Online trading has surged to record highs since the start of 2020 due to the volatility & uncertainty in the markets caused by Covid-19 as thousands of new speculative investors turned to markets in the hope to make returns from the movements in the market while many investors pulled out of their market positions. There were many stories of investors losing millions during this rush.
Forex market was also affected by this volatility and many retail traders tried to bet on volatile FX pairs and Oil. Many leading global retail CFD brokers like Admiral markets, Etoro, Plus500 reported growth in users and trading volumes.
Forex Market is a global market where the global currencies are traded & exchanged. It is probably the riskiest financial market for retail traders to invest. Many new investors are unaware of the risks involved in the retail forex and quite often scams that might happen to them while they decide to invest in the market.
Rise in Scams & Risks
As the trading activity has boomed, so have the scams and risks with it.
Many new retail investors are investing in the financial markets for the first time, without education, knowledge of the risks involved, or even financial adequacy in most cases. These retail traders & investors are often not fully aware of the regulations or even the basics of complex instruments like Forex & CFDs and risks associated with them.
Investing in the currency market can be highly risky especially for beginners who lack knowledge and experience how the forex market works. There are various risks that affect currency prices such as a change in interest rate, economic factors, and transaction risks which can’t be predicted correctly even by experienced traders.
Adding to the risks – there are many scammers & dishonest brokers that target and lure unsuspecting common people, new retail investors taking advantage of complexity and lack of knowledge among masses – often promising them high returns in the name of complex instruments like Bitcoin, FX, etc.
The retail investors need to be aware of these associated risks and how to avoid fraudulent schemes in the forex market.
We have listed common risks and scams that you need to be aware of:
1) Unregulated Brokers
One must always invest with legitimate & reputed brokers that are regulated by top-tier regulatory authorities and local market regulators.
You must check whether the brokerage house is registered with the regulating agencies or not. Almost every country’s forex market is regulated by a government-appointed regulator.
For example – CMA is the market regulator in Kenya that regulates Retail Forex brokers, and currently, there are 3 regulated non-dealing forex brokers in Kenya – EGM Securities (FXPesa brand), Scope Markets Kenya, Pepperstone Kenya.
The regulated brokers usually behave responsibly in the market, provide proper trading environment as stipulated by the regulator, better grievance redressal mechanisms and play according to the rule book. They are required to have a separate compliance officer for complaints, in case you are not satisfied by their complaint handling or response, you can also file a complaint with the regulator.
The regulatory bodies keep an eye on the licensed brokers through reporting & compliance requirements. And have the power to suspend their licenses if they fail to act in accordance with their guiding principles. They also ask brokers to submit their portfolios and compliance reports that keep them in check.
Unregulated brokers lack such scrutiny from market watchdogs and hence they are more prone to scams or provide poor service.
Trading with a regulated broker ensures investor protection and safety. So, it shouldn’t be ignored or overlooked.
2) High or Unsafe Leverage
Retail FX Investors often use leverage to increase their position size with a hope/intent to make a higher profit from forex trading. Leverage is a kind of loan provided by a broker to an investor. It increases the capacity of investors to trade with minimal marginal money.
For example, suppose Samantha is interested in buying 10, 000 Euros (against dollars). She is expecting that the exchange rate will rise. But she has only 100 EUR in her trading account. She approaches a brokerage firm named XYZ which provides leverage in the ratio of 1:100. The leverage would enable her to buy 10,000 Euros with only 100 Euros as margin money. So, the margin requirement is just 1% (100/10000).
As illustrated in the above example, leverage is a double-sided sword. Roughly seventy-eighty percent of retail investors lose their money due to the high leverage provided by brokers as people invest more than what they could afford.
As per Trade Forex Kenya, “Underfunded account and using high leverage to make quick money is the most common risk that retail forex traders are exposed to – where there is a high chance of losing money when there are sudden market movements. Traders often hit stop loss or are given a margin call and their trade is closed and they end up losing money.”
“The risk is so high that the traders can even lose more than invested money during margin call. “
New Traders lose the most money in forex, as saying goes 70-80% of retail CFD traders lose in forex, mostly because of unsafe leverage. To minimize this risk, traders must always save leverage of not more than 1:2 or 1:5.
For instance, the European Securities and Markets Authority (ESMA) has capped the leverage ratio for retail traders to 30:1 for major currencies and 2:1 for cryptocurrencies in 2019. Regulatory bodies often crackdown on brokerage firms when their leverage offerings become unsustainably high.
This restriction is not yet implemented by CMA. So, traders must use safe leverage themselves as a caution. The golden rule to remain on the safer side is to never use a leverage ratio higher than 1:5.
In short, it is riskier to invest more than what you can afford.
3) Fake Investment Schemes
Sometimes we come across ‘too good to be true’ schemes. These schemes also known as ‘Ponzi schemes’ promise unbelievable returns on investments. The retail investors with little market knowledge often become victims of these kind of schemes resulting in huge losses.
The modus-operandi of these schemes work like this. Funnel new investors’ monies to pay high returns to previous investors. The cycle continues: these schemes spread through word-of-mouth, and as the subscribers grow, more money becomes available to pay the alleged returns on the investments. It is possible that the early entrants might gain from their investments, but a large number of investors will lose their money at the end. Either these scammers run away with all the money or closes its operations and file bankruptcy.
For instance, the Nigerian government issued a public warning against a Ponzi scheme run in the name of Mavrodi Mundial Movement (MMM) which funneled millions of dollars from Nigerians.
4) Unsolicited Advice
The market gurus or signal sellers without much experience can cause more harm to investors than good. They may allege to have extensive knowledge and able to correctly predict the market. But in reality, they can be just a bunch of salesmen looking for retail investors to inflate their book. If a forex trader is employing these kinds of signal sellers, they become responsible for their predictions.
If your fund manager often calls for more money the reason being the market didn’t perform as expected, this is a bad sign. Don’t fall prey of unprofessional brokers.
5) Over Trading and Taking Big Bets
Overtrading means buying and selling of currencies in an unplanned excessive manner.
The successful traders are likely to trade with their trade plan based on market factors. They don’t run on emotions; they stick to their plans and often fix a risk rate for each trade. For instance, a trader can fix his risk rate at 1-9%, i.e., for each trade, they would risk their capital up to 9%. But if someone fixes his trade risk rate at 20%, it would take only 5 loss-making trades before he runs out of his capital.
To minimize the losses, the traders also adopt what is called risk: reward ratio. For example, if a trader expects $900 gain from a single trade and $300 risk (loss) then his risk: reward ratio will be 1:3 (300: 900). The professional traders often fix their ratio at 1:3.
6) Not Following Risk Management
As discussed above, the traders who don’t stick to their planned risk rate and risk: reward ratio, they become highly vulnerable to market changes.
The other strategy to minimize the risk is to use a Stop Loss order. An investor can make a stop-loss order with a broker to buy or sell a currency when it reaches a specific price level. Knowing when to stop is the best way to avoid losses.
In the End
Every investment comes with certain risks, forex trading is no different. Unplanned strategies and without adhering to proper risk management principles, sooner or later the trader would lose.
The starting point for any investor is knowing how much they could bet in trading that would not impact his normal life even if it makes a loss.
Secondly, don’t let emotions overrule the rational mind. Word of caution would be using excessive leverage provided by the brokers. The unsound leverage positions can potentially do more harm than good.
Thirdly, avoid getting caught in Ponzi schemes which promise astonishing returns. Always trade with regulated brokerage houses.
Fourthly, fix the available risk management tools such as Stop Loss to avoid unwanted losses on your trade.
Mastering anything in the world requires patience, skill, and discipline.