1. An understanding of probability and risk

An economics expert who doesn’t understand what risk is and how he must manage it can never be a trader. Excellent understanding of the banking system, a thorough grasp of the international flow of currencies will not be helpful if one is not capable of making use of the knowledge in the context of a carefully thought-out, conservative risk strategy. As such, understanding risk is the first and foremost requirement from a trader.

2. A realistic and rational approach to trading

A trader must be level-headed. Trading does not forgive stupidity, or emotional immaturity. Traders are naturally ambitious, but they should direct their ambition towards the goal of mastering the technique of trading, and curb it when it cautions about unparalleled opportunities, or never returning chances.

3. Patience, Diligence, and Independence of Mind

The trader must be patient to let his plans come to fruition over time. He must be diligent in applying the various lessons that he learns throughout his career. He must have an independent mind so that he can expose himself to the opinions of others yet still make his own judgment.

4. Disciplined Application of Money Management Principles

The most important technical aspect of trading is money management. One must make sure that the account is being managed in such a way that profits are maximized, losses cut short, and trade decisions are taken according to a logical, meaningful plan. The plan may not be perfect, and it may not work all the time, which is beside the point anyway. But the trader must be able to manage the loss in such a way that even the best case scenario does not lead to irreversible consequences.

5. Humility and Readiness to Correct Errors

Upon gaining the necessary confidence after applying these principles, one must keep focusing on his failings and recall that forex education never ends. Profits can be increased, losses can be reduced, as there is always room for improvement.

Many traders are worried about forex scams and fraud in the industry, and rightly so, but it is the case that the overwhelming majority of traders lose their accounts because of faulty trading decisions, unrealistic expectations, and a lack of education. The above recipe for success will in fact be enough to guarantee you profitability, but it is action, not pledges or words that counts, and applying these principle in live trading appears to be a formidable task for many traders. Yet the goal is out there, you know what you need to do, and instead of trying unworkable and unreliable methods, you can just focus on these skills to test what you can and cannot achieve in forex.

Is currency trading right for me?

The dynamic nature of the foreign exchange marketplace is an appealing draw to many investors. But as is the case with any type of investment vehicle, there are risks and rewards to be dealt with in currency trading. The opportunity for round-the-clock, computer-based virtual trading on the international currency markets is highly appealing to those investors who don’t wish to bound by the outmoded conventions of traditional equities and commodities markets. As an added attraction, the potential for a skilled investor to realize significant profits in foreign exchange is large. But market participants must also familiarize themselves with the potential downsides of international investing to determine whether or not foreign exchange should play a prominent role in their portfolios.

Managing risk

By definition, every astute investor is also a risk manager. He or she must constantly evaluate the potential upside of a transaction versus its potential downside, taking necessary precautions to preserve principal while taking maximum advantage of opportunities for growth. As is the case with other common forms of investing such as stocks, bonds, real estate, bank deposits, antiques and precious metals, currency trading also has some inherent risks and rewards. The decision whether or not to partake is a highly personal one, and should be made very carefully.

A completely different animal

At first glance, the appeal of the foreign exchange marketplace is easy to understand.

For starters, the foreign exchange markets are truly global in nature and operate around the clock. Unlike traditional equity markets such as the New York Stock Exchange (NYSE) or the National Association of Securities Dealer Automated Quotations (NASDAQ), there are no set trading hours for the foreign exchange market. With no opening and closing bells to constrain or influence trading activity, and no demanding shareholders to satiate on a quarterly basis, the foreign exchange marketplace is considered by some investment professionals and economists to be a better real-time barometer of global economic activity than many other computed indices.

Portfolio diversification

Anyone familiar with modern asset allocation models understands the benefits of maintaining a well-balanced array of investment vehicles that meet predefined criteria. The introduction of a foreign exchange component can offer a unique form of diversification to an investment portfolio. Due to the unique nature of the currency markets, foreign exchange rates are not tied to major equities indices such as the Dow Jones Industrial Average® or the Standard & Poor’s 500®, and are not directly influenced by bond rates.

Appealing potential

For the savvy investor, the notion of realizing large profits in foreign exchange transactions is enticingly high. Given the fact that the average daily volume of the foreign exchange market is 30 times larger than that of the U.S. equity markets, huge volumes of money are changing hands on a regular basis, giving investors more opportunities to realize profits. In fact, many hedge funds now make extensive use of foreign exchange instruments such as derivatives, futures and options as a means of supplementing lackluster returns in their equity portfolios.

Improved market access

For many years, the minimum investment threshold in foreign exchange was firmly fixed at $1 million or greater, effectively barring many individual investors from participating in these markets. But in recent years, this price-of-entry figure has dropped in many cases to just $10,000, providing access for many more non-institutional speculators.

With all of the good things going for it, currency trading might seem like it’s the right choice for almost every investor. Lest we paint too rosy a picture here, there are also some distinct disadvantages to dealing in the foreign exchange markets that one must factor into the decision making process.

Inherent risk

Each foreign exchange transaction is unique and comes with its own associated risks, including volatility, exchange rate risk, credit risk, monetary risk, interest rate risk, and the possibility of government intervention in the financial markets. A wise investor always takes the time to study these individual variables before deciding to plunge into a new currency transaction.

Rock around the clock

The global nature of currency trading means that the markets are always open, hence time zone differences must be reckoned with. London is the undisputed capital of foreign exchange, due in part to the large number of global investment banks located there, and to London’s geographic distance from the International Date Line. To catch what’s happening on the foreign exchange markets as London’s business day starts at 8 a.m. local time, a New Yorker must rise at 3 a.m., and a Los Angeles trader must be awake at midnight. Therefore, it comes as no surprise that U.S. participants in the currency markets sometimes have strange sleep cycles.

No safety net

Because the foreign exchange market is largely unregulated on an international scale, trading activity is generally subject to the laws and customs of each individual participant’s home nation. U.S. investors in traditional instruments such as certificates of deposit, stocks and bonds are afforded some form of protection by various governmental, quasi-governmental and private regulatory bodies such as the Federal Deposit Insurance Corporation (FDIC), the National Association of Securities Dealers (NASD), the Security Investors Protection Corporation (SIPC), the National Futures Association (NFA) and the Municipal Bond Insurance Agency (MBIA). However, in comparison, participants in the foreign exchange markets are afforded relatively few protections. Therefore, investors walking the high wire of the currency markets must be extra cautious when conducting their business.

The curse of devaluation

One of the most perilous events for foreign exchange traders occurs during episodes of currency devaluation. When a government devalues its currency in relation to other nations’ currencies, a substantial reduction in the prevailing exchange rate takes place. Sometimes, devaluation is a process that takes place over a matter of years. At other times, it happens in the blink of an eye. Either way, paper notes, bank deposits and other currency-derived instruments can quickly lose tremendous value, all due to a variety of social, economic and political factors which are completely beyond the average investor’s control.

A dramatic example of currency devaluation induced by inflationary pressures occurred when the German deutschmark suffered a precipitous drop between the World Wars. Saddled with war reparations imposed by the Treaty of Versailles, Germany was thrown into chaos when the prevailing exchange rate went from 4 marks to the dollar in 1916 to about 4 trillion marks to the dollar in 1923.

In 1960, the French government chose to devalue the franc in a move to rectify economic imbalances that had developed over the previous decade. Currency holders received one new franc for every 100 old francs in their possession. Needless to say, foreign currency traders who had acquired sizeable holdings in francs prior to the devaluation lost significantly sums of money as a result.

Another example of huge financial losses which were partially tied to currency devaluation occurred in 1998. Long-Term Capital Management (LTCM), a hedge fund based in Greenwich,Connecticut, used a series of complex investment strategies to build up a large, highly leveraged portfolio consisting primarily of domestic and foreign bond futures. When Russia suddenly devalued the ruble in August of 1998, the resulting shock wave spread around the world and severely impacted investments tied to the value of the ruble, including those amongst LTCM’s massive holdings. The event prompted the U.S. Federal Reserve Bank to assemble an unprecedented $3.65 billion bail-out fund from 14 different commercial banks in order to shore up LTCM’s losses and prevent further economic damage. LTCM eventually liquidated its remaining assets and closed its doors in 2000.

A weak dollar

While the markets rarely see devaluation examples quite as extraordinary as these, smaller scale devaluations happen on a fairly frequent basis. Even though the value of the venerable U.S. dollar is generally viewed as being fairly stable, between February 1985 and February 1987, the dollar still managed to fall almost 30 percent against major foreign currencies. There are no guarantees that this won’t happen again someday.

Your own worst enemy

Markets can rise and fall quite quickly, and an inexperienced currency trader can instantly be blindsided by his or her own poor decision-making. Many foreign exchange investments are executed on a highly leveraged basis, so dramatic swings in the market can lead to an investor being exposed to substantial risk, possibly culminating in catastrophic portfolio losses. Assessing personal risk tolerance is an important step for any individual to take before plunging into a new investment. It is a particularly appropriate measure with regard to entering the foreign exchange marketplace. Arming yourself with the appropriate knowledge and the best analytical tools can go a long way in making you a more effective currency trader.