UNDERSTANDING THE RISKS OF TRADING IN THE
RETAIL OFF-EXCHANGE FOREIGN CURRENCY MARKET
Although every investment involves some risk, the risk of loss in trading off-exchange forex contracts can be substantial. Therefore, if you are considering participating in this market, you should understand some of the risks associated with this product so you may make an informed decision before investing.
Forex dealers are not all regulated the same way. Only regulated entities, such as banks, insurance companies, broker-dealers or futures commission merchants, and affiliates of regulated entities may enter into off-exchange forex trades with retail customers. Therefore, you should make sure the dealer is regulated and check out the dealer's registration status and background with its regulator.
Although forex dealers must be regulated, firms and individuals can solicit retail accounts for forex dealers and manage those accounts without being regulated. Therefore, you should find out if these persons are regulated. If they are not, you may be exposed to additional risks.
You can verify Commodity Futures Trading Commission (CFTC) registration and NFA membership status of a particular firm or individual and check their disciplinary history by phoning NFA at (800) 621-3570 or by checking the broker/firm information section (BASIC) of NFA's website at www.nfa.futures.org. You may also contact the other organizations listed at the end of this Alert.
You should protect yourself from fraud. Beware of investment schemes that promise significant returns with little risk. Carefully check out the firms and individuals you are dealing with. You should also take a close and cautious look at the investment offer itself and continue to monitor any investment you do make.
The market could move against you. No one can predict with certainty which way exchange rates will go, and the forex market is volatile. Fluctuations in the foreign exchange rate between the time you place the trade and the time you attempt to liquidate it will affect the price of your forex contract and the potential profit and losses relating to it.
You could lose more money than you initially invest. You will be required to deposit an amount of money (often referred to as "margin") with your forex dealer in order to buy or sell an off-exchange forex contract. Only a relatively small amount of money can enable you to hold a forex position for much more than the account value. This is referred to leverage or gearing. The smaller the deposit in relation to the underlying value of the contract, the greater the leverage.
If the price moves in an unfavorable direction, high leverage can produce large losses in relation to your initial deposit. In fact, even a small move against your position may result in a large loss, including the loss of your entire initial deposit and the liability for additional losses.
Buying and selling forex options present additional risks. Many of these risks are similar to those inherent in buying options on futures contracts. Therefore, you should consult NFA's brochure, Buying Options on Futures Contracts: A Guide to Uses and Risks.
You are relying on the creditworthiness and reputation of the other party to the transaction. Retail off-exchange forex trades are not guaranteed by a clearing organization. Furthermore, funds that you have deposited to trade forex contracts are not insured and do not receive a priority in bankruptcy. Therefore, you should know who you are dealing with.
There is no central marketplace. Unlike regulated futures exchanges, in the retail off-exchange forex market, there is no central marketplace with many buyers and sellers. The forex dealer determines the execution price, so you are relying on the dealer's integrity for a fair price.
The trading system could break down. If you are using an Internet-based or other electronic system to place trades, some part of the system could fail. In the event of a system failure, it is possible that, for a certain time period, you may not be able to enter new orders, execute existing orders, or modify or cancel orders that were previously entered. A system failure may also result in loss of orders or order priority.
Hopefully, this information has provided you with a better understanding of the risks involved in retail off-exchange forex trading. As mentioned above, retail off-exchange forex trading carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose all of your initial investment and be liable for additional losses. Therefore, you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with forex trading and make an informed decision after consulting with your financial advisor and considering your own financial situation and objectives. If you suspect any wrongdoing or improper business conduct by a forex dealer firm, you may contact or file a complaint with NFA by telephone at (800) 621-3570 or online at www.nfa.futures.org/basicnet/Complaint.aspx.
For further information, you should also consult the following resources:
Commodity Futures Trading Commission
In an effort to educate customers about the risks of forex trading, the CFTC issued a Forex Consumer Advisory in February 2001 cautioning the public to be skeptical of newspaper advertisements, radio and television promotions, and Internet Web sites that tout high-return, low-risk investment opportunities in forex trading. The CFTC also issued an Advisory in March 2002 on how firms may lawfully offer forex futures and option trading opportunities to the retail public. For more information on the CFTC's forex initiatives, visit the CFTC's forex Web page at www.cftc.gov/enf/enfforex.htm.
Other regulatory bodies and authorities:
Recent NFA enforcement actions involving retail off-exchange forex trading:
NFA is a self-regulatory organization subject to oversight by the CFTC. NFA's primary mission is to protect investors and maintain market integrity.
NFA Members can file many of their required documents electronically.