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How to trade safely in the forex market

Investing is uncertain at the best of times, never mind as the coronavirus sweeps the globe. For savvy forex investors, it is important to be cautious at all times.
Forex trading can be rewarding, but there are pitfalls to be aware of and precautions to take. Image: Michael Nagle, Bloomberg

Forex market analyst Rahul Sharma of Forex Brokers SA says the forex market is one of the most liquid markets in the world. “Retail forex trading accounts for 5.5% of the global forex market where banks, institutional investors, businesses and governments take part. In 2019, the daily turnover of the global forex market was around $6.59 trillion.

”This can make it attractive for investors but the key to investing in the forex market is ensuring that you are educated,” he says.

There are three ways to trade in the forex market:

  1. Physical exchange: This is the most common and typically occurs when you are travelling abroad and want to change one currency for another. Your bank acts as a broker, buys or sells currencies on your behalf at the current forex rate, and adds its own broker fees to the transaction.
  2. Using a retail forex broker or a CFD (contract-for-difference) broker: When you invest via a CFD broker, you don’t physically own the asset (currency pair in this case); you are only speculating on the rise or fall of the currency, making a profit on the difference in the currency movement. Retail forex brokers are more popular and offer margin trading. Most of these brokers have multiple device platforms including mobile with low fees and low minimum deposit requirements.
  3. Via the local forex derivatives market: Where investors and businesses buy forex futures and options with the rand as the base currency. Forex futures and options are derivatives with forex as an underlying asset. Investors and businesses can buy or sell FX futures or options from the JSE and they have the option to use margin/leverage to buy more currency value with less investment. Sharma notes that futures and options can be used by businesses to hedge their business risk from global trade. “For example, if an importer wants to import $100 000 worth of goods from China in coming months, and suppose the current exchange rate is R15 per US$, they want to ensure that they will be able to buy USD at the same rate irrespective of the rand going down to R16 or R17,” he explains.

What are the risks?

“Forex trading is very risky for most retail investors as the forex markets are very volatile. Markets move constantly, making it difficult for traders to stay updated or keep track or to predict future movements,” Sharma warns.

He says there are three major risks:

  1. Volatile markets: The value of currencies traded in the forex market are highly dependent on a country’s fundamental factors, that is economic, geopolitical factors and market sentiment. “For example, market panic related to Covid-19 resulted in currencies of most developing countries losing up to 30% in value this year alone, as of March 2020,” Sharma explains.
  2. Risks of margin trading: Most brokers offer very high leverage. This is essentially borrowed capital from brokers allowing you to invest more money in the market. Sharma says an example would be a leverage of 1:1 000. This means if you are investing R100 in the market, then by using 1:1 000 leverage, you can now invest R100 000. This puts you at high risk as your market exposure is higher than your actual capital, and you risk losing your capital even with small market movements. Europeans have placed restrictions on leverage for CFD providers, but there are currently no such restrictions in place by the Financial Sector Conduct Authority (FSCA) in South Africa.
  3. Risk of unfair practices by unregulated brokers: Many SA traders trade with unregulated brokers, and they are at risk as there will be no protection in case of bad practice by the unregulated broker. It is vital that you trade with FSCA-regulated brokers only or choose a broker that is regulated by major foreign regulators.

“Like any other investment, there is no guarantee of profits in forex trading. It is a known industry fact that almost 60-70% of retail traders lose money in forex trading, mostly due to poor money management and the use of unsafe leverage. It is important for new traders to learn about forex, understanding of charts, supply-demand, and practice on demo before they start trading,” Sharma says.

What protection do South African investors have?

The FSCA regulates and oversees capital markets in South Africa, including the forex market. However, not all forex brokers are necessarily registered with the FSCA.

The onus is on the investor to check the registration of the forex broker before entering any transactions. Brokers who fall under the FSCA must have a local presence with a local office and at least one director residing in South Africa.

Over the counter (OTC) derivative providers, which includes CFD brokers, now also fall under the FSCA. This means all their transactions now go to the FSCA’s trade repository. Sharma says this will enable the FSCA to check all trading activity at the broker and ensure best practices are followed at the broker’s end.

“As per the FSCA’s new regulations, brokers need to ensure that clients are knowledgeable enough before they can open a live account. Clients, in turn, are also required to show their capital adequacy, which will ensure that only traders with a professional background and financial markets literacy can invest in the forex market,” he says.

What to look out for when choosing a forex broker:

Regulation: The broker should be registered with the FSCA and other major regulators such as the UK’s Financial Conduct Authority (FCA) or the Australian Securities and Investments Commission (ASIC). Ask the broker for their FSP number and then verify it on the FSCA’s search portal.

Reputation and history: Sharma recommends that you ask the following questions:

  • Are they regulated with Tier 1 regulators?
  • Are they publicly listed on a major stock exchange?
  • How long has the broker been in business and how long has it been regulated by the FSCA?
  • Are there or have there been any complaints against the broker?
  • How well does the broker respond to negative reviews and complaints?

Trading fees: Always look out for overall fees. “During our research, we found that some brokers charge low commission or fees per trade but charge very high fees on services such as withdrawals, maintenance charges and inactivity fees,” Sharma notes.

Available asset classes: Some traders prefer to trade commodities, while some want to trade rand-based currency pairs specifically. Always check if your desired asset class is available with the broker, and the fees should be as low as possible for that instrument.

Trading conditions: Check the platforms offered by the broker. Do they offer a rand-based account? What are their available order types and what is their order execution type? Does the broker have any history of freezing on its platform during normal market hours?

“Finally, make sure you read the broker’s terms carefully. You can also read independent reviews on broker comparison sites such as Forexbrokers.co.za, where we have compared the fees of some FSCA-regulated brokers,” says Sharma.

“Our site also compares about eight other trust factors that we consider to be important in a forex broker for the safety of investors.”

Brought to you by Forex Brokers SA.

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