Forex is the largest Over-the-counter – OTC exchange in the world and a highly liquid market, in terms of volume. Hence, it gives a great many opportunities to acquire good profits in shorter time frames. Yet it is generally viewed as risky to attain consistent success in forex.
Why is forex trading so hard?
Investors view forex markets as similar to any other financial markets simply based on price movements, yet unpredictable large markets like forex need special preparation to enter into. Trading in stock markets is simple while trading in the forex market is complex.
Traders should follow best practices to minimize the risk while maximizing the returns. Learning forex trading is not a one-time certification program. It is an ongoing process of gaining experience through practicing trading and understanding macroeconomic factors such as interest rates and currency fluctuations.
Below are a few challenges that make forex trading quite difficult to profit from.
Lack of knowledge
It is necessary to understand the nature of the currency price movements in forex. It is risky to trade in forex with little or no knowledge about the factors influencing it. There are a few economic factors, such as interest rates, announcements related to GDP growth, and the unemployment rate to be considered before taking long or short positions in currency trading.
Choosing the right broker
Teaming up with brokers who adhere to the law and offer reliable trading platforms is highly challenging. One should be beware of the fraudulent unregistered brokers who may misguide the traders into taking huge positions. Brokers also sell products that may not perform as advertised.
Trading platforms
Brokers provide add-on services such as software, webinars, and trading robots to attract clients. They also allow their clients to do demo trading prior to purchasing the software. However, it is necessary to verify if the broker is AFC-licensed for such services.
Lack of Market analysis
Most of the investors in forex perform their trades only by seeing the price actions of a currency pair without considering the other indicators. Price action trading is a wonderful technical tool and has been successful for years yet one cannot completely rely on it for making decisions.
Trading plan
The forex market is unpredictable, no matter how experienced one can be. After gaining sufficient confidence in trading currency pairs and understanding the market synergies, forex trading may lead to success. In order to avoid such risks in a highly volatile market, it is advised to practice the demo account for a month or two.
Discipline
Rather than having the urge to enter or exit the positions, traders should think logically and maintain patience to book profits. Even experienced traders make expensive mistakes in forex trading.
It is always better to be cautious before taking positions if any news is yet to be released. Decisions taken based on emotions such as fear, anxiety, temptation and greed most of the time go wrong and lead to huge losses as well.
Market volatility
Forex is the most active, high-volume, currency trading market and hence one should expect high volatility in the market. Fluctuations in currency prices may be very sudden and significant which may lead to potential losses in the blink of an eye. Competent and experienced traders await impending announcements and clues to initiate their positions.
Misleading information
Being incapable of developing a trading strategy with the available clues in the market is another challenge. Sentiments can be either positive or negative according to the prevailing information and the impending news releases. Amid plenty of market clues and pieces of information, it is not only difficult to analyze their accuracy but also to interpret the market sentiment.
Risk management
A knowledgeable trader knows that capital preservation is very essential in large-volume speculative markets like forex. Wrong interpretation of technical and fundamental analysis results in poor asset allocation strategies. Leverage, which allows a trader to borrow money from the broker to take large positions, may magnify the losses.
How to overcome the risks in forex trading?
As a trader, it is essential to acquire the knowledge to understand the nature of the market, one trades. A forex speculator should be capable of calculating the odds of trades being successful. Trading strategies differ from trader to trader depending upon one’s risk-tolerance level, financial circumstances, and capital principal.
Technical & fundamental analysis
Forex is a data-driven speculative currency market that is majorly influenced by enormous fundamental factors such as earnings reports, central bank’s interest rate, GDP and jobless report, etc.
An experienced trader can easily analyze if the underlying market clues and information are already priced in with the help of technical analysis and chart indicators like moving averages, Relative Strength Index-RSI, etc.
While both fundamental and technical analysis are equally important in making informed decisions in forex trading, we cannot rule out the market sentimental analysis which can be made only through experience.
Price analysis
Investment decisions made based on price actions may go wrong because it is necessary to ensure the timeframe of one’s trade matches the timeframe of the price chart.
For example, a short-term trader follows the price action in a 3 to 6 months chart whereas, a day trader follows only the hourly price chart. Though the short-term trend is positive, a pullback in price gives opportunities to go short in daily trades.
Risk management strategies
A measured risk can be managed. Though it is risky to trade in a highly volatile market, forex gives immense opportunities for profits as well. One should have proper planning about the amount of capital to be invested and relative target profit in order to frame an effective strategy.
It is very important to determine one’s level of risk tolerance in any trade. Below are a few risks in forex market trading:
- Exchange rate risk – change in currency prices
- Interest rate risk – change in interest rates that increases market volatility
- Liquidity risk – prevention of buying and selling quickly in a loss-making situation
- Leverage risk – magnified losses of borrowed money while trading in margin
- Liquidity risk – unavailability of currency pair at a desired price in the desired time
- Operational risk – quality of the trading software and platform
Trading plan
The success rate of trading is high when discipline is maintained and emotions are ruled out in an unstable market like forex. A personal trading plan comprises choosing the right currency pair, when to buy, and how much to buy.
It is very important to set a risk-reward ratio before tending to execute the plan. A disciplined trade includes setting up stops and limits, no matter how big the trade is. Stop orders and limit orders help to minimize the loss when the call goes wrong.
Learn more: 5 Proven Steps to Become Successful Forex Trader in 2024
Hedging
Hedging is a mitigating strategy; forex traders usually follow to offset positions in adverse situations. Traders’ open positions in the opposite direction to the existing trade so that the trade will be profitable when the market moves on either side. The objective of hedging is to safeguard the capital and minimize the downside risk.
Diversification
It is a very common mitigating technique that forex traders employ to spread the risk exposure across different currency pairs. This method prevents the trader from relying on a single currency, that possesses high exposure.
Diversification in forex trading involves two techniques. One is trading in multiple currency pairs to disseminate the risk and the other one is applying different strategies in different market conditions. Additionally, experts follow a strategy to diversify across different timeframes.
Diversifying the trading portfolio helps in minimizing the risk of significant losses thereby protecting the capital. It also helps the traders to strike a balance between risk and reward in forex trading.
Market volatility
While volatility is considered a risk in forex, experts believe that volatility is the primary reason why traders are profitable. Aggressive traders prefer volatile markets with high liquidity so the chances of profiting from the trade are higher.
Conclusion
Understanding the dynamics of the forex market and being aware of the external and internal factors influencing currency prices helps traders succeed and protect their investments. Utilizing technical analysis tools and effective risk management strategies minimizes the negative impacts.
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