As investors, we are always looking for the next best deal. We willingly move from one financial vehicle to the next in hopes of hitting it big. Disillusioned with the lackluster performance of stocks and bonds these past few years, many of us have moved our money over to the latest entrants in the investment scene—currencies and binary options.
In under a decade, currencies, usually referred to as Forex, (which stands for foreign exchange markets,) has become the largest financial market in the world with over $4 trillion traded on a daily basis. Forex trades are made by choosing which side of a foreign currency pair will do better against the other currency in the pair. A Forex trader decides which half of the currency pair he/she expects to change in value and places a trade accordingly.
When it comes right down to it, Forex trading is a form of gambling and is no different than placing a bit at the poker table in a casino house. Most traders do not understand the basics about Forex markets nor do they know how to choose the currencies to bet on. This lack of knowledge can be fateful and it results in over 80% of all newbie traders losing their money in a just a matter of days.
One of the problems about trading Forex is that opening an account with a broker is a no brainer and just like slapping down a few coins on the Blackjack table, depositing a few bucks in a Forex account is as easy as making a call on your Galaxy VI. There is a plethora of online Forex brokers to choose from and opening an account is free. What novice Forex traders don’t grasp is that without proper understanding and instruction on how to trade, trading Forex can never be profitable.
To make matters worse, most Forex brokers out there are only eager to ‘help’ out a trader by extending considerable leverage to his account. What this leverage means is that a trader can open an account with a minimum amount and be able to trade significantly more.
Leverage in the Forex market is meaningfully larger than the 2:1 leverage normally provided on equities and the 15:1 leverage offered by the futures market. If a trader has only $1000 to deposit, he can obtain leverage of up to 100:1 and be able to trade $100,000 of currency. This is like having the guy at casino desk who cashes in your dollars for chips dishing out 100 or 200 times the amount of chips your money is worth going under the assumption that you will lose it all in the slot machines. Your account will still be charged for the surplus.
This ability to trade significantly more than what you start out with sounds wonderful. And if by chance you choose correctly, you may just come out with a tidy profit on your original deposit. But what happens if the currencies move in the opposite direction of your prediction? Not only have you lost your original $1000, you now owe significantly more. Where will this money come from? You will have to dig deeper into your pocket to come up with the money to cover this lose.
Now comes the hard part. When you reach this point, you must make a serious decision. You can choose to end the dire situation by somehow paying off this debt and getting out of the Forex market altogether. Or you can request additional margin, which the broker will gladly provide, and continue trading with the belief that you know what you are doing and that you will eventually be able to cover the money owed. Since this is hardly ever the case, you will most probably find yourself spiraling downward until you reach a point where you can’t turn around. It’s never easy to walk away from the roulette wheel after you lost a pile of greenbacks.
Being on the wrong side of the win is really not a pleasant situation to be in and it illustrates the risk of trading Forex—or any investment vehicle—on credit. It all goes back to the old rule—if you don’t have it, don’t spend it.
Cina Coren is a contributing editor at Daily Forex, a Forex broker review site, and a freelance writer for several financial publications.