Forex Trading Benefits and Risks
Last Updated 11 August 2018: Attempting your own approach to foreign exchange investing and trading can be quite tricky. Without the proper understanding, placing money in an attempt to profit from random moves boils down to pure luck. Currency trading can, and should, be an investment.
That being said, this can still be quite tempting for some. And with educated guidance and lots of homework, this game can turn into a huge win. As you consider diving into forex trading and investment, here are some forex trading benefits and risks to consider.
Table of Contents
- 1 Rapid Success Of The Marketplace
- 2 Politics Plays A Role
- 3 There Are Lots Of Markets To Trade
- 4 Lots Of Free Stuff
- 5 Full Responsibility
- 6 The Amount Of Leveraging Is Attractive
- 7 Forex Trading Is Tax-Efficient
- 8 Central Banks Take The Spot Light
- 9 Profit Opportunities
- 10 One Bank Megastar Can Make A Difference
- 11 Exchange-Traded Funds
- 12 Currencies Are Like Chump Change
- 13 Interest Rates Risk
- 14 High Capital Is Required
- 15 The Long Haul Can Win The Race
- 16 Carry Trading
- 17 Knowing Who To Trust
- 18 Speed Is Not Necessary
- 19 Leave Your Emotions At Home
- 20 Confidence
- 21 Forex Never Sleeps
- 22 Know That Even The Big Boys Can Fail
Rapid Success Of The Marketplace
In a nutshell, forex trading came into effect because currencies need to be exchanged so that foreign business and trade can occur. The need for this exchange is the sole reason the foreign exchange market is the largest and most liquid financial market in the world. It actually dwarfs other markets regarding size (yes, even the stock market) with a reported trade value of more than $4.9 trillion per day as recorded by the Bank for International Settlements (BIS).
In addition to the size and volatility, the global structure has played a role in the success of forex. From Asia to Europe to the United States, the sheer scope of this marketplace covers the entire world making this the only market that is open 24 hours a day.
Politics Plays A Role
Just like with any investment, the value of the given currency has to be factored in during the trading process. In international investment, the currency value will be somewhat correlated to the internal conditions of the given nation. Understanding the political, economic and institutional setting about currency trades can help to tip you in the right direction.
There Are Lots Of Markets To Trade
Forex trading gives many currency pairs to trade on. Depending what platform you choose, there may be more than 100 different pairs to trade. This plays into the point above. Traders that have a good understanding of the political landscape and how a country’s economy is fairing can make significant gains.
Lots Of Free Stuff
There is a lot of content and learning materials to develop knowledge and understanding of currency trading. For example, we have our own eBook which is perfect for beginners. Traders can also take advantage of brokers offering free demo accounts to practice strategies and build up skills, on real time markets, before entering live trades.
This is a benefit or risk, depending on how to look at things. Forex traders have complete and utter control of every trade that is made. They don’t have to make any trades they don’t feel comfortable with. Individuals involved in forex trading always have the final decision.
With this is mind, all risks that come with forex trading lie with the trader. If they have not fully understood a pattern or strategy before entering a trade, it’s on them. This leads many new investors to quit because they make losses early on in their careers.
The Amount Of Leveraging Is Attractive
The forex market place is highly liquid which makes investors able to make extremely large trades without affecting the exchange rate. These large trade placements are made available due to the low margin requirements set by the majority of the industry’s brokers. However, this leverage has both pros and cons. When the rates make a small favourable change, investors can get huge gains. But when the rates move against them, they run the risk of a massive loss. Despite this risk, the amount of leverage in the forex market is appealing for many.
Forex Trading Is Tax-Efficient
For UK traders, spread betting is 100% tax free. Apply this to forex, since the assets are never owned, the profits made from trading are not subject to capital gains tax (CGT). This may not be the case for traders in other parts of the world but for us, it’s pretty good.
Contract for difference (CFD) trading is not tax free. However, it is still valuable. If a loss is ever made on CFDs, they can be used to offset against profits on other capital gains. Again, this is based on UK tax law and may not be applicable in other territories.
Central Banks Take The Spot Light
Central banks have monetary policies that are set up to directly correlate to how currencies perform. They make the rules, and we have to follow them, no questions asked. And sometimes they won’t make the same rule at the same time which makes for an interesting marketplace.
The forex market allows for the opportunity of profit in both rising and declining markets. How so? With each trade, you’re simultaneously buying and selling which means that short-selling is evident in every transaction. Additionally, the forex market is so liquid that you aren’t required to wait for an uptick. But remember markets are extremely volatile so although they might seem like they are going up, they may in-fact turn and take a nose-dive the exact opposite way. This is why it is essential to back-test your trading strategies if you ever want real peace of mind about what you are trading!
One Bank Megastar Can Make A Difference
It doesn’t take much to impact the currency exchange market. And while it’s said that one is the loneliest number, when it comes to FX trading, one can actually make a huge difference. With the amount of money being traded on the forex markets nowadays it takes a huge sum to cause any real movement. More importantly, individuals who have PULL or INFLUENCE are more likely to make an impact on the market. For example a spokesperson of a particular company saying the year was bad will make that company’s stock price fall. This works in the same way for currency exchange.
A favourite among self-directed investors, exchange-traded funds (ETFs) are a security that tracks a commodity or asset group containing currencies with a low leverage rate. Investing in either a single currency or a bundle, currency ETFs can assist new traders to capitalize on the potential benefits of forex trading. Essentially, ETFs assist traders by reducing risk through diversification.
Currencies Are Like Chump Change
As we all know an upswing in a currency can have profitable outcomes. So why aren’t traders investing solely in this sector? Due to unpredictable market forces, this sector is very volatile, gusting one way or another with almost no notice. While this shouldn’t be the primary investment piece, they can play a smaller part in every portfolio because currencies are almost non-correlated to the stock, bond and commodity market.
Interest Rates Risk
If a country’s interest rates rise, its currency will strengthen due to an influx of investments in that country’s assets. In Lehman’s terms, a stronger currency is going to produce better return on investment. On the other hand, if interest rates fall, the country’s currency will weaken as investors begin to withdraw their investments. Due to the nature of the interest rate and its circuitous effect on exchange rates, the differential between currency values can cause forex prices to dramatically change.
High Capital Is Required
You will find a lot of sites saying that you need low capital for forex trading. While this is true, in reality, it’s pointless unless you have at least $10,000 to start. Without this as a minimum, the revenue stream becomes a lot slower to scale up and become profitable passively. If the aim is to do forex as a full time job and live off the proceeds, it’s clear it’s not enough, We actually cover this in detail in our post on ‘How Much Do You Need To Start Forex Trading‘.
The Long Haul Can Win The Race
Experts in this field often talk about a process called mean reverting which means prices and returns will eventually move back to an average. With currencies, that average could potentially climb over time if and only if economic growth increases. And while that increase could take many years, in the long run, it could also mean a great profit.
Currency traders embrace carry trading because it allows them to borrow in a low-yielding currency while investing in a high-yielding one. Too good to be true? It just might be. Often investors forget to sufficiently account for the risk as the borrowed currency will appreciate over time. So while this strategy can appear to be your best friend, it might catch up to you.
Knowing Who To Trust
The more forex becomes a popular way to make money, there are going to be more and more ‘gurus’ claiming they know it all. Forex investors need to be wary that there are plenty of people looking to scam them. The only advice to give on this is to do research. Find out if what they are saying is true before entering any sort of agreement.
Speed Is Not Necessary
Attempting to beat the clock? The influx of currency, whether it’s over a span of a few hours or days, is essentially very dangerous. Why? The forex market moves very quickly. Unless you’ll be sitting in front of a screen to watch the market tick by tick, it’s common to make an investment and be deep in the red just an hour later. Unfortunately, that’s just expected with the undulations of currency.
Leave Your Emotions At Home
Rooting for a currency against all logic and evidence in hopes for a comeback is a lot like waiting for your favorite sports team to win after a long period of drought. Behavioral biases and emotions can cloud investor’s judgment leading them to lose money in the forex market. A currency investor will take a position only to find that market moving against them. While having a loss, they don’t want to close it out as they’ll have to admit that they made a mistake. These investors want to “get even” which more often than not, makes them lose more money than if they stuck to a sound investment logic. Long story short, emotions will only hurt you in the currency trading game.
This follows on nicely from the previous point. Confidence levels increase when investors make a decent profit, which in turn creates goodwill. With a high level of confidence, the investor can be overly active in trading currency which can create traffic. Traffic often leads more investors in dealing with currency and this can give more profit and can earn more money.
However, with experience comes possible naivety and over confidence. The more they trade and the more successful they become, it can be easy to forget that losses are possible. Ill discipline takes over and before they know it, they’re broke or chasing losses. Of course, with proper bankroll management and the right mindset to keep a level head regardless of the gains, this can be controlled.
Forex Never Sleeps
Markets never switch off for a break. They can sometimes become unpredictable, meaning that the investor will have to be constantly aware of what’s happening. This can be stressful. If the mindset isn’t right or there has not been good preparation, mistakes can be made. And in a never-sleeping market like forex, there can be consequences.
Know That Even The Big Boys Can Fail
For years and years, the FX Concepts of NYC was the king of forex hedge funds. Undoubtedly, they ruled the roost until the worst happened. After managing over $14 billion, FX Concepts went bankrupt due largely to the result of central banks devaluing their currencies. Inevitably the downward spiral caused everyone to find out that its propriety currency models no longer worked.
So while the forex market is fickle, the currency game played strategically can be won. Basically, it all boils down to patience and how long you’re willing to wait for a positive outcome. You can find out more about the risks and benefits to forex trading here.
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