Before, banks, large Financial Institutions, fund managers in large corporations, and high net worth individuals were virtually the only players in the forex market. However, with the surge of online trading, anyone can now open a forex merchant account and trade in currencies.
In 2016, UK financial regulator, FCA, surveyed retail trading, including CFD trading and binary options. They found that 82% of retail investors incurred a loss. Trading is a double-edged sword, where you can earn a big chunk of money or lose it all.
Before risking your money on it, this explains the importance of working out if the forex is suitable for you. We have consolidated the pros and cons of forex trading for you. Before getting started, every aspiring trader should consider them.
Pros of Forex Trading
The forex market has a plethora of benefits that make it a lucrative activity. This includes the following:
Unlike trading in any other financial instrument, forex trading usually has a significantly low cost. Trading solely depends on the bid-ask spread. Bid-ask spread is the difference between purchasing (bid) and selling (ask) price, published by brokers in real-time. Traders do not have to pay separate brokerage charges on transactions.
The forex market experiences the highest daily trading volume compared to any other financial market. This signifies the highest liquidity, especially in major currencies. Even large orders from currency traders can be fulfilled without large price fluctuations. This eliminates the risk of price manipulation resulting in tighter spreads and efficient pricing.
Ease of Going Long or Short
Unlike in some stock markets which may require borrowing assets for short selling, there are no such stringent provisions in the forex market. You always take a simultaneous position in the market as you are selling one currency (i.e. quote currency) and buying another (i.e. base currency).
No Central Regulator
Forex is an over-the-counter market. There is essentially no central regulator for the market. Under extreme conditions, countries’ central banks intervene as needed, but these are rare events. This also helps to keep the cost low. Traders place orders directly to the brokers. Another benefit of the deregulated market is the ability to enter short positions quickly.
The forex market is now one of the easiest financial markets to begin trading with. Traders can open online Forex merchant accounts from anywhere globally with usually low deposits. There are several Forex technical analysis tools to help short-term traders and hundreds of fundamental analysis tools and theories for long-term traders. These tools help traders with different levels of experience and knowledge to enter the forex market smoothly.
Forex market operates from 5 p.m. EST on Sunday and closes at 5 p.m. EST on Friday. These continuous hours are because Forex transactions are completed over-the-counter between parties, and not through a central exchange. Traders can take advantage of different active sessions’ forex trading hours.
Forex trading is available on high leverage. It can amplify your chances of profit or loss multiple times of the trading capital. Sometimes, the forex market offers leverage as high as 50:1. That means you can hold a forex position worth $50 with only $1. The profit or loss you make will reflect the final value at closure. So, you can earn a significantly larger amount with a relatively smaller deposit. However, it can also turn against you and increase your losses.
For this reason, you need to be careful while using this feature. You can use functions like stop-loss, price alerts, running balance, etc. to save you from severe monetary damage.
Less Chance of Market Manipulation
Any other financial market gets affected by any relevant information or news easily. But due to its size and depth, the forex market is very difficult to manipulate even for large corporations or hedge funds. Even national banks can find it difficult to make a visible price difference, but they do sometimes interfere to control sharp market movements in their base currency.
Cons of Forex Trading
Forex trading comes with many added benefits, although it also possesses several risks. Some cons are listed below that you should consider before diving into the market:
Lack of Transparency
As it is an over-the-counter market, the forex transactions are not carried out on a centralized exchange, There is almost no regulatory oversight. It lacks transparency as it is driven by brokers. With few brokers, traders may not get the best price, get limited quotes, or have no control over how their order gets fulfilled. To mitigate search risk, only deal with regulated forex merchant account providers falling within the purview of broker regulations. The market may not be regulated, but the activities of brokers are.
This is another example of a double-edged sword. If factors determining currency change drastically, currency price can reflect the effects. This can result in huge losses if the trader has not followed strict risk-controlling strategies. If a particular stock performs ineffectively, central regulators can intervene. While in the case of the forex, they have nowhere to go. The best way to mitigate such risk is to keep strict stop losses. Further, one must trade using well-executed strategies only.
Low Regulatory Protection
Lower regulatory protection is one of the major disadvantages of forex trading. As forex transactions are not carried out on a centralized exchange, regulatory oversight is sometimes limited. To avoid any such risk, traders are advised to investigate their brokers for their trading practices and reputation. You might not have to go through such trouble if you are in some specific jurisdiction like the UK or US as you may only be allowed to trade with regulated forex brokers.
Complicated Price Determination
Forex rates are determined based on various factors, mainly global, political, and economical conditions in the country. Such information is difficult to analyze and draw conclusions to trade on. Sometimes, through the central banks, even the government intervenes in the price determination process if required. Most traders rely on technical indicators. If the prediction goes wrong due to any factor, it can result in a huge loss.
If anyone is looking for opportunities in the forex market, he must go through all the pros and cons given above. If the pros outweigh the cons, one can consider this market a good opportunity. Of course, the forex market has many drawbacks, but one can succeed with discipline, dedication, and patience.