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14th May 2022

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How to maximise returns and skirt dangers in online trading

Friday April 30 2021


A forex bureau in Nairobi. FILE PHOTO | NMG

As the world becomes one big global village through connections offered by the internet, so are opportunities made available.

One of the chances for Kenyans is to trade in global online markets in a bid to diversify their portfolio and deal in some of the top stocks from major economies of the world. This diversification also helps investors to minimise their portfolio by distributing their investments across different sectors, markets and asset classes.

However, it is instructive to note that trading in global platforms comes with certain inherent risks. To make a successful career in this, investors need to understand the pitfalls they are exposed to and learn how to mitigate them.

One of the biggest risks is the exchange rate. This relates to the volatility of exchange rates between various currencies. Most Kenyan investors who trade in global online markets usually begin by converting their funds from Kenya shillings to US dollars. Even though some brokers offer local currency denominated trading accounts such as Scope Markets Kenya. Having to convert Kenya shillings to the greenback on the spot involves accepting the risk of transacting at a higher exchange rate.

This risk can normally cost an investor between zero percent and three percent on the deposit side and a similar amount on the withdrawal side. One particular advantage that offshore investors get from this is that the US dollar is vastly stronger than the Kenyan shilling and converting their profits back gives them a better return on investment. This basically converts the risk into a reward.

When investing in currencies, there are risks that the country’s Central Bank may vary interest rates based on economy-centric reasons. This may in turn increase or lower the currency’s volatility and overnight rollover fees.

If the change is in favour of the investor’s position, a trader may earn positive overnight rollover fees and volatility-based profits. To mitigate against interest rate risks, investors closely follow country-specific monetary policy proceedings to understand their forward policies and adjust their positions accordingly.

Investors may also hedge their positions against interest rate risk by taking carry trades. This implies buying a currency that pays a higher interest rate while selling one that charges a lower rate. Online traders may also suffer systemic risk, which refers to what they face when a company collapses and this triggers a ripple effect on the entire market or industry. A good example is the 2007/8 financial market crash wherecollapse of Lehman Brothers led to the eventual tumbling of the entire US stock market.

This risk is often caused by interdependencies between various companies in a financial system. A well-diversified portfolio in geographically separate stock exchanges should help an investor offset this risk.

There are also systematic risk associated with the broader market where investors cannot avoid or mitigate the risk. An example is the global Covid-19 pandemic that has led to economic shutdowns, travel restrictions, and disruption of supply chains. The pandemic has caused significant crashes in global stock market prices as well as commodity prices. For investors, this as an opportunity to buy stocks and commodities at discounted prices.

Latency risk is associated with the speed of internet connection which may lead to slippage. This works both ways. Your internet is slow and you execute a trading position on your device, it takes a couple of 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 opposite direction, you gain value.

Finally, global online brokers offer traders a facility dubbed leverage. This magnifies their purchasing power enabling them to take huge positions above their account size.

When the positions move as speculated, investors may enjoy magnified profits of up to 400 times. Opposite, investors are forced to face margin calls when their initial margin gets depleted.

Kenyan investors wishing go global should learn as much as possible about inherent risks in order to cut exposure to the risk and maximise on their returns.

Kamau is a research and markets analyst at Scope Markets Kenya. [email protected]

2021-04-30 15:00:00

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By admin