Forex Trading Pros And Cons
The first decision a new trader has to make is which market to trade.
Stocks, futures, mutual funds, options, exchange traded funds are all good candidates but unfortunately require trading accounts that are too large, at least initially, for many beginning traders.
For these traders the foreign exchange market (Forex) may be the best starting point.
Is Forex trading profitable? Let’s look at the pros and cons of Forex trading.
The Plus Side Of Forex Trading
High Trading Leverage
This is the big advantage and profit of the Forex for many traders. Brokers will allow traders to take trades with up to 50:1 margin (country dependent).
Compare this to the stock market where the broker may grant you 2:1 margin. With a small account you can control a large trading position in Forex and when you have a winning trade the payout can be huge.
“Leverage involves borrowing a certain amount of the money needed to invest in something. In the case of forex, that money is usually borrowed from a broker.” – Investopedia
Unfortunately high leverage also means high risk and we’ll cover this when we talk about the Forex trading cons.
Ability To Scale
One of the most attractive features of Forex is that you have great flexibility in position sizing which makes the Forex trading profitable. Most brokers allow you to trade full sized lots, mini lots or micro lots.
- Trading full sized lots each pip in a USD pair is worth $10,
- Trading minis each pip is worth $1
- Trading with micros each pip is $0.10.
Depending on the size of the trading account this allows the trader to control and limit his risk.
For example when entering a Forex swing trade with a 500 pip risk the trader can limit his risk to $500, or $50, or as little as $5 depending on the type of position taken, so even a small account can take advantage of large moves in the currencies.
Around the Clock Forex Trading
No matter where you live or what hours you work the Forex market is up and running. As long as you have a computer and an internet connection you can trade.
Low or No Fees
Most brokers don’t charge commissions on Forex trades. Instead they are compensated by taking the spread between the bids and ask on the buy side.
Depending on the broker, currency pair and time of day this can be as low as one or two pips, although it can go significantly higher. Of course the impact of this pricing will depend on the size of the trades you take.
A one or two pip spread is quite modest when taking a 100 pip trade, but can be significant if scalping five or ten pips on each trade.
Free Trading Software and Data
Almost all Forex brokers provide free real time Forex data, free charting, and trading software. Traders can obtain the free MetaTrader platform and a demo account from most brokers, and once ready can open a funded live account and continue to use the same software. This is not the case with most other trading instrument types, so this is a big plus for Forex traders.
Free Web Resources
A search on the internet brings up page after page of resources for the Forex trader, including brokers, educational materials, calculators, software and manual strategies, etc. Some of these are quite good and can help the new trader learn about this market, others unfortunately are scams or sales pitches. Buyer beware!
The Downside Of Forex Trading
The dark side of high leverage is high risk. Sure a trader can tally up huge wins using 50:1 margin, but what happens when the first losing trade comes along?
The broker will in all likelihood force an exit to the trade and the trading account will be wiped out.
The fact that brokers are offering insane margin levels doesn’t mean that they should be used. The key to surviving and thriving in the Forex markets is being able to survive a series of losing trades. No matter what system is being used, losing trades will come, and they will come in streaks of three, four, or more losing trades in a row.
The prudent trader will therefore limit the amount of his trading capital that he risks on each and every trade.
Our recommendation is to risk no more than 2% of the trading capital on any single trade. By limiting the risk on each trade even a series of ten losing trades in a row won’t destroy the trading account, instead the account will only suffer a 20% drawdown which, while still painful, can easily be recovered.
And thanks to the scalability of Forex trading, everyone, even traders with small accounts, can control the risk they assume with each trade.
Around the Clock Trading
Just because Forex can be traded 24 hours a day doesn’t mean that it should be traded 24 hours a day.
The reality is that markets move differently throughout the day: at peak hours moves can be large and have follow through; at off-peak times price will chop around with little direction.
As it turns out each time zone has its own trading session, from the Asian to the UK and the US, and each of these tends to exhibit the most activity during the early parts of the trading session.
Instead of just trading any old time of the day the successful trader will observe the major markets in his time zone and focus his trading on their peak hours.
No Centralized Exchange
Unlike stocks or futures the Forex market has no centralized exchange or clearing house.
Instead each broker acts as its own exchange and the broker in effect becomes the market maker. This can lead to abuse on the part of the broker or worse.
Fortunately regulations in major markets like the US have greatly reduced the risk but some traders still get drawn in by brokers from locations with little or no regulation and get scammed.
Because of the lack of a centralized exchange we also see price variations from broker to broker. When dealing with major brokers in well regulated countries these differences will be small but traders need to be aware of this fact especially if their charting data provider is not the same as their broker as it can lead to inconsistencies between intended and actual execution of trades.
The major traders in Forex are the large financial institutions. They have departments staffed with highly paid traders and millions of dollars invested in the best trading software and hardware.
That’s the competition for the individual trader, and these large institutions can push prices around (within limits of course) simply because of the volume that they control.
The best way for the individual to compete is to use a well-tested and profitable trading strategy, tight risk management and a focused and disciplined attitude towards the business of trading.
Trading Forex can be a very profitable business for the individual trader, but like every high reward business it also has significant risks. Research and study the markets and paper or demo trade before placing your first live trade.
And put the odds in your favor by trading with a large reputable broker in a well regulated country, and maintaining focus and discipline while trading a tested strategy with solid risk management.