Foreign exchange trading – also called forex or FX trading – can potentially help you generate income and wealth. However, it also carries a high level of risk.
This article explores how currencies are traded, the risks involved, and how to educate yourself if you’re considering entering the market.
Tip: Not sure about forex? Build your wealth via a savings or investment product.
What is forex trading?
Foreign exchange trading involves buying and selling global currencies in a decentralised international marketplace, to make a profit via global and central banks.
Currencies of two different countries – such as South Africa and the United States – are sold in “pairs”, with one being a base currency and the other a quote currency.
Forex broker FXTM explains that all forex transactions are done electronically and simultaneously by traders such as banks, investment companies, and individual investors.
Foreign exchange is one of the world’s most liquid financial markets; meaning, this asset can be converted easily, immediately, and freely into cash on the open market without influencing its market price.
However, trading is unpredictable and risky because supply and demand are based on continually changing exchange rates; and inflation, interest rates, natural disasters, and political events can all cause currency fluctuations.
Forex trading in South Africa
In South Africa, the Financial Sector Conduct Authority (FSCA) regulates all forex traders. According to SA Shares, at time of writing, about R427 billion (more than US$25 billion) in forex is traded locally each day.
Forex trading is legal for South African citizens, provided they use an FSCA-regulated and licensed over-the-counter derivative provider (ODP) forex broker.
“Most legitimate international brokers are fully regulated in their domiciled country and the country in which they operate,” says Garth L East, managing director of forex trading and training company FX Varsity. “However, always check with the FSCA to confirm that a broker is registered, and that they have no non-compliance reports against them. Also, talk to FX traders who already use them.”
The allure of quick profits
East says forex trading is attractive because all you need is a computer and an internet connection to get started, with profit and financial freedom seemingly in reach. However, he compares a novice investor trading without sufficient knowledge to an inexperienced driver being given a car and driving it down a busy highway.
“It’s madness to open a forex trading account without proper training, flop some money into it, and simply follow the stream,” he cautions.
Jonathan Racussen, dealing director of foreign exchange solutions company Currency Partners, warns against “confusing luck for skill”, overconfidence, chasing losses, and letting emotions such as fear and greed impact decision-making.
“It’s possible to make money if someone has some skill and luck, but people often see forex trading as a get-rich-quick opportunity, and they can lose all their capital.”
He remarks that trading is a high-stress activity that can significantly affect your personal life.
Tips for responsible trading
While there’s no foolproof way of managing forex trading risk, both East and Racussen stress the importance of education, research, and discipline.
Learn about the markets
If you want to learn about forex trading, East says, there’s a lot of material available, including forums, books, courses, and resources on platforms such as WikiFX, Forex Factory, and Myfxbook.
“It’s important to study and practice. Copy a good trading strategy, or formulate your own,” he says.
“You can also consider reputable, accredited training academies specialising in forex education.”
Research potential brokers
When choosing a broker, it’s crucial to thoroughly research and compare companies, including business history and reviews by past and current clients.
Apply discipline
Racussen notes that it’s essential to have the discipline to trade only with an amount you can afford to lose.
East emphasises the concept, “learn, then trade, then earn”, and recommends following the 1% rule – risk no more than 1% of your initial capital on any forex trade.
Racussen strongly advises amateurs against trading currency for short-term gains, and notes that FX currency should only be purchased as part of a distinct transaction, investment plan, or purpose.
“Diversify your investments and spread your risk across various platforms. If you’re eating dry crackers midway through the month because you can’t budget, forex trading is not worth the risk,” East concludes.
Tip: Use our budget calculator to determine how much you can afford to invest.