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Posted on Thursday, March 26th, 2009 at 7:27 am

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Eliminating Risks of FOREX Investing by Adam J. Heist

It is quite unwise to remain under the notion that FOREX trading is free of risks; just as some websites would have you believe. If you are going to trade in heavy sums of money, chances are that the trades will work in your disfavor. But, a wise investor will know exactly how to identify and avoid those risks. Such an investor could make great profits at the FOREX.

The FOREX is rife with scams. Of course, the incidences of these scams have gone pretty low in recent years, but that doesn't mean one will trade in it throwing all caution to the winds. You must be very particular about your broker; it helps to do some background check to verify credentials. If the broker is affiliated to a reputable bank, insurance company or some such financial institution, then you may be well confident of his/her genuineness. The registering body for FOREX traders is Commodities Futures Trading Commission (CFTC) or the broker must be a member of the National Futures Association (NFA). It is also advisable to get a report from the Better Business Bureau and the Consumer Protection Bureau.

There are several more risks that one needs to know of, even after getting a reputable broker. The following are some of the risks:-
(i)There are unexpected rate changes at the FOREX that the trader must know about. Fluctuations can occur while the trading is still going on. If prices fall, then there could be severe losses to the trader. These could be minimized by issuing stop orders, but all traders may not be aware of this order. A stop loss order will close all the positions if the currency prices fall lower than a predetermined cutoff. There are also limit orders that close the positions when a profit target is achieved. A wise investor will make use of both the stop loss and the limit orders in order to reduce losses and make profits at the FOREX.
(ii)Sometimes the interest rates of two countries are different. If this happens in the FOREX quote, then there could be a deviation from the projected profit or loss.
(iii)Lack of honesty is occasionally encountered at the FOREX. If one of the parties in the transaction dishonors their debt when the deal is closed, there could be a credit risk. This could also happen when the party declares insolvency.
(iv)Governments of the countries associated at the FOREX could limit the flow of currency. This is seen much more in the lesser-used currencies in the FOREX.

Even though there are so many risks at the FOREX, there are also ways in which these risks can be reduced or even eliminated. The first step in reducing risks is to develop a strategy including a plan of when to enter and when to exit the market. This would require a good research of market trends of the FOREX in advance. Also, the wisest investor is one who put only that excess money in the FOREX which doesn't make much difference to the financial position if lost.

Knowing about the technical analysis and how to read and understand the financial charts is very important. These can be learnt through the internet and by reading books written by FOREX gurus.

However, the greatest of education cannot guarantee profit-making at the FOREX. This is because the market can move in unpredictable ways. Stop loss orders and limit orders must be used to prevent losses from any eventualities.

Most traders use stop loss orders. But even these need careful understanding of the market trends. If the trader is looking for a long position and expecting the price to rise, then the stop loss order would be ideally placed at below the current market price. The converse is also true.

Let us understand this with an example. Suppose a trader takes a short position with the following quote:
USD/CDN = 1.2138/43
This quote means that the trader can sell 1 USD for 1.2138 CDN or sell 1.2143 CDN for 1 USD. Let us also suppose that the investor is taking a short position.

In the above case, a good order would be:
Sell USD:1 standard lot USD/CDN @ 1.2138 = $121,380 CDN
Pip Value:1 pip = $10
Stop Loss:1.2148
Margin:$1,000 (1%)

Here the trader is selling 100,000 USD and buying 121,380 CDN. If the USD value goes above 1.2148, then the stop loss order would be executed. Here, the trader would lose $100.

But if the USD/CDN falls to 1.2118/23, the trader can sell 1 USD for 1.2118 CDN or sell 1.2123 CDN for 1 USD. Since the trader entered in the transaction by selling USD, then he/she must now buy back the USD and sell CDN to make the profit. So, the trader buys back 100,000 USD at the current rate for a total cost of 121,233 CDN. Since the original sale was for 121,380 CDN, the trader would have made a profit of 157 CDN or 129.51 USD.

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