Forex Risks and How leverage can work against you
The Forex market is an ideal business for significant profits . However, the potential Forex risks are as great, if not more. The FX market, as a whole, is full of misconceptions of what is right and what is wrong when it comes to trading. Many traders are confused by the misinformation being circulated by “experts”. They do it without education and more often than not, by their Forex brokers.
To name just a few areas in which Forex traders go wrong, it is the whole concept that it can provide an immediate and risk free profit. This is of course completely false, and may even be the opposite of the current reality of the FX market. The statistics are out there. It is anywhere between 80% and 90% of all transactions in the Forex market end up with losses. So, in essence, you must take into consideration all Forex risks as it can provide immediate losses as well.
Another aspect of Forex risks is a common mistake of jumping to the world’s largest market unprepared mentally and through an extensive market research. You must make sure you have enough capital to trade on. Moreover, that you are emotionally prepared. That, by the acquisition of a deep understanding of yourself and what kind of trader you are before risking your money.
There are certainly a lot of money to be made in Forex, but if you will not spend enough time trading on a demo account and learning this industry, and be familiar with all Forex risks you will probably not see any of that money.
What is leverage? What is the margin?
Another common mistake is thinking that in order to achieve the true potential the Forex market has to offer, you need to trade with a high level of leverage. Before entering this falsehood, and why it is critical to your success as a trader, let’s take a moment to understand the basic concept of leverage and margin and why it is considered to be as one of the biggest Forex risks.
Some definitions on the rules of this game:
“The mechanical energy or advantage obtained by using a lever”.
“The degree to which an investor or business is utilizing borrowed money”.
“The use of credit or borrowed funds to improve one’s speculative capacity and increase the rate of return on an investment, as in buying securities on margin”.
In my own words, leverage is the ability to use the amount of funds you hold in order to increase the amount you can borrow from an external entity. The capital they bring to the table is known as margin.
Forex Risks – High Leverage
When people discuss the advantages of FX trading, what they usually first mention is its high leverage. When trading Forex, you can open positions worth hundreds of thousands of dollars with a capital of two hundred dollars or even less. Admittedly, this attracts many people to trade Forex. However if those people actually spent a few minutes thinking about this concept and essentially what they are doing with their money, it might be a little more reluctant to trade with a leverage of 1:100, 1:200, and even 1:400. Leverage is actually one of the greatest Forex risks.
Forex Trading Leverage is somehow like driving a car. Anyone who has driven a car knows that when driving at a speed of 60 km/h or 200 km/h, the steering wheel turns have a completely different effect. If you are driving at low speed and accidentally turn the wheel slightly, the car will change very little, and give you the opportunity to correct the error. However, if you are driving at very high speeds and make the same mistake, the consequences will be fatal. The car will completely change directions and you will have much less time if at all to fix the situation.
In Forex trading , leverage is equal to high speed. The higher the leverage, the faster you drive. Therefore, it takes the smallest change in the market, can cause irreversible damage to your account. However, if you drive slowly and carefully, you can arrive at your destination a few minutes later, but at least you will get there alive.
Conclusion: Forex trading holds great opportunities and advantages over other financial instruments. One of them is leverage. However, there are also some Forex risks you must be aware of. The most common one is related to the over use of leverage. If you keep that in mind and know how to use it wisely while trading patiently, you can enjoy long term successful trading. Remember, this is not a sprint but a long distance journey!
Read the related: Forex Risk Management