Associated Benefits and Risks of the Foreign Exchange Market

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Associated Benefits and Risks of the Foreign Exchange Market image

Lots of actions and high-profit potential – that’s what the Forex market is like.

On average, there are more than $5 trillion trades every day. In terms of trading volume, the Forex market is the largest in the world. That’s why so many risk-taking investors and traders are flocking to this market.

Naturally, it’s the same with any investments and businesses. Forex has its own set of benefits and risks.

But before we go into detail, let’s define first what Forex is.

The Foreign Exchange Market (Forex)

Foreign Exchange (Forex or FX) is a global market for trading currencies. At the same time, it’s also the largest financial market worldwide.

Trades happen by determining one currency’s price against another currency. For example, one of the most often traded currency pairs is USD (United States Dollar) and EUR (Euro).

If you have visited another country with a different currency than your own, you might’ve experienced foreign exchange transaction already. For instance, if you’re from the US and you’ve traveled to Europe and wanted to buy items in cash, then you could’ve exchanged your dollars for euros.

That’s the cycle – the only difference is it works on a larger scale.

If you’re interested in forex, then you should also know the benefits and risks associated with the foreign exchange market.

Benefits of Forex

No Commissions To Pay

If you have experienced trading before, then you might’ve paid fees like:

  • Exchange Fees

  • Brokerage Fees

  • Clearing Fees

  • Government Fees

In forex, there are no additional fees you have to pay, including commissions. Forex brokers make money by integrating the cost of transaction on the buy and sell price of the currency pair. The buying price is different from the selling price – it’s called the spread.

If you want to know more about what spread is in the Forex market, read this article.

The Flexibility of Going Long or Short

Because Forex trading is dealing with currency pairs, it means you’re always going short and long on a currency per pair.

In trading, going short means “shorting” on a currency or stock — believing the value will decrease. When you short a currency, you’re betting that the value of a currency against the other half of its pair will go down.

In contrast, going long means you’re holding onto a currency  — believing its value will increase over time.

The beauty with Forex is the speed. You’re able to quickly switch from either position. For instance, you might think that the value of EUR will increase against USD. Then, you can quickly buy the EUR/USD pair. If you think otherwise, you can sell the pair.

Your profit or loss would depend on your position — the accuracy of your prediction.

Hedging Forex

Hedging allows you to trade in opposite directions.

It is a way where you can protect yourself from the loss. By hedging, you reduce the amount of your loss when something happens unexpectedly.

Most Forex brokers allow direct hedging. You can place a trade that buys a currency pair and one that sells the same pair — all at the same time. If your timing is right, you don’t have to worry about any losses.

When the market moves against your first trade, you can make money with the second one. If the market reverses, you can simply stop the second trade.

Wide Variety of Currency Pairs to Trade On

Unlike other markets, there are lots of currency pairs available for trading. You’re not stuck with a single pair, hoping one would increase or decrease in value over the other.

If you’re good at speculating global events as well as economic movements of various countries and nations, you’ll be able to pick their respective currencies and make a profit.

There are different pairs available with most Forex brokers:

  • Major Pairs: These are the currency pairs from major economies. They’re also the most traded pairs in the world. Examples of major pairs include EUR/USD, USD/JPY, GBP/USD, AUD/USD, USD/CAD, USD/CHF, and NZD/USD.

  • Minor Pairs or Cross-Currency Pairs: These pairs don’t include the US Dollar. However, they do have the 3 most traded currencies besides the US Dollar — the Yen, Euro, and Pound. In comparison to major pairs, they have a smaller market share exhibiting lower market liquidity. Examples of minor pairs include EUR/GBP, JPY/AUD, AUD/CHF, NZD/CAD, and others.

  • Exotic Pairs: These pairs represent currencies from developing countries as well as from other developed European countries. Some of the exotics pairs are USD/BRL, EUR/RUB, and ZAR/JPY.

  • Continental Pairs: Some brokers offer pairs specific to continents like the Americas, Asia, the Middle East, and others.

Again, not all Forex brokers have the same pairs. But most of them have the most traded pairs — there still a wide variety to choose from. If you need help with what to look for in a trading platform, check out this article.

The Magic of Leverage

Leverage provides you the ability to trade more money than the actual amount in your account. It works by letting you open a trade on the Forex market by paying only a small proportion of the full value.

Leverage is usually expressed in ratios. Let’s say your Forex broker allows a 10:1 leverage. If you have $10 in your account, that means you can exchange $10 in the market with a dollar from your account. In total, you can control a trade of $100 at just $10.

The profit or loss you receive comes from the full value of the trade. If you’re fortunate, then you can have a great profit from a small investment.

However, losses can also be fatal to your account. One mistake and your balance get depleted. This is the reason why lots of Forex brokers have a risk warning in place.

No Fixed Lot Size

Basically, a lot is a standard number of currency units you can buy or sell.

The standard lot size in foreign exchange is 100,000 units of currency. There’s also a mini (10,000), micro (1,000), and nano (100) lots.

In the spot foreign exchange where the sale of currency is for instant delivery, you can determine your own lot size. Because of this, traders can participate in the market even with only $50 in their account and potentially earn great profit through leverage.

Always on the Move

The Forex market will keep you on your feet. Anything can happen in foreign exchange.

Fortunately, you’re not restricted to trade in a single direction. Once you find a currency pair you’d like to trade, you can either buy or sell it.

As mentioned earlier, there’s a wide variety of currency pairs you can trade on. You’ll never run out of action in Forex as long as there’s still balance in your account.

Trade Around the Clock

The action doesn’t stop until you drop. You can trade with Forex 24 hours a day, 5 days a week.

The Forex market doesn’t sleep. It opens Monday morning — Australian time and closes Friday afternoon — New York time.

This means that you can trade whenever you want — morning, afternoon, or evening. Since Forex is worldwide, there will always be an open market somewhere in the world.

High Liquidity

In simple terms, liquidity is how fast an asset can turn to cash. In Forex, this means you can take your money in and out of the market with minimal price movement.

There are lots of buyers and sellers in the FX market waiting for a trade. Your trade position will never get stuck since there are lots of traders ready to take the other side of your trade.

Furthermore, high liquidity in Forex means transactions are quick and easy. This lowers the transaction costs and spreads on trades.

Uncontrolled Market

With Forex, you’re sure that no single entity can control the market.

There may be several large establishments participating in the market, trading large volumes of money. However, the Forex market is so large that nothing can really control it.

There may be instances when the entry or withdrawal of some entities, or even the state of major economies can affect the flow of the market. However, it’s certain that the foreign exchange market can’t be controlled.

Lower Barrier Entry

Just because it’s a market where currencies are traded, it doesn’t mean you need lots of money to get started.

In fact, some foreign exchange brokers allow traders to start with even as little as $25. It’s so much less compared to the cost it would take to start trading on stocks, options, or even futures.

Even with $25, the profit you can potentially earn is big, especially with leverage. Anybody, even with those of little capital, can start trading in Forex.

Risks of Forex

Fluctuations of Currency Value

There are lots of factors affecting the currency’s value. It could be political reasons, internal reasons, or other things.

For instance, if the US Dollar suddenly increases value against the Euro, American companies would buy European products in large quantities. This is because the prices of these products are cheaper when you bought them while the Euro is lower than USD.

When USD is exchanged with EUR en masse, time will come when the demand for EUR would increase. Then, the value of EUR would increase due to the demand.

In turn, the market doesn’t have a clear direction. A currency with an increased value could suddenly drop tomorrow.

Double-Edged Sword Nature

Remember the benefits mentioned above? Some of those can easily turn against you.

For example, let’s consider the leverage. With a small investment, leverage could help you profit so much. However, you could also lose more than what you have.

Fluctuations in price could heavily affect your gains and losses. If luck isn’t on your side, you could instantly lose all your assets.

Another one is the market’s relentless movement. Though this may give you a good fortune, it could also give you heartache when you lose all your assets.

With Forex, just remember that things could suddenly turn against your favor.

High-Risk Factor

Currency prices are constantly moving. This rapid and unpredictable change is called volatility. There is nothing certain with foreign exchange.

Because of that, you have to be alert with the price movement. Even a small change could mean a total loss for your trade investment.

Professional traders use technical analysis and other trading instruments to minimize potential risks. These instruments can take experience and expertise to use. However, it only minimizes risks and doesn’t assure anything to the trader.

When you’re trading in the foreign exchange market, you have to understand that along with the benefits and large potential profits you can get, there are also associated risks that could potentially drain your trade investment capital.

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