Ups and downs of forex trading

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Hope I am not offending anyone by calling forex trading "speculation on a consistent scale"! I have yet to personally know of anyone who consistently makes money trading forex, and who actually has something called a social life! Tongue

Jun 5, 2011
Ups and downs of forex trading

There is plenty of potential in the market but be aware of the pitfalls
By Lorna Tan, Senior Correspondent

The pursuit of financial freedom has led many retail investors to consider foreign exchange trading.

Online forex trading has seen a tremendous growth in popularity and its appeal is easy to understand.

The forex market is the largest and most liquid of financial markets. It is available 24 hours a day, seven days a week. It is recession-proof and requires a small cash outlay and easy execution.

Ms Marion Lang, head of sales and marketing at forex trading services Oanda Asia Pacific, highlighted that global activity in the sector often exceeds US$4 trillion (S$5 trillion) a day. Over US$1.5 trillion of the total involves spot trading, which refers to the buying of one currency with a different currency for immediate delivery.

Although there are numerous currency pairs in the forex market, the more liquid and active pairs are EUR/USD, USD/JPY and GBP/USD.

Currently, Singapore is the fourth-largest forex market in the world. It is easy to spot advertisements here marketing forex seminars and workshops.

The danger arises when retail investors are taken in by the hyped-up promotions that characterise forex trading as a get-rich-quick activity, said financial experts and the Consumers Association of Singapore (Case).

Mr Seah Seng Choon, Case's executive director, said it has received inquiries and complaints about forex programmes.

There were 13 last year and as of the end of April, it has received six cases so far this year. They range from complaints about pressure selling to alleged misrepresentation on the cost and benefits of the programmes as well as the existence of a particular overseas forex training programme.

Forex is not suitable for everyone, said Mr Ben Fok, chief executive of Grandtag Financial Consultancy. He suggests asking these questions: Do you have time to monitor macroeconomic events that could affect your trading? Do you understand when to cut your losses? Do you worry after you have taken an open position?

Here's what experts say about the pros and cons of forex trading:

Accessibility

Pro: You can start trading forex just by having access to the Internet. This means you can be anywhere, working or otherwise. Time is also not a problem as forex is traded 24 hours a day.

Con: Many traders stay up late into the night to observe small movements in the currencies so as to generate potential profits. If forex trading becomes an addiction, it will distract you from your daily life, affecting your sleep and work time, said Forex Asia Academy founder Choo Khoon Lip, a full-time foreign exchange trader.

Leverage

Pro: To start trading, you need a small margin deposit ranging from a few hundred dollars to $1,000. Based on this deposit, the trading platform is willing to effectively 'lend' you a larger sum for trading purposes. Just how much depends on the 'leverage ratio' offered by the trading platform. It can range from a low 10:1 to as high as 500:1. There is a potential for huge profits with a small cash outlay.

Con: But leverage is a double-edge sword. There is a corresponding danger of taking on open positions that pose too much risk in relation to the size of the account. If you do not have money-management skills, this can spell disaster, said Mr Fok.

Market Sensitivity

Pro: The forex market is sensitive to the current economic situation. Many traders keep themselves updated on upcoming news events, such as unemployment rates, so that they can profit from the currency movements.

Con: But if there is bad economic news, the forex market can react unfavourably, said Mr Fok. So if you do not guard your position in the market, it will affect your position instantaneously.

Stop-Loss Tools

Pro: There are a number of stop-loss techniques, such as setting predetermined trading limits that can help investors prevent major losses in their trades.

Con: But in reality, traders may turn greedy and succumb to the temptation of wanting to gain as much as possible from the forex market. Traders can also become over-confident and trade without placing any limits.

This can result in major losses, warned Mr Choo.

Before venturing on your trading journey, here are some things you should know:

1. Realistic Expectations

Do not treat forex trading as a get-rich-quick financial tool but as an earn-money-slowly activity, said forex trader Jimmy Wong, owner of forex school JF Lennon & Associates. 'Remember that a minimal gain is so much better than a loss. Live to trade another day,' he said. His advice is to work slowly to increase your equity.

And this is what operations executive Eileen Lee, 34, has been doing since she started live trading seven months ago. After trading stocks for five years, she decided to learn about forex trading which she reckoned was recession-proof.

Wary of the potential danger of losing big, she has set aside $10,000 - money that she can afford to lose - as her initial capital outlay for her trades.

'I'm still testing out different strategies to see if they suit my lifestyle,' she said.

2. Live forex trading

Before you trade live, you are encouraged to practise your currency-trading techniques in a demo account for at least three to six months.

'By then, you may already have a fair estimate on the accuracy and profitability of your forex-trading strategy. But if you do not feel confident in using that technique, do not trade live yet,' said Mr Wong.

Go live only when you already have a technique that you can trust completely and stick with it. Do not make frequent and major tweaks in your system since it will only change the strategy beyond recognition. Let the forex technique work for you. Changing trading techniques too frequently is not really a good sign for any forex trader. And start a live account only with money you can afford to lose, he added.

3. Money Management

Mr Choo advises first-time traders to start small. Most forex brokers offer smaller trade sizes. 'These 'mini accounts' are great for getting your feet wet and seeing how the whole system works. It is great for those people with a limited amount of capital,' he said.

Money management is an essential aspect for all traders. This is particularly so because forex losses can spiral out of control if not properly managed. As such, money management tools play a vital role in ensuring your ability to continue trading successfully.

4. Emotion Management

It is easy to understand why we need to rein in our emotions and avoid falling prey to herd instincts when it comes to investing. But the fact is, many end up trading based on emotions instead of following strategies most of the time, observed Mr Wong. And he learnt it the hard way when he lost $800,000 of his savings in forex trades in just four months.

This was in 2008 when he was a forex newbie. Starting with a capital of $100,000, he was on a winning streak and made gains of $600,000. Then he started to get greedy.

'I was thinking that if $100,000 can fetch $600,000, what if I start trading two, three and four times the trading sizes?' he said. He upped his trading size and things got out of hand. Before long, he lost the $600,000 that he initially made and even lost his initial $100,000 capital outlay. He put in another $700,000 which he subsequently lost.

With his savings shrinking, he disciplined himself to trade only smaller lots and watched his emotions and money management very carefully.

That painful experience gave rise to Mr Wong's '60-30-10' principle - that 60 per cent of your time, energy and attention should be focused on managing your emotions, 30 per cent on money management and 10 per cent on your strategy.

5. Forex Strategies

Forex trader Yeo Keong Hee, who conducts forex workshops at Adam Khoo Learning Technologies Group, said traders tend to spend too much time on the least important things. This includes checking out the endless list of newly invented indicators and software that promise quick money.

'The trading approaches should be kept simple. I do not believe that complexity necessarily provides an edge for the trader,' he said.

He recommends that traders establish a well-defined trading system (or a few systems), involving systematic ways of looking for high-probability entry and exit levels. He also emphasised the importance of developing a consistent way of controlling risk in a systematic way, that is, planning for losses, so that losses are kept smaller than profits.

Lastly, have the mental discipline to follow a systematic and proven decision-making process to achieve the above.

6. Forex School

Here's a checklist to help you pick a good forex school:

•What are the credentials and current track records of the trainers and/or school owners?

•Who designed the trading system and has it evolved over time?

•Watch out for schools that encourage you to trade live immediately by introducing brokers.

•What is the staff-to-student ratio?

•What are the course fees?

•Is there a follow-up system for graduate students?

•What are the alumni saying about the school?

•Does the school have any sort of certification?

7. Forex broker or trading platform

At the end of the day, you must place funds in order to trade. You would want a broker with a track record and history who offers financial reliability and is regulated by a respectable regulator like the Monetary Authority of Singapore, said Oanda's Ms Lang.

At Oanda, the leverage ratio is set at 20:1 by default and can go as low as 10:1, while the maximum is 50:1. The firm has a requirement that new account holders have at least six months of experience under their belt before they can sign up there.

lorna@sph.com.sg
My Value Investing Blog: http://sgmusicwhiz.blogspot.com/
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