DEFINING RISK IN FOREX
April 13th 2010 02:30
Most Traded Currencies data source: Wikipedia
If you are just about to try Forex trading, (especially if you are planning to do it on your own on-line) the first thing you’ll notice in every website you’ll visit is the warning that says “forex trading presents substantial risk to your capital”. You’ll see it in almost every page.
It’s like seeing the warning “smoking is dangerous to your health.” It is in practically every pack you buy if you are a smoker.
Unfortunately, those danger signs are usually ignored.
I will not dwell on the reasons why they often go unheeded. That was not my objective for writing this piece. What I will try to do is to help those who are just about to go into the foreign exchange trading understand the risks that they will be faced with.
I can rattle off a number of risks that one may encounter in the course of Forex Trading; in one’s health, self-steem, etc., but I will concentrate on the risks on capital.
Any newbie who was invested in the stock market when the world economy collapsed in 2008 would now have a good idea on what “risks” in investing is all about.
But, still, they will not have a full appreciation of what “risks” means in forex, unless they have already tried trading in currencies.
To explain: in the stock market, one of the worst things that can happen to you is that you bought shares of stocks of a company that eventually goes belly up (recession or no recession). When that happens, the company files for bankruptcy and, well, you’ve lost.
But in reality, that company can still be resurrected or sold (as a whole) to another company that is willing to take over its operation or it can be broken into pieces and sold in parts. The thing is, whichever of those was eventually resorted to, you still have a chance – no matter how slim- to recover part or all of your investments.
That is because what you bought are shares of the company in question. You have those shares to show as proof to everyone that you own part of that company that is being cannibalized and you have proof to show that you are entitled to a portion of its proceeds. If the company is resurrected and became profitable again, you may even end up a winner in the end.
Bottom line, in stock market, in some instances, you may have already lost and yet you still have a chance of winning again by just holding on to your shares (without doing anything else) - given time. And in the stock market, time is almost always in the favor the investor.
That, of course, is by no means always the case.
And that, definitely, is not the case in Forex. In forex trading, you are not buying shares. You are buying currencies which come in pairs.
In the stock market, when you lose in your bet you lose a percentage (big or small) of the value of your shares (which can be recovered). In Forex, when you lose in your bet you lose the money that you put at risk by placing it as your bet.
There is no recovery there.
The only thing you can do to recover the money that you lost in your bets in forex is to place another bet - where you can win, or lose again.
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