Pros and cons of forex trading you should know about

Shifts in global markets offer up opportunities for traders to make future projections and take advantage of short-term volatility by trading securities, such as stocks, options, futures and forex.

Forex trading, in particular, has emerged as a quick and efficient way of taking advantage of changing global market conditions and securing wealth.

Forex, as a short-term tradable asset, can be highly volatile, but with small profit margins. To make forex more appealing to traders, most brokers offer a high degree of leverage, which means traders can borrow funds from the broker to increase their buying power and capital gains from the trade.

This guide will look at the features, advantages and disadvantages of forex and the trading strategies that have emerged in the trading community over the years, to see if forex trading is in line with your financial objectives.

Advantages and opportunities of forex trading

The conditions in the global forex markets are constantly changing and forex traders can take advantage of the opportunities presented to them.

When compared to other tradable assets, forex gains the upper hand in terms of its high degree of liquidity, access to leverage and ease of onboarding.

Accessibility

While many people might not trade forex on the markets on a regular basis, the process of exchanging currencies is the core principle behind forex.

Anyone with a functional and verified brokerage account can start trading the forex pairs of their choice.

Many brokers offer hundreds of pairs which can be influenced by a range of unique factors.

Forex brokers also offer tools for technical analysis, as many trading strategies are based on technical indicators, first-time traders can take their time getting to know the ropes of forex terms, trading strategies, indicators, and chart patterns to look out for.

The forex markets are open 24 hours a day on weekdays, as opposed to the predefined working hours of stock and commodities exchanges.

Leverage

Forex brokers are known for offering much higher leverage than their equity counterparts. While stock traders may have access to 2:1 or 3:1 leverage, forex traders are used to using 50:1, 100:1 leverages.

This is due to the low profit margins available for traders throughout a given trading day. Having such a low margin requirement can be a double edged sword, however. While profit margins are slim, forex trading is still quite volatile, and making uninformed trades with borrowed funds can quickly backfire and lead to losses.

High degrees of leverage is typically used by professional traders and is not advised for newcomers to the capital markets.

Liquidity

Since forex pairs are the same as currency pairs, there is no other tradable asset that is more liquid than forex.

Compared to assets like stocks, options and futures, forex does not need to be converted into cash, as it essentially is cash.

Billions upon billions of dollars worth of forex is traded on the global markets each day, which makes entering and exiting trades quite straightforward.

Despite this, certain forex pairs benefit from a higher degree of liquidity than others. Major pairs, such as USD/EUR, GBP/USD, USD/JPY, etc. all represent major pairs and benefit from much higher liquidity than a pair of minor currencies, such as CAD/AUD, CHF/NZD, NZD/EUR, etc.

Disadvantages and risks of forex trading

While forex trading can be a convenient strategy for growing and safeguarding wealth, this does not mean that it is risk-free and does not come with its disadvantages. The profit margin in forex can be rather limited, while volatility is high. This can be especially tough for retail traders, as the bulk of the price action is driven by large financial institutions, such as banks and hedge funds.

Volatility

Forex can be highly volatile throughout trading days and while this presents ample opportunity for traders, it can also mean unexpected price changes.

Much of the analysis that goes into forex trading is based on technical indicators and market data, which can be cumbersome for new traders.

Some forex pairs are more volatile than others – major pairs benefit from expansive liquidity, while some exotic pairs can go in either direction, as the economies behind these currencies are also volatile and somewhat unpredictable. Currencies of countries embroiled in conflict, civil unrest, or economic crisis, can be exceptionally volatile when compared to major pairs, which are far more stable in the short term.

Three unofficial subsessions exist to denote the changing degree of volatility throughout a 24 hours trading day – the New York, London, and Tokyo sessions. Sometimes these sessions overlap during a brief period of time, which can lead to heightened volatility. These periods typically come after the news from the other session has already hit the markets. Keeping track of market news and preparing for a session is key in mitigating unexpected trading losses.

Limited profit margin

While forex is a volatile asset class, this volatility does not typically translate into high profit margins. Many volatile stocks can net a gain of over 10% during a single trading session – this is not the case with forex.

To achieve the same day trading results as stocks, a forex trader will require significantly more capital.

This is the reason behind the high degree of leverage offered by forex brokers – to fill the gap of razor thin profit margins by increasing the buying power of traders’ accounts.

However, increasing buying power like this comes with even more risk, as the funds are borrowed from the broker and need to be repaid at a later date.

Institutional influence

It is safe to assume that all capital markets are dominated by large institutions, as opposed to retail traders. However, this fact is even more pronounced in the world of forex, due to the fact that forex deals with cash, and institutions, such as banks, frequently participate in the forex markets to hedge against the risks associated with their loan and deposit portfolios.

In such a scenario, large-volume trades executed by financial institutions can sway the markets without retail traders having much influence over the direction a particular forex pair takes.

While such a degree of influence can mean additional risk for some forex traders, others can structure their strategies around the trading patterns of some large institutional investors.

Having the benefit of analyzing the trading activity of large institutions can open up new profitable opportunities for FX traders.

Should you day trade forex?

Day trading refers to the trade of assets on a daily basis to acquire short-term gains from price fluctuations.

Day trading FX in particular will not be for everyone. The high degree of volatility relative to the thin profit margins might not be of interest to every type of trader.

However, traders with solid expertise in technical analysis and plenty of market information can steadily benefit from a short-term FX trading strategy.

Day trading in general is a strategy much different from long-term investing. A lot of technical analysis goes into day trading decision making and this is the primary reason as to why day trading is not advised for inexperienced traders.

Despite this, day traders with a solid enough trading strategy have the opportunity to beat the annual performance of stock indexes, such as the S&P 500, but this also means a high degree of maintenance and monitoring going into each trade.

Alternatives to forex trading

Of course, forex is far from the only asset feasible for day trading. Assets such as stocks, commodity futures and options offer varying degrees of risk and volatility, but can be effective vehicles for short-term traders nonetheless.

Stock trading

Trading stocks is the most obvious alternative that is significantly different from forex. Stocks are individual shares in public companies that are listed on a stock exchange. The core principle behind trading these securities in the short-term is the news cycle and catalyst schedule for the given company. Regulatory filings with the SEC, financial performance reports, managerial changes, changes in business operations, etc. can all be significant factors that can send a stock’s price skyrocketing, or plummeting.

Stocks also offer higher profit margins in individual trades. It is not at all uncommon for a stock to post over 20% in gains coming off of positive financials and future guidance. Stocks, much like forex pairs, are not made equal. Blue chip stocks that have a long-established business model and a steady revenue supply, are far more stable and predictable than startups with no recorded revenues and/or functional products to speak of.

Many stock brokers offer fractional share ownership and charge no commissions per trade.

Options trading

Options are financial instruments that give investors the opportunity to make plays on the price direction of a given financial security. Options are tied to underlying assets and fluctuate based on the volatility of the underlying asset.

Call options represent a ‘bet’ on the price increasing during a specific period of time, while ‘put’ options are bets on the price decreasing.

Unlike stocks and forex, options have expiration dates, premiums and strike prices.

• Premium is the amount a particular options contract costs
• Strike price is the price at which the contract can be exercised
• Expiration date is the deadline after which the option will expire

Options come with a plethora of complex trading strategies, and a key factor and risk driver to consider with options is what happens when the option does not go as the trader expected.

If the option goes past the strike price and is not exercised, or if the contract is not sold, the expiration date will render the option worthless – losing the entire investment.

While there are strategies in place to mitigate such risks, options are inherently risky and a ‘zero-sum’ market, meaning the source of the funds is derived from the losing trades of other market participants.

Futures trading

Futures contracts are financial instruments that give traders the opportunity to protect their funds from sudden price movements.

Futures can be backed by stocks and commodities and are binding agreements that ensure the delivery of the underlying asset upon expiration.

Like options, futures trading is also a zero-sum game, and futures, especially commodities futures, can be very volatile.

The potential for profit and loss in the future is unlimited. Futures also use leverage, which can amplify the profit and loss potential of a given trade.

Main takeaways of forex trading pros and cons

Forex trading can be a solid option for traders with a decent appetite for risk. Not every forex pair is as risky as the next one and major pairs benefit from much higher liquidity and lower volatility than many other pairs.

Forex is the most liquid financial asset available on the market as it deals with actual fiat currencies used in different countries.

The performance of a certain currency is deeply tied to the economic performance of the issuing country.

Forex trading offers a high degree of leverage and liquidity than other assets, but is more prone to institutional trading and offers a lower profit margin.

Forex is not the only pair tradable asset on the market and traders can choose between stocks, futures, options, etc. among others.

FAQs on forex trading pros and cons

Is forex trading risky?

Forex trading can be volatile in the short-term and strategies that are not clearly defined can lead to loss of capital. Not all forex pairs carry the same degree of risk however, and major pairs are significantly less volatile than exotic pairs.

Can I make money day trading forex?

Forex trading is characterized by low profit margins, however, a solid strategy that includes the use of leverage can beat the annual returns of equity markets.

Which forex pairs should I trade?

First time traders are generally advised to stick with forex pairs with the highest liquidity. Major pairs such as USD/EUR, GBP/USD, USD/CHF are less volatile and more liquid than minor or exotic pairs, as they represent highly developed economies and offer a greater degree of stability.

Can I use leverage in forex trading?

Forex brokers offer some of the highest leverage across all asset classes. The leverage can often go beyond 100:1. This is due to the fact that forex offers high liquidity and lower profit margins.

How to start trading forex?

To start trading forex, you will need to open a brokerage account, verify and fund it and choose the pairs you would like to trade. It is beneficial to have a clear plan and objectives in place before entering the first trade.