The Foreign Exchange Market is the largest financial market in the world. Bloomberg, a global leader in financial data and analysis, reported a daily currency trade volume of over $6.6 trillion, back in April 2019. This was a 29% increase in volume compared to April 2016.
24/5 availability, low capital requirements, high liquidity and zero low-entry costs are one of the few factors that has made retail forex so popular among investors.
With the rise of 3rd-party trading platforms like – MT4 and MT5, many low-cost retail brokers have opened in recent times which resulted in the growth of retail forex trading globally. In Africa too, retail FX trading has grown in the past few years and presently there are estimated to over 1.3 million African forex traders that trade in forex daily.
The trading in forex market is done on currency pairs. Traders can buy, sell or exchange currencies based on the current exchange rate of a currency pair like EUR/USD. FX trading involves a lot of risks and traders have to take risks related to leverage, interest rate, economy and counterparty into account before starting forex trading. Also, there are other risks related to human emotions and insufficient knowledge of the financial instrument & market uncertainty.
We take a look at some of the aspects of retail forex trading, the reasons behind its increasing popularity among African investors and the risks involved.
What is Retail Forex Trading?
Retail forex trading is a part of the larger forex market where banks, government and companies transact. Retail forex traders speculate on the exchange rate fluctuations of different currencies. Speculators buy currencies with the aim to sell them off at higher price later on.
Speculation can result in gains for the traders but the risks involved are very high. This is because, during the period that an investor holds the currencies they’ve bought, the currencies can fluctuate in value due to various reasons which can be hard to predict for most traders.
The forex market trade is done on currency pairs such as – the EUR/USD or Euro/US Dollar pair. Here, the base currency is Euro and the quote currency is US Dollar. Presently, the exchange rate of the EUR/USD pair is around 1.18. This means, in exchange for 1 Euro you can get 1.18 US Dollars. The EUR/USD pair is the most traded currency pair in the world.
Why is it so popular among African investors?
Africa has seen an increase in retail forex trading demand over the past few years. Currently, South Africa, Nigeria, Kenya, Tanzania have around 200,000, 190,000, 65,000 and 50,000 forex traders respectively. And Zimbabwe too has reportedly over 45,000 traders in the retail forex market.
One of the main reasons for this impressive growth in the region is the establishment of local forex regulatory bodies in Africa like – Financial Sector Conduct Authority (FSCA of South Africa) and the Capital Markets Authority (CMA of Kenya) which created secure & regulated trading environment for SA & Kenyan traders in which they oversee the conduct of the market participants as well as educate local investors about the risks. The FSCA and the CMA issue brokerage licenses as well as function as financial watchdogs over institutions that provide financial services and products.
Moreover, the startup & regulatory costs imposed by the FSCA and CMA on African brokers are much lower than most other regulatory bodies in EU, UK and Australia. This resulted in many local brokers like CM Trading, BlackStone Futures to open & grow their business in Africa and also encouraged big overseas brokers like FXTM, IG, HotForex, Avatrade, Pepperstone to get forex broker license from FCSA & CMA.
These brokers help build the local ecosystem in Africa for new traders by establishing local IB networks, trader groups, seminars where new investors are educated about forex trading.
Apart from above, African forex investors are attracted to forex market due to its unique nature over the other financial markets. This includes high volume, liquidity, low entry costs, ease of deposit/withdrawal options, 24-hour services and on-the-go trading facilities that can be availed by using just a mobile application or any platform of choice. Further, with the rise of mobile internet, social media and digital communications, more and more young people are coming to know about trading and are turning to online investing.
But, this growth has also caused rise to investment scams in Africa, just as there are genuine brokers who aim to provide safe environment to the investors and build a reputation for themselves, there are also some unregulated entities/persons who want to cheat inexperienced investors with false claims and promises.
Risks of Investing in the Forex Market
Most of the risks involved in forex trading arise from trading with insufficient knowledge about the markets.
But, most common risk that new forex investors take is trading with an unregulated broker. Not all unregulated brokers pool money from the public with ill-intent. But, in most cases this is their intent and many new investors fall prey to such persons/entities who make huge promises of returns or never invest their money in the markets. So, it is always wise to choose a regulated forex broker that is licensed by bodies like FSCA, CMA, FCA or ASIC.
In case you run into any disputes with a regulated broker, you always have a dispute resolution body to appeal to for damages and seeking legal aid. But this is not possible in case of unregulated entities. So, it best to avoid them and be safe than sorry!
Apart from above, there are some inherent risks associated with retail forex trading. Such as:
- Market Volatility and Unexpected Movements
The forex market is very volatile in nature. This is because the value of any currency is influenced by various economic, political and natural factors.
Any event, whether of local, national or global significance, can have the potential to crash the markets. This is why investors need to stay highly alert and updated, to be able to make a move in case of any unfavorable development.
For example, in the month of March, almost all currency pairs became volatile and some even dropped upto 35% in value. The cause was the outbreak of novel coronavirus. Developing nation currencies took the worst hit and one of the worst affected ones was the South African Rand – falling by around 32% against the US dollar, in the months of March and April.
- Risks of using High Leverage/Margin Trading
Margin based trading allows you to trade with only a fraction of the required capital for an investment. It is expressed as a ratio of the minimum amount of money needed to make the investment against the actual amount of capital required for the investment. Most brokers in Africa offer high leverage with low margin requirements to their clients.
For example, for an investment worth $1000, a leverage of 1:1000 implies that you only need to pay $1 as margin to the broker.
Leverage is a double-edged sword. Higher leverage means higher profits, but only if the trade plays out in your favor. If it doesn’t, you can lose just as much as you stood a chance to gain.
- Over Trading & Investing more than you are willing to lose
Due to the volatile nature of the forex market, any trade can go wrong in seconds. If you invest all your money at once, there is a chance that you might end up losing all of it. This is why one should only invest a fraction of the money from their savings and only invest what they can afford to lose.
Risk Management could help reduce risks of a forex trader where trader can determine his/her risk tolerance and make adjustments to their portfolio based on the same. It can be done through tools provided by brokers like:
- Negative Balance Protection-
Protects you from incurring losses more than the amount you have deposited.
- Stop-loss Orders-
Protects you from incurring losses greater than your risk tolerance. A stop-loss order can stop a trade if the losses exceed a pre-defined threshold.
However, even with proper planning and use of risk management tools, investors can still lose a lot of money. This is because the forex is much riskier to invest in than other investments like government bonds or mutual funds. For new investors, it is recommended to start trading in small amounts. This will help you to get accustomed to the market and also determine whether or not it is suitable for you.
Is Forex Trading Legal in Zimbabwe?
There is no clarity on rules relating to Online Forex Trading in Zimbabwe as there is no direct law or directive allowing or banning online forex trading activity.
Foreign exchange transactions are regulated by Reserve Bank of Zimbabwe and exchangers must be regulated by bureau of exchange. And trading is allowed to Regulated Organizations through new forex auction system.
Individual Investors are not allowed to invest online as there are restrictions on online & offline foreign exchange transactions. Yet some investors find their way to do so, which is illegal.
There is no regulation for forex brokers in Zimbabwe making it risky for investors. There is no forex broker that is regulated in Zimbabwe and if anyone claims so, take caution.
If you still want to invest in forex at your own risk, you must do proper due diligence on local Forex laws, online investing restrictions in Zimbabwe and on brokers you want to choose. Most globally reputed forex brokers are regulated under different top tier regulations like FCA, ASIC, FSCA and you must only trade with them.
New forex investors should study, analyze the market and strategize accordingly and before starting off with real money, test their strategy in a demo account. Most reputed brokers provide demo accounts to their clients. Demo accounts can help you familiarize with the effectiveness of your strategy and also help you understand more about the trading platform and tools offered by the broker.
Make sure you understand the laws and regulations in Zimbabwe on online forex trading before you invest any money.