As part of its investor education initiative, the SEC has issued an Investor Bulletin educating consumers about the risks of retail foreign exchange (“forex”) trading. “Forex trading can be very risky and is not appropriate for all investors,” explains Lori J. Schock of the SEC’s Office of Investor Education and Advocacy. “Individual investors considering forex trading need to fully understand the unique characteristics of this market and consult their financial adviser before making any investment decisions.”
The four-page bulletin puts special emphasis on the danger of leveraged trading. Leverage, it explains, is the use of small amounts of money (commonly called margin) to purchase large amounts of a product (in this case, foreign currency). Most forex trades are conducted on a leveraged basis because the larger scale of leveraged trades allows investors to profit off of minor fluctuations in the market. However, those same minor fluctuations can also lead to devastating losses. And because the forex contracts are leveraged, investors may end up owing even more than their initial investment.
The SEC also wants consumers to understand the following:
- “Quoting conventions are not uniform.” Investors must be careful they understand which side of the transaction they are entering.
- “Transaction costs may not be clear.” Even if a firm says they are “commission-free,” they may be marking up ask and bid prices to make a profit.
- “Transaction costs can turn profitable trades into losing transactions.” Frequent trading can rack up transaction costs that eat through profits.
- “Trading systems may not operate as intended.” Automating trading systems can get out of hand if an investor does not understand the system’s triggers.
- Fraud is very common in the forex market. Get-rich-quick schemes should always be avoided.
- “Special Risks of Off-exchange Forex Trading.” No central market place means no way to tell if a price is fair. There is also no central clearing, which leaves consumers at risk if a counter-party defaults.
Anyone engaged in retail forex tradings via banks or retail forex dealers (“RFEDs”) should be aware of new CFTC, OCC, SEC, and FDIC rules governing the industry.