How To Trade Forex, Avoid Forex Scams | Invest
When people think of investments, they tend to think of the stock market. Stocks certainly get the most attention in the financial media. Other markets, such as bonds and commodities, are also attracting significant interest. However, there is one financial market that is bigger than all the others combined in terms of trading volume. This is the foreign exchange market, or forex for short.
According to the 2019 Triennial Survey of Central Banks by the Bank for International Settlements, the foreign exchange market handles more than $6 trillion in trading volume every business day. The foreign exchange market encompasses a wide variety of participants, including governments, banks, multinational corporations, institutional investors, tourists and business travelers, retail traders, and more. The immense trading volume provides significant opportunities for savvy traders.
However, it is important to realize that forex trading is a zero-sum market, which means that for every winner of a trade, someone loses an equal amount. This is because currencies do not produce profits or pay dividends like a business would. The stock market, being a positive-sum game due to increasing corporate profits and economic growth, tends to produce better long-term returns for investors than forex trading.
However, while forex may not be an ideal way to build long-term wealth, it offers a number of intriguing trading opportunities due to the unique characteristics of the currency market. And while there are plenty of legitimate ways to make money in the forex market, scams do exist and can turn investors away. Here are some factors to consider before getting into forex trading:
- Benefits of forex trading now.
- Effects of geopolitical events on forex trading.
- Scams to watch out for in forex trading.
Benefits of Trading Forex Now
Forex trading has become particularly attractive in 2022 due to several factors, one of which is the sudden rise in interest rates and inflation. Much of the currency trading is driven by differences in interest rates between different countries. A forex trader can buy a currency yielding 5% per annum and sell short another yielding 1% per annum. This would translate to an annual gain of 4% per year simply due to the interest rate differential. This interest rate difference is known as “carry”. Carry trading, or taking advantage of these interest rate differences, is an ever-popular forex strategy. With leverage, which is widely used in forex, this hypothetical 4% annual gain can be magnified many times over. It is important to note, however, that carry trades carry a significant risk, namely that the value of the underlying currencies could fluctuate by more than the interest rate differential, thus wiping out the potential profit.
Carry trading declined in importance after the 2008 financial crisis, with most major central banks setting their interest rates at or near zero. This has reduced the possibilities of arbitrage between different interest rates around the world. Now, however, with central banks such as the US Federal Reserve rapidly raising rates, the opportunities are multiplying.
Effects of Geopolitical Events on Forex Trading
Geopolitical events are another key factor driving increased interest in forex. The invasion of Ukraine caused investors to seek safety in their wallets. Traders turn to forex “in times of global geopolitical uncertainty, such as we have recently experienced with Russia, Ukraine and China,” says Stephen Akin, registered investment adviser and founder of Akin Investments. “The security trade, often referred to as the ‘King Dollar,’ has been used to protect investors around the world seeking the security of the US dollar.”
Indeed, the dollar has appreciated strongly in recent months. For example, this summer, it reached parity against the euro. This means that, for the first time since 2002, $1 was equal to 1 euro. This is a notable event, as historically the euro has generally been worth much more than the dollar. The dollar also appreciated strongly against other major currencies, such as the Japanese yen, Swiss franc and British pound.
Linked to these geopolitical upheavals, there is also the surge in commodity prices and the inflationary impact associated with it. Countries that produce a lot of raw materials, such as oil, copper and iron ore, are benefiting from the current inflationary environment. Meanwhile, countries that import commodities do not fare so well in the global trade market.
Richard Gardner, CEO of leading white label forex trading platform M4, Modulus, explains how it has played out in 2022: “This year, events in Ukraine have driven up the price of commodities, including oil and natural gas. This has been a major boon for commodity currencies, especially relative to economies that tend to import those same commodities. You can see this play out, for example, by comparing the Norwegian krone to the Japanese yen this year.
Given this dynamic, a forex trader could buy the currency of a commodity-producing country, such as Brazil, while betting against a commodity importer, such as Japan. Since the start of the year, the Brazilian real has appreciated by around 30% against the Japanese yen. Brazil also has a much higher interest rate than Japan, so this hypothetical trade would benefit from a high amount of positive carry interest in addition to capital gains. And then there is leverage. It is not uncommon for traders to use three, five or even ten times leverage on positions, which could multiply a 30% gain into something much larger.
However, this leverage can be a double-edged sword. Akin explains, “Forex trading is high risk because of the leverage it provides. This leverage allows you to control a large investment with a relatively small amount of money. potential returns, but can also result in significant losses.”
Scams to watch out for in Forex trading
While there are many legitimate ways to profit from the forex market, there are also some pitfalls to watch out for. According to Angelo Ciaramello, CEO and co-founder of retail education company The Funded Trader, there are three types of forex scams to watch out for. He describes them as the portfolio manager scam, pump and dump, and trading bots.
Portfolio manager scam. In this scam, an unregistered portfolio manager will contact investors via social media using a pseudonym and promise unusually high returns. These bad actors can be avoided by dealing exclusively with licensed financial advisers, says Ciaramello.
Pump and empty. This type of scam is currently most prevalent in cryptocurrency markets, but pumps and dumps can also occur in illiquid foreign exchange markets, where a chat room or social media group will drag the price into a direction and then unload their positions on people who bought into the artificial price movement.
Trading bots. Trading bots are software that execute trades on behalf of the trader, Ciaramello explains. “They claim to have an algorithm that will deliver important results, like being able to achieve financial freedom just by using their bot.” However, these bots rarely deliver on their promises, he says, adding that traders should only use companies that have legitimate quantitative trading strategies.
As a general rule, it makes sense to avoid forex brokers that promise abnormally high returns and ensure that their funding methods are safe and reliable. “Beware of a brokerage that does not allow withdrawals or, conversely, makes withdrawals unreasonably difficult,” says Gardner. “A good way to avoid this type of scam is to make a small deposit and then withdraw it to ensure you can access your assets.”
Also beware of companies that have a limited track record. “Beyond a test deposit, you’ll want to choose a regulated brokerage that has a track record of fairness and success,” says Gardner.