Foreign exchange (FX or forex) trading is when you buy and sell foreign currencies to try to make a profit. Even the most skilled and experienced traders have difficulty predicting movements in currencies.
How forex trading works
Foreign exchange trading attempts to make a profit by predicting the value of one currency compared to another.
FX trading is normally conducted through 'margin trading'. A small collateral deposit worth a percentage of a total trade's value is required to trade.
Trading in international currencies requires a huge amount of knowledge, research and monitoring. Before you put your money on the line, get independent advice from a licensed financial adviser.
Margin FX trading is one of the riskiest investments you can make. It raises the stakes further by letting you trade with borrowed money, but you'll be responsible for all losses. This may exceed your initial investment.
Contracts for difference (CFDs)
Contracts for difference (CFDs) are a way of betting on the change in value of a foreign exchange rate. CFDs can also bet on a change in share price or a market index. You're not buying the underlying asset, just betting on the price movement.
CFDs often use borrowed money, which can magnify gains or losses. For every person who wins, there is a person on the other side of the contract who loses the same amount. You will also have to pay expenses.
CFDs are generally highly geared products. The money you invest will generally only be a fraction of the market value of what you're 'contracting' for.
The contract is a legally binding agreement, no matter what the market value of the asset is. If the market turns against you, the issuer of the contract:
- will require you to pay extra money
- may close out your contract, for whatever it's worth at the time, to recover some money. If there's not enough money, you will still be legally obliged to make up the difference.
Risks of forex trading
- Small market movements can have a big impact. Most FX trading products are highly leveraged. You only pay a fraction of the value of your trade up-front, but you are still responsible for the full amount of the trade.
- Exchange rates are very volatile. They tend to move around a lot even within very short periods of time. There are significant investment risks as currency fluctuations may move against you, causing you to lose money.
- Currency markets are extremely difficult to predict. Many difference factors affect exchange rates
- Limited protection from risk management systems. Stop loss orders will only cap your losses. You may also pay a premium price to guarantee your stop loss order.
- Forex scams and fraud. Offers and advertisements that sound too good to be true probably are. Read what the US Commodity Futures Trading Commission has to say about foreign currency trading fraud.
- Forex provider risks. If your FX provider became insolvent, you may not get your money back.
- Trading delays can severely affect results. You may not be able to make trades when you'd like to, because of a lack of liquidity in the market, execution risk, or computer system problems.
Forex trading software programs, seminars and courses
Forex software programs available for forex trading. They may claim their programs can let you know when to make trades. But no person or program can ever accurately predict movements in foreign currencies.
Be wary of companies promoting a particular product that gives you access to better exchange rates or easy money. They may let you trial their trading platform for free at first. This is usually just a teaser for you to buy the software or platform.
A basic FX trading course or seminar won't give you enough information to start trading.
Do your own checks on forex providers
Different forex products involve different risks. Read the product disclosure statement (PDS) carefully before investing.
Check that the forex provider has an Australian Financial Services (AFS) Licence. ASIC Connect's Professional Registers will tell you if they do.
If the provider doesn't have an AFS licence, check it's regulated by an appropriate overseas authority. Trading with these providers may not give you recourse to Australian laws. See check an investment company or scheme.
Costa loses $56,000 through a dating app scam
Costa started chatting with Cindy through a dating app. After a couple of days, Cindy suggested they switch to a private messaging app so they could chat more often. After about a week of constant chatting, Costa felt a really strong connection with Cindy.
Cindy shared how she had made a lot of money through online foreign exchange (forex) trading. Cindy shared screenshots that showed she was making between $US10,000 to $18,000 on single trades. Cindy sent Costa a link to the website of the company she used. Costa’s online research about the company revealed some negative reviews. Cindy explained the reviews were from competitors trying to undermine the company’s success.
Costa was hesitant to create a trading account with the company. Cindy became very distressed that Costa did not trust her. She continued to pressure Costa into opening an account. Costa finally agreed. Cindy helped Costa to open an account, download a forex trading app and make trades.
Within three days, Costa had transferred the $A51,000 minimum deposit to his account with the company. Cindy helped Costa make trades on the forex trading app. Over the first few days, Costa made between $US50 and $US500 a day. Cindy encouraged Costa to transfer another $A5,000 to his account.
The next day, Cindy told Costa she had made a mistake on a trade. Cindy said she had lost his entire account balance in minutes. Cindy stopped responding to Costa.
Costa realised he had been scammed, and he reported it to the company. The company closed Costa's trading account. Cindy and the company ceased all communication with him.
Costa found out that the company was based overseas and not licensed in Australia. There was little hope of Costa recovering the money he lost.