Pros and Cons of Forex Trading

The biggest appeal of forex trading is how easy it is to get into it. One can open a forex account on a shoestring, with minimum deposits ranging from very small to as low as $1, although it wouldn’t make sense to open an account for that little amount of money, as it wouldn’t allow you to place any trades.

However, you decide what you want to start with, how much you want to put on the line initially, and you of course can add more later as you go. This ease of entry and accessibility is what really makes forex trading stand out as much as it does, where one can take meaningful positions with very little capital.

This is primarily due to the high amount of leverage that forex trading offers, as well as the very small lot sizes that are available. For instance, to control a micro lot of a currency, $1000 of it, at a 50:1 leverage ratio, you only have to put up $20 of your own money.

In the United States, leverage is capped at 50:1, but if you live in other countries you may be able to get more leverage, 500:1, 1000:1, or even higher in some cases. At 500:1 leverage, your $20 would control $10,000 worth of this currency instead of just $1000. So now you can place a mini lot order instead of just a micro lot.

In this example, if you manage to get just a fifth of a cent profit on your trade, that’s going to give you a 0.2% return on your investment, but this 0.2% isn’t on the $20 you put up, it’s on the $10,000 that your mini lot controlled. So that’s $20 profit on a $20 investment, doubling your money in as little as a few hours.

This is pretty heady stuff indeed, and is what drives a lot of the hype surrounding forex trading, the pure potential that is portrayed, usually by people who are looking to sell you something. Now that in itself isn’t a bad thing, and while there’s a lot of free information out there of a good to very good quality, it might be worth your while to purchase certain material, although what you don’t want to buy is too much hype.

Leverage Works Both Ways

What should really stand out in our example is that if you can make $20 on this trade for a movement as small as a fifth of a cent in your favor, that much movement against you will wipe out your $20 if you let it.

The good news here is that even trading at margin rates as high as 1:500, like our example, you can still manage your risk by placing stop loss orders. You don’t always get the price you place the stop order for, but forex markets are liquid enough that even in times where the trade is moving against you quickly, you should be able to get pretty close at the very least.

You also don’t want to be trading your last $20 this way, with this much risk, unless you don’t care about losing it and are willing to make another deposit to replenish it if the trade goes against you such that you lose it all and deplete your account balance.

Trading with less leverage of course reduces these risks relative to your investment, in other words the chances of suffering a more significant loss can be significantly reduced, and it may not always be best to use too tight of a stop loss because this may have you exiting a lot of trades where it would have been better to stay in, but this requires that you be able to endure fluctuations that are not material to the viability of the trade.

Used correctly, stop losses should be used to get you out of positions where the rationale of the trade has been invalidated, not when you lose more than you are comfortable. So these stop losses need to be structured according to the trade and your strategy with it more than your bankroll or risk tolerance. If you can’t justify hanging in there when you need to, you need to pick a different strategy or use less leverage.

Forex Trading Is a Lot Like Chess

Just like when learning the game of chess, it doesn’t take that much effort to learn how the pieces move and some basic strategy. However, when you take this basic knowledge of the game and pit your skills against a good player you are going to be in for a rude surprise about how good you really are at playing this game at this point in time.

This is what happens with many forex traders, they may have gotten a little knowledge and know the basics but when they start trading real money, they find out that this isn’t quite as easy as they thought it would be.

Few things worthwhile are that easy though, and mastering any form of financial trading takes knowledge, experience, and skill. Talent does matter here as well, but you at the very least need to master the skills, like you do playing chess, if you want to be good at this.

On the one hand, having forex trading being so accessible is a great thing, but you don’t want to get too far ahead of yourself either and end up losing money you wish you hadn’t lost. Getting a solid education on at least the basics as well as gaining some real experience trading a demo account, which is still called paper trading, is a wise approach indeed.

You Can Get into Forex with Practically Nothing, But You Have to Manage it

Proper money management is one of the most important skills that forex traders can have. This might be the biggest thing that separates successful forex traders from the inexperienced, who often will mismanage their funds and go broke time and again before they learn this important lesson enough.

The fact that you can get started with such a small amount of money, hundreds of dollars instead of thousands or tens of thousands depending on the alternative, is a huge benefit. Perhaps the biggest benefit of this is that when you learn the lessons that always need to be learned, it will cost you a lot less money as long as you don’t overextend yourself.

So when one is starting out, and in the early stages of one’s trading experiences, it is very wise to err on the side of being conservative, and reserve being more aggressive to when you’re able to handle the extra risk involved, when you’ve proven yourself enough.

The real risk here is that you don’t know what you don’t know, and you are going up against some very skilled participants in this market, but if you are dedicated to your education, which includes both theoretical and practical training, well many people do develop into successful forex traders.

Forex Is in Many Ways The Perfect Market

Some people will tell you how volatile the forex market is, and it can be depending on how you are trading, and if you are overleveraged relative to your ability to handle risk, then it certainly can be too volatile.

It’s the leverage that determines this though, as opposed to some derivatives for example, like options, which are inherently more risky and volatile, and there’s no good way to manage this. So you are putting all of your investment on the line and can suffer some big swings against you, but that’s just the way it is with options, but with forex it’s all up to you basically as far as the risks you take.

Traded without leverage, forex trades would be very pedestrian indeed, to the point where trading for speculation purposes would make no sense, and in fact the greatly increased stability of currency movements is why brokers can offer the massively high degree of leverage they do compared to other forms of trading.

By being able to set this according to your own needs and desires, up to the maximum allowed which is a huge amount, and also using proper money management to control risk, the degree of volatility and risk involved in forex trading can essentially be whatever you want it to be.

The fact that the forex market itself is so accessible is another big benefit of it, and this is particularly meaningful to those who work for a living and just trade forex on the side, as they are usually busy at work during market hours.

This means that one’s ability to participate in trading will be very limited, placing their trades during non-market hours for instance, but with forex one can get as involved as one wants to be due to market being open 24 hours a day and only closing on weekends.

The fact that forex trades can be placed without paying commissions or other brokerage fees is another big benefit. You do pay the spread, but you always pay the spread with financial trading, but that’s all you pay with forex trading.

This is a lot bigger deal than most people imagine, as having to see trades both make up the spread and then move enough to cover the other costs of the trade makes trading, and especially short and medium term trading, much more difficult.

The limited number of things to trade with forex trading is another big factor in its favor. The sheer number of things to trade with forex is quite small, as opposed to looking at hundreds of different things, or more, in other capital markets. There’s so much liquidity in currency trading that one could even pick a single currency pair to specialize in and never trade anything else if one wanted.

This also means that the information in the market that one needs to manage is a lot more concentrated as well, with a lot of info on just a few currency pairs. This makes things a lot easier to digest and manage.

Overall, while forex trading can be very risky, and does require a fair bit of skill and effort to master, all of this can be well managed as long as one understands how to do it. This does require a fair bit of patience, and this is something not everyone has, but we can learn to be more patient, and with forex trading, we really need to stay within ourselves so to speak if we want to do well over time.