower spreads and have high liquidity. Exotic pairs are highly volatile and far less liquid.

6. Profit is not guaranteed – 70-80% of retail traders lose

Forex trading is inherently risky. Although expert traders do make money, around 70-80 % of retail traders lose. Many factors determine whether the forex pairs will go north or swing south. Some risks such as country risk or market risk are beyond a trader’s control. But how and how much you trade with can have significance on your investments.

For new traders, the forex market can be very intimidating. If you are new to trading, only risk what you can afford. Use no leverage, and start with lower capital. Learning and mastering the forex trading takes time and tests your patience.

Remember, profit is possible, not guaranteed.

7. Risk Management is Important  

Understanding risks is important, but knowing how to minimize the risks is certainly more important. When someone trades without adopting the right risk management strategies, they are simply gambling. Nobody hits a jackpot in just one day.

Here are some simple strategies that traders often use to minimize their risk:

Start with low capital: Start with minimum capital and trade in micro-lots.

Risk-reward ratio: Ask. Does this trade have the potential to give you three times more returns than the amount you are risking? If you use a 1:3 risk-reward ratio you will have a better chance of winning in the long run.

For instance, you can put a stop loss for 3 pips and set your profit at 9 pips. So here you are risking 3 pips for the chance of gaining 9 pips, or 1:3 ratios.

Never risk more than 2% of your entire capital on one trade. Use the leverage wisely. Before risking your money, first, learn trading by opening a Demo Account. It will help you learn the basics of trading without the risk of losing money.