Foreign Exchange Currency Trading Guide

Be aware: Trading foreign exchange is risky, complicated and, generally, unprofitable for part-time traders. Our guide explains everything you need to know

Updated 9 November 2020

​What is forex trading?

Forex (also known as foreign exchange or FX) involves buying and selling foreign currencies to make a profit. Unless you have reliable insights as to where foreign currencies are going, making money from FX is near-impossible in the long-run. This is because you’re trading alongside major investment banks, full-time FX traders and hedge fund managers. Even the most skilled and experienced traders struggle to predict FX movements.

This guide explains:

• ​How Does Forex Trading Work?
• Forex Trading Beyond Basic Trades - Understanding Contracts for Difference (CFDs)
• 7 Must-Know Foreign Currency Trading Facts
• How do I get started with FX trading?

Know this first: Many New Zealanders have been caught out by forex trading schemes that have promised big profits but ended up in huge losses. The difficulties people face means no one wants to admit they made a mistake. Personal finance journalist Mary Holm is very cautious about forex trading, and we share her views. If forex trading was so lucrative, there would be far more people doing it. The reality is that the road to foreign currency trading riches is paved with significant losses, scams and frauds. Be very cautious about proceeding. 

Your free guide to foreign exchange trading, thanks to Stake

• This MoneyHub guide is sponsored by our friends at Stake.
• If you're looking to understand how foreign exchange trading works, and what your options are, our guide helpfully takes you through everything that's important.
• Outside of forex trading, Stake is the only investment platform to offer free brokerage for US shares and FX trading, so you can trade as much as you want. Our Stake review explains more.

​How does forex trading work?

In its purest form, you’ll profit if you predict one currency will appreciative relative to another. You'll also lose money if the currency you believe will rise later falls. How much you lose depends on how much it falls before you decide to sell your position.

Let's take an example to explain forex trading generally:

• Nick takes the view that the US Dollar will rise against the New Zealand Dollar (NZD) in two hours. He invests USD 100, currently worth NZD 150.
  
• In two hours, USD 100 now buys NZD 151.50.
  
• He decides to sell and makes a profit of NZD 1.50.

​Foreign exchange trading attempts to make a profit by predicting the value of one currency compared to another. Most foreign exchange traders run multiple trades at once and monitor the performance of all the positions to maximise the profits. However, the process is high risk. Furthermore, forex trades can be placed using a ‘margin’, which means you don’t invest the entire amount in each trade, but instead use your money as collateral and your losses may exceed your initial investment.

Is forex trading for beginners?

We don’t think so. Any FX trader will need to have experience, as well as research insights and monitoring tools. For every trade made, there is a winner and a loser. Banks and major financial institutions trade foreign exchange and have superior insights and experience than the average at-home trader/investor.  

The Financial Markets Authority has a detailed guide on forex trading. We agree with their sentiments about the high-risk nature and regular occurrence of scams. For this reason, we can’t identify forex trading in any form as suitable for part-time investors or traders.

Forex Trading Beyond Basic Trades - Understanding Contracts for Difference (CFDs)

Another way to trade forex is by using Contracts for difference (CFDs), which is a popular trading method on many platforms. CFDs let you bet on a change in the value of a foreign exchange rate, share price or a market index. In all cases, you’re not buying the underlying asset (i.e. foreign currency), you’re merely betting on a movement in the price. You're not buying the underlying asset, just betting on the price movement.

Know this: Any CFD comes with high risk – it’s a legal contract, and for every winner, there is a loser. Additionally, every CFD is highly geared, meaning the risk is significant as your investment is significantly less than the trade value. When you hear people lose $50,000 in three or four forex trades, it will often be due to CFDs that were not successful.  

Important: Even small forex movements can prove disastrous to a trader. This is because each trade requires only a small deposit or upfront payment; the real profits (or losses) are generated when the trade completes.

Your profit or loss is determined by the difference between the entry and exit price on a trade. Remember that prices are always quoted with the sell price on the left and the buy price on the right. You enter a trade via one and exit via the other. To help you understand how forex trading works, view our CFD examples below, which take you through both buying and selling scenarios.

CFD Forex Trading Examples:

Situation 1: Nick trades in EUR/GBP

• Right now, EUR/GBP is trading at 0.84955 (buy) / 0.84960 (sell)
• Nick decides to buy $10,000 because he believes the price of EUR/GBP will go up (i.e. the Euro will become stronger against the British Pound).
• Nick’s CFD has a margin rate of 0.20%, which means he has to deposit 0.20% of the total position’s value as “position margin”. In this example, that is 0.20% X ($10,000 X 0.84955) = $16.99.  
• Nick knows that if the forex price moves against him, he can lose more than his $16.99 investment.

Outcome A: Nick has a profitable trade

1. Nick predicts correctly; the price rises over the next hour to 0.85520 (buy) / 0.85530 (sell). Nick decides to close out on his trade by selling at 0.85530 (the current sell price).
2. The price has moved 57.50 points (0.85530 – 0.84955) in Nick’s favour. This generates a profit for Nick of $57.50 ([$10,000 x 0.85530] – [$10,000 x 0.84955]) = $57.50.

Outcome B: Nick has a losing trade

1. Unfortunately, Nick’s prediction is incorrect. The price of EUR/GBP drops over the next hour to 0.83380 / 0.83390. Nick now thinks the price will keep falling, so he decides to cut his losses and sell at 0.83390 (the current sell price) to close the trade.
2. The price has moved 114 points (0.85530 – 0.83390) against Nick. This generates a loss of Nick of $114, well in excess of his original $16.99 investment.

7 Must-Know Foreign Currency Trading Facts

​Exchange rates are unpredictable, volatile and movements are near-impossible to pre-empt

Within a day they can move significantly. The examples below are for illustration only; many forex traders start small and profit $50 or lose $100 before going on to larger trades. Fluctuations of exchange rates in any day can quickly lead to significant losses and a very stressful experience.

Ask yourself this – do you know where the value of the USD against the EUR will be in two days time? If you don’t know (or don’t have any idea about why exchange rates are moving), getting into forex trading is unlikely to be a good idea.

Forex trading is not the same as investing in an asset

Unlike investing in assets like shares, there is limited protection from foreign exchange markets moving against you. You can lose all of your investment (and more) very quickly if you make the wrong decisions. Some platforms offer stop-loss orders, which means your position will close if the exchange rate drops below a certain level. This is designed to limit your losses, but using a stop-loss will cost an additional fee.

The internet is full of forex scams and frauds

You will see display adverts on many notable online publications, including Stuff.co.nz and NZHerald.co.nz, which trick Google and publishers to promote their ‘too good to be true’ offers. YouTube is also awash with ‘gurus’ promising riches with minimal investment. If you sign up to the paid programs or platforms, there is a high risk you’ll lose 100% of your investment. They exist to take money from aspiring (but inexperienced) traders. If you sign up to a program or platform, make sure you're 100% certain of what's involved, how it works and how much you can lose.

(It's likely) no one you know has experienced a long-term forex trading success

We believe the ‘riches’ so often advertised are a myth (or, at best, greatly exaggerated) for the average do-it-from-home forex trader. Every trade has a winner and a loser, and when you’re playing against banks, hedge funds and professional traders, it’s easy to see who will lose.

​Forex platforms can disappear overnight (and take your money with them)

Anything outside of New Zealand is usually NOT covered by any legal protection. Many forex operations are based in countries that offer limited or questionable legal protection – Cyprus, Albania, Romania and Turkey are some examples. This adds to the general risk of losing money from unfavourable trades.

​Many forex seminars, programs and courses continue to cheat New Zealanders

Such 'opportunities' may be in-person or online, and offer introductory teases such as “learn millionaire forex trading strategies for $50” and “our online trading course gives you the skills for unlimited profits”. The reality is that participants will be hard-sold. Generally, we’re very negative with regards to the promoters of FX education and tools. In most cases we see them advertised to mum and dad-type investors with the promise of big riches despite the audience having little or no experience with what they’re trading and how it will make (or lose) money. Worst still is the upfront course or coaching fees charged; $3,000 or even $7,000 is not unusual to learn the “techniques”.

We believe such courses offer very little to aspiring traders, other than a fast way to lose a lot of money. It’s arguable that if FX trading was so profitable for the promoters, why are they wasting time marketing to wannabe traders?

We firmly believe that courses or platforms promising riches from forex trading should be avoided and reported to the FMA. Remember – no person, program or tool can EVER predict movements in foreign exchange markets.

​If you do want to trade, do thorough checks before depositing $1

It’s very easy to get sold into forex trading platforms, but the risks are so high that doing due diligence on is essential. It’s critical to make sure that the forex provider is registered with the Financial Markets Authority so you are legally protected. If it doesn’t, check to see if it’s regulated by an overseas authority. You won’t be covered by New Zealand law, but there may be some protection.

How do I get started with FX trading?

​We’ve not linked to any FX trading platform, as our editorial policy does not encourage speculative investments for anyone who isn’t professional.

The Financial Markets Authority offers a useful overview - you can read their guide in full here: 

1. Check you are using a New Zealand-licensed provider
2. Read the product disclosure statement (PDS)
3. Pay careful attention to your trades. If you think things might be getting beyond your ability to cover potential losses, then stop.