How to Maximize Returns and Avoid the Dangers of Online Trading
As the world becomes one big global village thanks to the connections offered by the Internet, so do the opportunities.
One of the chances for Kenyans is to trade in the global online markets with the aim of diversifying their portfolio and trading some of the major stocks of the world’s major economies. This diversification also helps investors to minimize their portfolio by distributing their investments across different sectors, markets and asset classes.
However, it is instructive to note that trading on global platforms comes with some inherent risks. To be successful in this business, investors must understand the pitfalls they face and learn how to mitigate them.
One of the biggest risks is the exchange rate. This is related to the volatility of exchange rates between different currencies. Most Kenyan investors who trade in global markets online usually start by converting their funds from Kenyan shillings to US dollars. Even though some brokers offer trading accounts denominated in local currency such as Scope Markets Kenya. Having to convert Kenyan shillings into greenback on the spot involves accepting the risk of transacting at a higher exchange rate.
This risk can normally cost an investor between zero and three percent on the deposit side and a similar amount on the withdrawal side. A particular advantage that offshore investors gain from this is that the US dollar is significantly stronger than the Kenyan shilling and that converting their profits gives them a better return on their investment. It basically converts risk into reward.
When investing in currencies, there is a risk that the country’s central bank will vary interest rates based on economic-centric reasons. This in turn can increase or decrease currency volatility and overnight refinancing costs.
If the change is in favor of the investor’s position, a trader can earn overnight rolling costs and volatility-based profits. To mitigate interest rate risks, investors closely follow country-specific monetary policy procedures to understand their forward policies and adjust their positions accordingly.
Investors can also hedge their positions against interest rate risk by carrying out carry trades. This involves buying a currency that pays a higher interest rate while selling a currency that charges a lower rate. Online traders can also experience systemic risk, which refers to what they face when a business collapses and this triggers a ripple effect across the entire market or industry. A good example is the 2007/8 financial market crash where the collapse of Lehman Brothers led to the eventual collapse of the entire US stock market.
This risk is often caused by interdependencies between different companies in a financial system. A well-diversified portfolio in geographically distinct exchanges should help an investor offset this risk.
There is also systematic risk associated with the larger market where investors cannot avoid or mitigate the risk. One example is the global Covid-19 pandemic which has resulted in economic shutdowns, travel restrictions and disruption of supply chains. The pandemic has caused major collapses in global stock prices as well as commodity prices. For investors, this is an opportunity to buy stocks and commodities at discounted prices.
The risk of latency is associated with the speed of the internet connection, which can lead to slippage. It works both ways. Your internet connection is slow and you execute a trade position on your device, it takes a few microseconds before your order reaches the broker’s server, during which the market price may have changed.
If the price has changed in the direction of your trade, you lose value, and if the price has changed in the opposite direction, you gain value.
Finally, global online brokers offer traders dubbed leverage. This amplifies their purchasing power allowing them to take huge positions above their account size.
When positions move as speculated, investors can enjoy profits magnified up to 400 times. Opposite, investors are forced to face margin calls when their initial margin runs out.
Kenyan investors who want to globalize should learn as much as possible about the inherent risks in order to reduce their risk exposure and maximize their returns.
Kamau is Research and Market Analyst at Scope Markets Kenya. [email protected]