What are the dangers of forex trading for retail investors?

In Summary
  • Recent figures by broker comparison website Forex Brokers South Africa suggest that Kenya has around 70,000 retail traders who invest in forex market through online brokerages.
  • Kenya’s online forex trading market is expected to grow even more as more brokers enter the market.
Image: /COURTESY

The advancements in smartphone and the internet technology have led to the development of online retail trading infrastructure which has attracted a lot of investors to the financial markets worldwide.

In Kenya, internet penetration has grown at an impressive rate and there are approximately 22.86 million internet users in the country as per the report on January 2020. This has brought many retail investors to financial markets who are investing in stocks & forex.

Recent figures by broker comparison website Forex Brokers South Africa suggest that Kenya has around 70,000 retail traders who invest in forex market through online brokerages. Kenya’s online forex trading market is expected to grow even more as more brokers enter the market.

Many forex brokers have seen this surge in numbers of retail investors in Kenya as an opportunity to offer their services and expand their business in Kenya. Leading CFD Trading Brokers like FXPesa, FXTM, Pepperstone are offering their services in Kenya through various online platforms and apps to enable mobile and web trading in markets like forex, indices and global stocks.

The Kenyan government has regulated the financial market industry for the safety of investors as there are many high risks involved with it. This includes online retail trading on Forex and stocks. CMA is the capital market regulator in Kenya that licenses, supervises and monitors all capital market entities. They have licensed four brokers that can offer Online Forex Trading services in Kenya as a CFD instrument.

But despite regulations in place for the protection of investors, the Forex trading poses many risks for the investors. There are factors that affect the forex market which is beyond the control of the regulators.

If you are planning to invest in the Forex market then you need to take into account the dangers mentioned below:

 

  1. Risk of losing more than invested capital:

Your profits and losses are all are dependent on the leverage you choose with your broker. Some brokers offer leverage to the extent of 1:1000 or even more but it’s not necessary that you have to choose such high leverage levels. You can go for options such as 1:25 to reduce the risk. You need to completely aware of the risk involved in highly leveraged trading.

For example, if you invest $1000 (Ksh. 110,000) at the leverage that is 1:100, then the total amount available for trading will equal $100,000 (Ksh. 11,000,000). If the market goes 100 pips against your direction, you could end up losing your $1000 invested capital.

New investors are not aware of the risks associated with leverage or margin trading, so they choose high leverage levels to make higher profits. But it’s best you choose a leverage level where you can afford to cover up the losses in case your trade doesn’t go well.

Professional traders say that one should enter the forex market only if they are ready to lose money. But if you let go of the fear of losing money then you truly test the dangerous waters for yourself.

 

2. Danger of market unpredictability

Unlike other financial markets where one or two factors influences the price, the factors affecting the price of currency pairs in the forex market are many. It’s not possible to keep track of all factors that affect currency pairs.

For example, assume a scenario in which the US government imposes tariffs on imports from the United Kingdom. This decision by the US government will affect the value of GBP/USD i.e., the British Pound against the US Dollar drastically. Once this news is public, the market will experience a high volatile period where traders will be buying and selling currencies based on this news.

This news can affect the market for a few hours or a few days, it depends on the volume of trade being done on the market. Whether or not a particular factor is a long-term effect or not depends on how the market reacts to it.

Some emerging market currencies fell by as high as 40% during the COVID-19 period. Not many people would have predicted that the markets would take such a bad hit. Not only did the markets fall but the lockdown extended far more than it should have, thereby hurting the markets even more.

A highly volatile market might be a good playing ground for an experienced investor who understands market conditions and makes short trades. New investors should trade smaller volumes before making big bets.

 

3. Broker fraud & Insolvency

There are more than thousands of brokers that offer forex trading services to many users around the world. While some of them are highly regulated and licensed, some brokers are not licensed and don’t follow all protocols.

If you were given a $100,000-dollar trading limit for a $1000 dollar investment, then the broker must have $100,000 dollars to lend to you to trade. If a broker is giving $100,000-dollar limit to one user then calculate how much limit it would have to give if there are thousands of users on their platform.

Many brokers make a bet that not all users will make a profitable trade at one time. It’s because of this simple strategy that they are thriving. But even if the brokers have to give so much limit then the brokers should have access to a large number of funds. But not all brokers will have access to a high source of funds.

When brokers don’t have access to a source of funds then there’s no way they can pay you, rather they will file for bankruptcy and leave you high and dry. Recently in South Africa, a broker known as JP markets was accused of cheating its users by offering something and delivering something else, they were even accused of taking the opposite side of their clients’ positions, thereby betting against clients. The broker was asked to be liquidated by South Africa courts and pay its users.

So, it’s essential that you understand the history of the broker and where they come from. Educate yourself on the policies of the broker and check if the broker has acquired all necessary licenses to conduct business in your country.

The burden is on the user to know if the broker is duly licensed and regulated. You will need to do the necessary research to see if a broker has checked all the requirements in the checklist.

If you lose your investment with an unlicensed broker then it will be very hard for you to recover your money back as the CMA doesn’t have any power.

Choose a broker who is regulated by CMA so you can be sure that you can take action against the broker if something goes wrong.

 

4. Scams & Unsolicited advice

Many consider Forex trading as one of the fastest ways to double your money in a matter of minutes. Large crowds of people are attracted to it mainly because of the chance to get high pay-out.

Whenever someone offers an opportunity to make money, we immediately jump into it to make a quick buck. The brokers bank on this and offer dubious schemes to investors to double their money. Investors don’t read a lot into the terms and conditions as they are set on earning high profits.

Scams take place because of the lack of awareness. Investors are not aware as to how much profit can be made or how much investment it takes to double your money. It’s not as easy as it sounds since doubling money is not the proper way of doing forex trading. It’s almost impossible for any broker or trader to promise that he can double your investment, if someone makes this promise to you then you should know that you are being scammed.

If every investor was able to double their money in Forex then shouldn’t everyone be making money in the forex market? Shouldn’t all investors be earning millions? Nearly 70% of the investors who trade in Forex Market lose their money even after making an informed decision.

Remember that the brokers & scammers try all possible ways to make money off you, that’s the main motive. They don’t care if you make money or not, so you need to be smart enough to know if they are trying to cheat you.

 

Beware & Pay Attention

Just because your friends or someone you know trades in the forex market, doesn’t mean even you have to trade in it. You need to understand what the market is, how it functions and learn how to read the market conditions.

To make quick money don’t try to fall prey to scams because it’s not possible to make big amounts of money in small time. You need to be patient and you need to do your research before investing any money, even as little as Ksh. 10,000.

Start by reading about the financial markets, risks, broker and what functions they offer. Talk to licensed investment advisors, and understand if this is an investment you want to make.

Before trading with any broker, check if the broker is regulated, currently there are only four non-dealing forex brokers in Kenya licensed by CMA. Choose any one of them. Read their policies and do demo trades before investing real money.