Interested in forex trading? Here are 5 ways to make it safer
Trading forex is as much about managing risks as reaping the potential rewards.
One of the biggest barriers for people thinking of trading forex is the fear of it being highly risky and unsafe. While it's quick and easy to open an account with a forex broker and start trading, understanding how the forex market works and how to manage your risk isn't quite as simple.
However, there are several measures you can take to make trading safer and easier. Keep reading for five tips on how to manage your risk when you trade forex.
1. Do your research
Whether you're thinking of trading forex, investing in shares or choosing any other type of investment, it's always important to do your research. In fact, knowledge is one of the most effective risk management tools at your disposal, so be sure to do your due diligence.
And if you're new to the world of forex, there's a lot to learn. Currency markets are complicated and there's an extensive range of factors that can affect the value of one currency relative to another. In the words of the Australian Securities and Investments Commission's Moneysmart website, "currency markets are extremely difficult to predict", so there's no such thing as having too much knowledge.
You also need to make sure that you fully understand the risks involved in forex trading. These include everything from exchange rate volatility to the potential for losses to exceed your initial deposit, so you need to know exactly what you're getting yourself into.
Finally, it's essential to research forex brokers before deciding on one that's right for you. There are a lot of scams out there, so make sure the broker you choose has an Australian Financial Services (AFS) licence or is regulated by a relevant overseas body.
2. Start with a demo account
OK, you've read countless trading guides, watched online forex trading tutorials and even attended a webinar or two – but that doesn't mean you're ready to start trading with real money. Even figuring out how to navigate your online broker's trading interface can take a while, so it's a good idea to practise before you try out the real thing.
That's why some brokers, such as VantageFX, offer the option of a free demo account. By signing up for a trial, you'll be given a "virtual" balance so you can experiment with trading on the platform. This gives you a chance to understand how to use the platform and test out your trading strategies without losing any money.
These free trials are usually available for up to 30 days. And while you might be eager to just skip the trial and start trading with real money straight away, a more patient approach could reap rewards in the long run.
3. Understand how leverage works
It's easy to get swept up in the excitement of the potential rewards on offer when you trade on leverage with forex CFDs. But remember that while leverage can magnify your returns, it can also magnify your losses.
So even though you can trade with only a small deposit, you're still responsible for the full value of your trade. That's why trading accounts come with a warning about the potential for losses to exceed deposits, and why you should be very cautious when trading highly leveraged products.
Using less leverage will lower your risk, so make sure the amount you risk per trade is only ever a small percentage of your trading balance.
4. Use stop-loss orders
The different order types available via your forex trading account can be a little overwhelming at first, but one order you should familiarise yourself with is a stop-loss. A stop-loss is a risk management tool that offers protection when the market moves against you.
You can use a stop-loss to automatically close your position when the price reaches a specified level, thereby allowing you to limit your losses. There are also special types of stop-loss orders available, such as a guaranteed stop, which protects you against slippage during periods of market volatility. Trailing stops, which allow you to secure profits if the market moves in your favour, can also be useful.
5. Make a plan
Our fifth and final tip to make forex trading safer is to develop a clear and concise plan before you risk any money. So before you sign up for a forex trading account, sit down and think about:
- What your trading goals are
- What sort of risk/reward ratio you're comfortable with
- How much money you're willing to risk on each trade
- When you'll cut your losses (or lock in profits) from a trade
This should help you approach forex trading with a sensible and carefully thought-out approach.
Of course, creating a plan is one thing, but sticking to it is another kettle of fish entirely. Discipline is an important trait to help you manage your risk, so try to take emotion out of the equation when making trading decisions. Keeping a record of all your trades, including what decisions you make and why, will also help you learn from your mistakes in the future.
The bottom line
There's a good reason brokers require you to read a lot of disclaimers and warnings before you sign up for an account – trading forex comes with a high level of risk attached. But if you take steps to boost your knowledge and manage risk, you'll increase your chances of trading profitably.
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