2.1. Forex Trading Risks.
THIS SECTION IS VERY IMPORTANT!!
I will not sugar coated nor try to hide the good and the bad of Forex Trading. Please read carefully this section so that you will know in advance what kind of risks you will face when you trade Forex. It is very important that you think all of the possible risks that might occur, and then you manage, minimize or eliminate those risks. Open your mind and see it clearly that Forex Trading is not as rosy as it is advertised by brokerages, forex gurus and money managers. All the risks that I will mention below are real; they happened before and they will happen again; and you should not underestimate them.
Forex Trading is very dangerous!, especially for newbies. The moment you enter Forex trading business, you are already risking 100% of your capital, not 1% or 2% of your capital. And even you can end up losing more than your investment!. There are a lot of risks associated with Forex Trading which are beyond your control. Therefore, always use capital that you can afford to lose and always prepare for the worst.
It is my duty as a teacher and as a fund manager to remind my students and my clients over and over again that the risks are real and never to be underestimated.
These are the important factors of Forex Trading and the risks associated with them:
- The product itself, which are the currencies and the countries behind the currencies.
- Trade major currencies only. If you trade major currencies, such as USD, Pound sterling, Japanese Yen, etc then you will trade developed and stable countries’ currencies which are much safer than if you trade not major currencies such as Indonesian Rupiah. In 1998, there was a political unrest which made 1 USD = Rp 2,000 devalued into Rp 20,000 (1000% depreciation).
- If you compare between trading currencies and trading individual company stocks; individual company stocks can go to zero if the company goes bankrupt, in contrary, currency of a developed country is very unlikely to become zero. Furthermore, the government of the country will make an attempt to make the value of its currency within range, the currency can not be too low or too high otherwise the economy will be messed.
- If you are a long term trader, especially a carry trade trader, you need to be careful about the change of regulations and interest rates. When swap rate becomes negative, it will eat your profit little by little and suddenly you will realize that there is a big dent in account balance. Do not underestimate the power of swap rate, and especially if you trade with high leverage.
- Do not think that Financial Ministry of a country is full of smart people. There is always stupid people everywhere even in the highest place. If you recall the very idiotic decision taken by the Swiss Government (SNB 15-1-15), when the SNB suddenly removed the EUR-CHF floor just a few days after announcing that the Swiss Government will uphold the floor. Many traders and brokerages suffered big losses. Some brokerages went bankrupt. Always remember that moment.
- That black Thursday (SNB 15-1-15) proves that:
- Even Forex Market is not as liquid as it claimed. EUR-CHF dropped about 4,300 pips within minutes. Nobody wanted to buy your EUR-CHF positions; liquidity provider freezed trading; you could not either buy, sell or close new or current positions. You mostly ended up with negative balances if you used leverage more than 1:4.
- Stop loss is not guaranteed to be executed.
- Even margin call can not save your account balance. You may ended up with negative balance.
- Unthinkable can happen. Black swan is everywhere and appears more frequently.
- You can lose more than your initial investment!
- Trading Systems. Most trading systems can be divided into two big groups:
- Systems that try to predict price direction, either by fundamental analysis or technical analysis. Most of them use risk-reward ratio technique. If the prediction was a mistake then they cut loss. They are proud to be scalpers, swing traders, momentum traders, and fundamentalists.
- The other ones that have realized that prediction is useless or only little use for them to make money. In order to compensate lacking of accurate prediction, they use martingale, hedging, averaging, carry trade, grid and money management technique. Each trading system or technique has its own weaknesses and strengths. You need to find out what they are. But no matter what your trading system or technique is, it all depends on the leverage of your trading system or technique uses. If you use leverage more than 1:10, you are certainly doomed to fail, because:
- Forex Market can be illiquid, so that your stop loss can not be executed and not even margin call can save your account.
- By using leverage more than 1:10 you are forced to predict where the price is going to be. But the fact is, nobody can predict where the price is going to be in the short term.
- When you are forced to predict, than you are also forced to use stop loss in order to stop further loss when your prediction is wrong. As you know that stop loss is not guaranteed to be executed. What happens when your stop loss is not executed? You will suffer huge amount of loss.
- Trading Platforms and Equipments.
- Accidents. You can make mistakes putting orders, for example: you intend to buy 0.01 lot, but you accidentally buy 1 lot, or you intend to buy but you click sell instead.
- Technical error such as lost internet connection while running trading robots.
- Power lost.
- Your computer or smart phone is stolen or hacked.
- Your kids mess up your computer or smart phone and trade your account without your knowledge.
- Your EA-s or robots have bugs without your knowledge.
- How much money should you use for your trading?
- Forex Trading is very dangerous. A lot of things are beyond your control. It is not wise to plunge all of your capital into Forex Trading alone. Always diversify your income source. My advice is max 30% of all of your capital and use capital that you can afford to lose.
- If you do not have enough capital in your account balance (or use high leverage), one strong move against your position such as what happened in 2008 economic crisis and 2015 SNB will wipe your account entirely, and it is possible that you will end up with negative balance.
- Additional fund takes unusually long to be deposited therefore you get margin call.
- Your opening account balance currency is subject to that currency inflation.
- These are the minimum requirements of a brokerage: segregated, registered and protected with Investor Compensation Fund such as FSCS, ICF or Finma. If you use a brokerage which have those three requirements, when something bad happen, 95% chance you will get all or some of your money back. But if your brokerage does not have those three requirements, 99% chance you will lose all of your money.
- Segregated account. Do you think it is bullet proof? Do you think your brokerage will follow strictly the rules to segregate? Do you know what segregated account really means?
- Registered brokerage. Some brokerages will guarantee your fund up to certain amount of money under Investor Compensation Scheme. But, the first rule of Forex Trading commanded that you should not trust anybody. If something bad happen, you are at the mercy of the government of your brokerage. There will always be a loophole that can be exploited against you.
- If you choose a correct and registered brokerage, your money and your trading is fairly safe. Just like a casino, it is very unlikely that a casino goes bankrupt, unless they do something stupid. However stupidity does exist somehow. Therefore you always diversify your brokerages to minimize your risks.
- Your brokerage runs away with your money or goes bankrupt.
- Your brokerage suddenly change the leverage into much smaller leverage. It means that you suddenly has much smaller capital to withstand the price swing.
- Your brokerage has the right to close all of your positions under certain circumstances.
- Your brokerage trading server experience glitches so that your stop loss or limit order is not executed appropriately.
- You are the most important factor to be successful in this business. People spend a lot of money, time, and effort to go to school and college to get a degree. Do you remember how much sacrifices did you make to go through school? How long does it take for you to finish your school and college in order to be qualified for a professional career? Yet, when trading Forex, a lot of people are not willing to spend money and effort to get the knowledge. They are used to free stuff, they rely on signal providers, black box systems, robots, trading gurus, etc. They just simply don’t bother to study and think by themselves. They can not be blamed entirely, Forex trading marketing ploy makes trading Forex as an easy get rich formula within a click of your mouse. People just get the impressions that they just need to open a trading account, do buy and sell and get rich within months. The fact is Forex trading is not just as easy as buying and selling currencies. Please invest in yourself, go and spend some money to get the knowledge and the education. I believe Forex Trading is a valuable skill to have.
- Your perception about Forex Trading. If your perception about trading Forex is about the same as everybody else. You are doomed to fail. No matter how hard you try, if you do not change your perception, you will never succeed in this business.
- You get tired and in a bad mood so that you make mistake in making decision or executing trades.
- As a human, you will have greed. You will tend to make a shortcut. Please don’t, please stick to your plan!
- Family pressure. You will hardly catch up with your standard of living, meaning that you and your family are always want more. The pressure to make more income is real. The easiest and the fastest way to increase your profit is by increasing your leverage and or increasing your capital. It will be very dangerous if you increase your leverage beyond your calculated plan. And it is dangerous if you put big portion of your capital in trading Forex alone.
- At some point in your trading journey you will have a burnout feeling. This is the most dangerous time, you will have a tendency to deviate from your plan and take unnecessary risk taking a shortcut to make big money. You will overtrade and overleveraged. Be aware over this situation, I have warned you.
- Trading is a lonely business. You do everything by yourself, you do not need any employees, you do not need your wife or your husband, and you can decide everything by yourself. Your fate is in your hand. Most of you can not consult with somebody else, therefore making a mistake is easier.
- If something wrong happen then it is solely your fault. Do not blame anybody or anything else. If you are falling down, learn from it, wake up and continue your journey.
- Pressure from inside and outside will break or make you. Master yourself, then you will become a successful trader.
- Other risks associated with Forex Trading:
- Your fund manager cheats you.
- Unethical Forex Guru.
- Unethical Trading System creators or and sellers.
- And so many other things that are beyond your control.
I will discuss in more details about this section in my mentorship program:
- How to manage, minimize and eliminate all risks associated with Forex Trading mentioned above.
- Strengths, weaknesses and associated risks of Trading Systems (prediction and non prediction trading systems).
- Strengths, weaknesses and associated risks of each trading techniques (martingale, hedging, averaging, carry trade, grid and money management technique).