Foreign exchange trading

About foreign exchange trading

Foreign exchange (Forex) trading is the buying and selling of foreign currencies.

People trade in forex either to try to make a quick profit by betting on the changing value of a currency or to provide certainty about the cost of future foreign currency payments (called ‘hedging’).

Understanding returns

Returns can come from purchasing foreign money (that will need to be held in a foreign currency bank account) with the hope that the currency will increase in value against the NZ dollar

They can also come from buying and selling contracts linked to the exchange rates between two currencies from a licensed derivatives issuer. These contracts could be called things like forwards, swaps, options, contracts for difference (CFDs), and margin FX contracts.

Understanding the risks

Forex trading for profit is very risky.

For every person who gains a dollar from forex trading, someone else loses a dollar. And that's before taking into account costs and fees, which can be significant. Because changes in foreign exchange rates are often influenced by unexpected events, even highly experienced traders using specialist tools often get it wrong.

If you do choose to trade forex, you will need plenty of spare money to cover losses caused when exchange rates move against you.

Be wary of promotional offers for 'free' or 'no loss' trades

Especially from online platforms that may not be based in New Zealand. These often have strings attached, so examine their terms and conditions closely before committing.

Beware of forex trading ‘training’ and ‘tools’

You should be wary of anyone who tells you that a particular product or technique can give you access to better exchange rates or easy money. While software programmes and training courses can teach you how to make forex trades, no person or programme can ever accurately predict movement in foreign currencies.

Forex trading risk is hard to manage

Forex traders can use risk management techniques such as ‘stop-loss orders’ to try to limit trading losses. For example, if you agree to a stop loss order to automatically close your trade when the exchange rate reaches a specified level, in theory, this will cap the potential loss. But it would not be guaranteed, as stop orders may not work at all when there are extreme movements in the markets. You might also have to pay additional fees or costs to have a stop loss order in place.

Borrowing to trade is extremely risky

‘Leverage’ or ‘margin’ trading are terms used to describe ways of trading with borrowed money. This is like borrowing money to place a bet. You may pay only a small portion of the value of your trade up-front, but if you lose you will need to repay the full amount borrowed, plus any amount you’ve lost. This means that even small movements in currency values can have a big impact on any gains or losses you make through forex trading.

What to do before you invest

If you do want to trade, you should talk to a financial adviser with expertise in this area before deciding to start. Ask them whether it is a sensible strategy for you, and ask for guidance on the level of loss you can afford.

We strongly recommend you seek financial advice.

Check you are using a New Zealand-licensed provider

Forex trading using contracts linked to the exchange rate between two currencies is classed as trading a ‘derivative’ financial product. In New Zealand, individuals or businesses offering these contracts must hold a ‘derivatives issuer licence’ from us. 

We recommend New Zealanders avoid overseas forex trading services not licensed by us, even if they appear to be regulated by an overseas authority. Visit our warnings and alerts page for warnings about forex dealers.

Read the product disclosure statement (PDS)

Licensed derivatives providers must give you a product disclosure statement (PDS) before you trade with them. Different types of forex trading products involve different risks, so you should read the PDS carefully. In particular, you should look for information on:

• how the particular product you’re looking at works. If you don’t fully understand it, give it a miss. Remember that complexity usually means risk
• 'counterparty risk’ – the risk that the forex provider won't be able to fulfil its obligations to you if something goes wrong. For example, if your provider became insolvent, you may be an unsecured creditor and have difficulty getting your money back
• how they handle market risks such as lack of liquidity in the market, and trading delays. You may not be able to make trades when you'd like to
• fees and other charges
• information about leverage.

Managing your investment

Pay careful attention to your trades. If you think things might be getting beyond your ability to cover potential losses, then stop. Foreign exchange rates can undergo big changes quickly and even tools like stop-loss orders may not be enough to save you from losing money.