The forex market is the largest and most liquid market by far with a daily turnover of over 5 trillion US dollars. This makes it one of the most traded markets, attracting an ever-rising number of people who want to earn a sizeable income. One of the main reasons why more and more people opt for forex trading is because the barrier to entry to entry is relatively low.
However, forex trading is definitely not for everybody. Trading currencies is a high-risk, high reward endeavor. While you can earn a significant amount of money through the forex market, you can also have your trading accounts wiped off if you operate without tact.
This has led many traders to wonder if forex trading is really worth the risk. There is no definitive answer to this question since successful forex trading is dependent on a number of factors. Managing fast price movements and appropriate trade sizes, all while using borrowed funds to amp your bets can be incredibly tricky.
A single unfortunate trade may blow up your entire account. However, with a well-informed trading and forex risk management strategy, you can realize impressive profits. Herein is a comprehensive look at these factors to help you determine if trading currencies is for you.
The Benefits of Forex Trading
1. Unparalleled Liquidity
The most liquid market is the forex market. With trillions changing hands each day, you don’t have to worry about liquidity when trading any of the major currencies including USD, EUR, GBP, CHF, CAD, and JPY.
Forex liquidity means minimal slippage when trading during normal market conditions. Discrepancies between the execution price and displayed price are rarely present.
3. Ability to Go Short or Long Anytime
Since you trade currencies in pairs, when you are bearish on one currency, you are bullish on the other – and vice versa. For instance, if you are bearish on GBP/USD, you go short by purchasing dollars and selling pounds.
If you are bullish, you can go long by selling US Dollars and buying Pounds. This is different from stock markets where you are only allowed to short-sell during an uptick. This is a great advantage for forex trading as you can profit from both upward and downward trends anytime.
3. High Leverage Choice
Forex trading offers the highest amount of leverage when compared to other markets. Mini trading accounts offer high-end leverage because of lower minimum deposit requirements and smaller lot sizes. High leverage allows you to maximize your profit potential, particularly on small price movements. However, the potential for loss is also large.
No single trading entity (no matter how big) controls market prices for extended periods due to the number of participants and the size of the forex market. As such, the playing is level (to an extent) and the market calibrates itself quickly.
In addition, there are no middlemen. A forex broker just facilitates your connection with another market participant. What this means is that the forex market is only subject to the global economy, and not a single organization or individual.
5. Lower Costs
Forex transactions are completed the OTC way, with traders directly dealing with market makers and other parties. As such, there are no exchanged fees and clearing fees with forex trading. Typically, market makers won’t charge a commission on trades you execute through their platforms. Electronic Network Communication (ECNs) charge only a small commission above the bid-ask spread.
6. Global 24-hour Market
Forex trading operates throughout the world and is open 24 hours a day for five and a half days a week. This means that you can trade whenever you want to and not according to market dictations.
You won’t have to wait for an opening bell or scramble to execute your order before a daily close. You can be as passive or active as you’d prefer and trade on your own schedule.
Forex Trading Risks and How to Mitigate Them
1. Market Risk
Market risk or systematic risk is the inherent risk to the forex market resulting from inflation, geopolitical factors, elections, and economic and financial announcements. It involves all factors that can affect the prices of trading currency pairs. While you can mitigate unsystematic risk with diversification, you cannot control systematic risk.
However, as a forex trader, market risk is the most useful type of risk. To make money from forex trading, you need the prices to move around (market volatility). This way you take advantage of price differences when selling and buying. You make winning trades due to market risk. On the other hand, it’s a risk since if the markets are unfavorable, you may lose money.
2. Leverage Risk
Leverage is among the major benefits and risks of forex trading. You can use leverage to increase the returns on your investments significantly. However, it may also increase your losses since it mirrors the currency market movements.
Leverage works best with margin trading, where you utilize great market exposure while depositing a small portion of capital. Many novice traders don’t understand how risky high leverage can get, and they tend to use the highest possible effects. You don’t have to use a 200:1 leverage effect because your forex broker offers it.
Also Read: High Leverage Forex Brokers
3. Counterparty Risk
Counterparty risk is the risk involved with the party with which you open and close your forex trading positions; in other words, your broker. The major risk is that your broker fails to pay you, either due to poor regulatory enforcement (the scammers) or bankruptcy. As a trader, it can be difficult to measure this risk, so you rely on due diligence and regulatory bodies.
How to Choose a Forex Broker
Your forex broker can determine the success of your trading venture. When choosing a best forex broker, you should consider the following points:
- Broker type – Market maker or ECN?
- Security – How safe will your funds be with them? What certifications do they have?
- Trial account – Does your broker offer a demo account?
- Trading platform – How many different currency pairs are you allowed to trade? Is the order placing system satisfactory? Is order execution instant? Does it feature a charting interface?
- Account and trade size – What is the minimum trading account amount? What is the minimum trade size?
- Commissions and spreads – Are the spreads fixed or variable? Do they charge commissions on opening and closing positions?
- Margin – what is the margin percentage? Lower margin requirements often mean more leverage offered.
It is worth noting that there are many other types of forex trading risk including liquidity, country, technology, transactional, interconnection, inflationary, policy and exchange rate risks.
All in all, Forex Trading is worth the risk and is a serious business. Just like with any other type of investment, there are benefits and risks involved. The good news is that it is definitely possible to make sizeable profits from trading currencies.
However, it requires hard work, due diligence, possible professional financial advice, commitment, and patience. Forex trading is not a gambling or a get rich quick scheme. You must take an informed approach, taking the time to study market trends and sentiments and applying techniques and tools to manage risks and your money.