The forex market has become increasingly popular in the digital age, with global daily trading volumes having risen incrementally from $5.1 trillion in 2014 to $6.6 trillion at the end of 2020.
However, forex is a deceptively complex marketplace, and one that offers a number of benefits and potential pitfalls to traders depending on their risk appetite and underlying investment strategy.
The Pros of Forex Trading
The forex market is home to an estimated 170 major, minor and exotic currencies from across the globe, which are traded in pairs and as derivative assets. This allows you to speculate on price movements without assuming ownership of the underlying instrument, creating the potential for profit in a depreciating market.
But what are the other benefits of forex trading? Here are some of the best examples:
- Liquidity: Liquidity refers to the ease with which assets can be bought and sold, with currency pairs categorised as one of the most liquid options in the global market. This particularly applies to major currency pairs like EUR/USD and USD/JPY, which experience huge trading volumes and tend to trade within relatively narrow ranges.
- Leverage: When you first learn how to trade forex, you’ll begin to understand the fundamental relationship that exists between leverage and margin. In short, the former refers to the process of taking on debt to open trading positions that are considerably larger than your initial deposit, whereas margin is the amount of capital borrowed. It’s usually expressed as a ratio and can optimise returns when used wisely, with some reputable brokers offering leverage of upto 100:1.
- Low Capital Requirements: Due to tight spread in terms of pips (which refers to a specific unit of change in an exchange rate currency pair) and the availability of leverage, it’s possible to start forex trading with a relatively small amount of capital. This makes the market more accessible to part-time or amateur traders, who can also benefit from the fact that their profits will be completely tax-free.
What are the Cons of Forex Trading?
Interestingly, some of our forex trading pros can also be described as cons in certain instances. For example, failing to manage your risk when taking on highly leveraged positions can lead to disproportionate losses, so it’s important to keep this in mind as an inexperienced trader.
There are other risks, challenges and pitfalls to navigate too, including the following examples:
- Increased Volatility: The concept of volatility can also be viewed as either a positive or a negative, depending on your appetite for risk. For example, scalpers execute hundreds of short-term orders every single day in a bid to capitalise on real-time price fluctuations, accruing incremental profits in the process. However, volatility can be problematic for risk-averse traders or those with a longer-term outlook, as prices can fluctuate significantly during each 24-hour period.
- A Lack of Transparency: Relatively speaking, the forex market is a deregulated space, in which brokers dominate and individuals often trade directly against professionals. This creates an inherent lack of transparency, which is further exacerbated by the lack of control about how trades are fulfilled and the underlying fact that currencies are issued by banks that act as central points of control in the marketplace.
- The 24/7 Nature of the Market: The forex market is accessible 24/7 for six days during the week, with activity separated into three distinct geographical sessions (North America, Europe and Asia-Pacific). This can make it hard to regularly monitor prices and volatility, at least without a systematic trading strategy and the careful selection of currency pairs. Stop losses can also help to safeguard your capital overnight and minimise risk over time.