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Forex trading

Foreign exchange trading is highly complex and risky

Page reading time: 4 minutes

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:

Risks of forex trading

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.

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Bruce loses $2,800 in an FX trade

Bruce wanted to trade in forex and so he deposited $A3,500 with a margin FX provider. Bruce decided to buy $100,000 Australian dollars (AUD) against US dollars (USD) at 0.9100, which was a contract worth $US91,000. He paid a 0.5% margin of $A500.

Unfortunately the value of AUD against USD fell to 0.8850 and Bruce closed out his position, losing about $A2,825 (including the margin of $A500 he paid). So out of his original $A3,500 he was left with about $A675, less any transaction costs.

If Bruce had not closed out this trade and the value of the AUD against USD continued to fall, he may have had to meet a margin call and lose many times his original investment.