Why Online Forex Trading is risky for most Retail Investors

Retail forex trading, a small segment of global currency market that makes up individual investors has been steadily growing over the last 25 years.

The growth in retail FX has been attributed to advent of internet and cheaper online forex trading platforms in late 90s. Since then, retail forex trading has picked up in whole world including Africa.

Last year, despite the COVID-19 pandemic woes, the online forex trading in Africa registered a tremendous y-o-y growth.

According to the latest statistics and report published by Trade Forex Kenya there has been on an average approx. 82% growth of retail forex trading volume in Africa in 2020 alone. There are now 1.5 million retail forex traders in Africa. The growing retail interest can be explained in four points: small capital requirement, ease of access to global markets via internet, 24X5 availability and low barriers to entry.

Despite its growth, the online forex trading industry has only been regulated in 2 countries in Africa with over 70+ regulated entities in Kenya & South Africa combined, while many unregulated forex brokers are also working in the continent adding to the already inherent risk that the nature of business carries.

Retail investors buy a currency pair and expect it to rise in the future so they can earn a profit. Those who have traded in shares would find it very much similar. Nevertheless, forex trading is quite risky in comparison to stock trading. Forex Trading online does not come without its risks, and scams.

Here are some characteristics of forex trading that makes it risky:

1. Most investors lose money

One of the most attractive features of the money market is ‘leverage’. Retail Forex is offered as a leveraged CFD instrument by retail brokers, it is common practice in Africa for brokers to offer leverage upto 1:1000 or 1:2000. Almost every broker will suggest using leverage to earn more profit. Some can offer as high as a 1:2000 leverage ratio.

Let’s take an example. Suppose you’re interested in trading EUR/USD currency pair. To enable you to trade one Standard lot ($100,000), your broker offers you 100:1 leverage. That means you just need $1000 to open a $100,000 position.

Let’s say your investment value rose to $101,000 (you’re lucky!). It means you got $1000 or 100% profit on your investment.

Now let’s consider this. Your position sank to $99,000, in which case you lost your entire margin money of $1000, and that will trigger a margin call. That’s why leverage is sometimes called a “double-edged sword.”

The unwise use of leverage is often the typical reason behind investors losing money in forex trading. According to forex data, approximately 70% of traders lose money.

2. Profits are not guaranteed

Every broker advertises how easy their trading platform is, high leverage, and excellent customer support, but nobody tells you how risky the forex trading is.

Many experts believe that forex trading is highly speculative. Earning a profit from forex requires knowledge, skill, patience, vigilance, and wise use of leverage.

Forex market is very volatile and operates 24/5 market. And that makes it a notoriously unpredictable market. Gaining profits on a regular basis is difficult. If you’re new to this trade, start with a demo account, and don’t use leverage, at least for the first few months.

3. Volatile and unpredictable market

The forex market is the biggest financial market in the world. But it is also the most volatile market. Volatility means you can lose a significant amount of money very quickly in a matter of few seconds.

For instance, the recent COVID-19 pandemic caused a lot of disruption in the global economy. Except for few major currencies, many African currencies were devalued to sustain their economies. Many traders unaware of the situation lost their forex investments in quick succession.

Not long ago when the Switzerland government abolished the Swiss Franc-Euro peg in 2015. The announcement caused the currency market to respond with force; Euro went into free fall against the Swiss franc. Those who invested in EUR/CHF didn’t see it coming and lost their entire investment in just a few days.

Any critical news can impact the forex market. Keep an eye on the financial news. The money market never sleeps.

4. Lack of liquidity/delay in execution

Liquidity simply means the supply and demand volume of a particular asset. For instance, EUR/USD, USD/JPY, and GBP/USD are the world’s most liquid currency pairs. They take a large chunk of global forex trading.

On the other hand, USD/Mexican Peso or USD/Turkish Lira are examples of ‘exotic’ currency pairs. The term exotic signifies that the pair can be illiquid – lack of enough buyers and sellers and stability. Investing in exotic currencies can be risky.

Another risk in forex trading arises when you or your broker cannot close the order at the right time. The delay in execution can affect returns on your investment.

5. Letting emotions come into play

Many experts believe that the recent surge in forex trading after COVID-19 is due to rising unemployment and businesses going sour. Many people are looking for quick money. But forex trading is very technical and requires knowledge. Even experienced traders are not able to earn profit consistently.

Don’t let your emotions come into play while trading. Many traders lose their money for two simple reasons: greed and overtrading. Greed makes them take more risk, use more leverage, and trade more frequently. In simple words, be rational while trading. Don’t be addicted.

The forex market is not the place for betting, easy money.

6. Unregulated brokers

Trading with unregulated brokers poses a serious risk to your investments. Unregulated or non-transparent brokers often lure the common investors by promising unsustainable profits. But they may not be what they seem.

For instance, an ongoing investigation into the fraudulent practices of a South African online forex broker, JP Markets, revealed that ‘For every loss that a client made on a transaction, JP Markets made an equal and corresponding profit.’ So instead of working in the interests of their clients, JP Markets was working against them. Now imagine, if the company closes its shop, what will happen to the investors’ money.

That’s why you must choose a well-regulated broker for currency trading. You should ideally select an online broker that is highly regulated in your own country.

If online forex trading is not regulated in your country, choose a broker that is regulated by FSCA of South Africa or CMA of Kenya. While selecting a foreign broker outside of Africa, ensure that your broker has Tier I and Tier II licenses from global regulatory bodies such as FCA (UK), ASIC (Australia), and CySEC.

You can refer to this comparison of best forex brokers for your research on broker fees, regulations. Choosing a regulated broker will ensure that your interests will be protected if there is a ‘conflict of interest. It’s already risky trading in forex; why take an unnecessary risk by trading with an unregulated broker.

7. Not all countries regulate online forex trading

In Africa, online forex trading is legal in only two countries: South Africa and Kenya. The rest of the African countries including Tanzania currently lack a regulatory framework for online retail forex trading.

Why is national regulation necessary? It ensures that you can turn to your national regulator if your broker is not transparent or goes bankrupt. It’s a kind of investment protection you get by trading with a licensed broker.

8. Ill Advice and Scams

The online world is a wild west without a sheriff. There is no end to online fraudsters that lure ordinary investors by promises like ‘double your money in a month.’

It’s not limited to forex trading; stock trading or cryptocurrency trading faces similar risks. They all have a similar modus operandi – run the scheme for a few months/years and run away with the investors’ money. If you’re new to trading, always choose a well-regulated licensed broker.

Similarly, there are many ‘online gurus’ that advise people to invest in particular assets. In reality, they are getting a commission to promote those assets or online platforms. Build your knowledge base, have faith in yourself, don’t follow anyone’s advice blindly.

9. Not using proper risk management

Warren Buffet summarizes the value of risk management effectively in one line – “risk comes from not knowing what you’re doing.”

Trading without proper risk management is like sailing a ship without a compass. There are specific helpful forex tools you can use to minimize the risks. For example, the ‘stop loss’ triggers automatically when the market moves against you. It’s a handy tool in a volatile market situation.

Proper risk management includes wise use of leverage, defining risk-reward ratio, building a trading plan, managing your emotions, keeping an eye on the news, investing what you can afford, and so on.

Takeaway: Heed caution before starting to trade

As with every trade, forex trading is inherently risky. But it doesn’t mean you can’t make a profit by trading in currencies. If you know when to put pressure on the gas pedal and put a break, you are more likely to earn profit from your investments.

If you’re entirely new to trading, start with a demo account before risking any real money in the actual trade. Choose a well-regulated broker in your country. If your country lacks forex regulation, choose a Tier I and Tier II licensed foreign broker.

Calculate risk and reward ratio for each trading order. Use leverage wisely. Learn the essentials of forex trading and know the risks. Build your trading plan, don’t let your emotions take over you. Use risk management tools.