Can Forex Trading Put You in Debt?
Yes, the Forex market can put you in debt if you do not take the right precautions. The following are some of the scenarios that could land you in debt faster than you can imagine.
Taking loans to invest in trading
One of the fundamental rules of trading and investing is to avoid funding your trading activities using loans. This means that you have to find other ways to fund your trading account instead of borrowing money with the intention of paying it back with your trading profits.
The logic behind this rule is that trading the Forex markets involves significant risks and even profitable traders do have losing streaks. Trading with borrowed money puts significant pressure on you since you have to repay the lender at an agreed-upon time.
This means that you will most likely try to force the markets to give you profits, which is a disastrous mindset that could see you make bad trading decisions, leading to losses. Sometimes the markets go nowhere for days despite the fact that you have the right trade, which could lead you to close even good trades at a loss since you want your profits today.
Therefore, never take loans to fund your Forex trading activities, this will most likely land you in debt.
Overleveraging your trades
Most Forex brokers offer leverage to their clients, which allows them to take positions that are bigger than the size of their trading account, this is very similar to margin trading in the stock markets.
The main advantage associated with leverage is that it can help you boost your profits more than you could with the funds that are currently available in your account. However, leverage is a two-edged sword given that it can also multiply your losses and wipe out your trading funds if you have losing trades.
This is why country regulators such as the UK Financial Conduct Authority (FCA) have implemented laws that limit the amount of leverage offered to retail traders to a maximum of 1:50. However, professional traders can negotiate for higher leverage levels from their brokers.
Ignoring proper risk management (greed)
Greed is one of the most common reasons why many Forex traders blow up their accounts and end up in massive debt. For example, many greedy traders ignore the often-repeated rule of not risking more than 1-2% of your trading account on a single trade.
According to this rule, it would take over 50 losing trades to blow up your trading account. However, most Forex traders ignore this simple rule and risk way more than they should per trade, which eventually depletes their trading accounts.
Another risk associated with not using proper risk management is when unexpected events happen to lead to sudden moves in the Forex markets such as flash or mini crashes, which could quickly decimate your account and put you in debt if you had risked more than the recommended 1-2%.
Professional traders know that you should avoid the markets if you are in an unstable mood as you are likely to make mistakes that you would have avoided if you were in the right frame of mind.
This means that you should always assess your current emotional state before starting your trading day and it is advisable to cease all trading activities if something emotional happens once you have begun trading.
For example, it is not advisable to be trading when you are grieving or immediately after a heated argument with a partner as your moods after such events are usually not the best making you prone to making rookie mistakes.
You should also take a break from trading after an extended winning, or losing streak in order to ground yourself and shake off the impact of your previous trading results. You are likely to be overconfident after a winning streak, while you may attempt to revenge trade after a losing streak, both of these states are likely to make you careless leading to losses.
There are tens of reasons why Forex trading could put you in debt and the above list is not exhaustive. However, the best way to avoid going into debt is to develop a sound trading plan and to always follow your trading rules without exceptions.
Your trading plan should include a proper risk management strategy, a series of checks to ensure you have the right mindset, and should have an edge that could make you a winning trader over the long-term.
Also, remember that many FX brokers, especially the European ones, now offer negative balance protection, which means that retail traders cannot lose more than the funds they put in a trading account. You should consider this when choosing a broker as it will prevent you from going into debt in case of a massive negative market gap or flash crash.