What is Forex trading?
Forex trading involves the exchange of one currency for another using several trading platforms. These currencies are traded in pairs because one currency has to be bought while the other is sold simultaneously. Foreign exchange was initially exclusive to banks and financial institutions, but retail traders can now speculate on currency prices and trade in line with their directional biases.
How does Forex Trading work?
Forex trading allows traders to make profits by taking advantage of the exchange rate fluctuations that occur daily. The strong currencies are bought while the weak ones are sold to make profits. Before trading forex, you need to learn a trading/investment strategy. These strategies provide a means for traders to make better decisions and increase their win rates and profitability. The currency exchange can be facilitated by forex brokers, or through futures and forward contracts. If you have reasons to believe that a currency’s value will increase, then you can buy that currency and sell a weaker currency simultaneously.
There are several advantages and disadvantages of forex trading and you need to understand them before deciding to trade the currency market. Keep reading to learn some of them.
Pros and Cons of Forex Trading
Pros
Low Transaction Cost
Trading the forex market comes at a lower cost than other financial assets. The commission and spreads are low due to the high liquidity and variety of forex brokers available. The spread is the difference between the bid and ask prices of a currency pair. The high liquidity ensures that spreads are small and this reduces the fees charged for spreads. However, this could vary depending on the broker and the nature of the currency pair. Some brokers offer accounts with zero spreads and commissions to help traders me the most of their strategies.
Huge Profit Potential
Thanks to the flexibility of forex trading, the forex market possesses an enormous profit potential for traders to take advantage of. Various trading sessions overlap to provide 24-hour access to the forex market because the value of the world’s currencies fluctuates constantly. If you use a forex robot, you can earn passive income from trading because the robot can scan the market for trading opportunities all day long. Coupled with the high risk to reward ratio available, there is high profit potential for you to take advantage of. This potential, however, is not a guarantee. You should still study and put in the work till you’re able to trade successfully.
High Liquidity
The currency market is highly liquid because there are lots of market participants who exchange currencies daily. From retail traders to hedge funds and large financial institutions, the large pool of funds injected into the forex market increases the market liquidity and makes it easy to execute trades. High liquidity ensures that the spreads are low and every transaction can be facilitated by a counterparty.
Variety of Tradable Instruments
There are many currencies to trade because most currencies from developing and emerging economies can be exchanged on forex trading platforms. These currencies are paired to form the major, minor and exotic currency pairs. These currency pairs have unique characteristics that allow traders to choose whichever pair works best for them. The major pairs contain the United States dollar and as such, they’re highly liquid and largely traded. Minor pairs on the other hand are highly volatile while exotic pairs are also volatile but with low liquidity.
Ease of Access
The forex market is quite accessible to traders around the world. Most trading systems and strategies can be learned online and brokerage accounts can be opened in minutes. This ease of access is a huge advantage because it allows for borderless currency exchange and makes trading accessible to people all around the world.
Low Capital Requirement
The leverage provided by brokers allows traders to make significant returns with little capital. Besides being easy to access, currencies can be traded with little capital because leverage increases the buying power of a trader’s deposit.
High Volatility
Volatility refers to the degree of price fluctuations that occur in an asset. The forex market is highly volatile because it’s affected by news and economic data released daily. The news leads to significant price swings and allows traders to make profits quickly.
Cons
High Leverage Increases Risk
The high leverage provided by forex brokers can increase the risk of trading. New traders who trade forex with leverage are likely to abuse it and fail to manage their risk accordingly. Leverage is a two-edged sword because it can lead to huge returns as well as huge account losses.
No Guarantee of Returns
Trading the financial market is inherently risky and the forex market isn’t any different. There is no guarantee of making profits in the forex market because as retail traders, we don’t control the currency prices. This means that you can learn to trade and still lose some of your capital while trading.
The complexity of Price Prediction
Predicting the likely direction of price can be difficult because there are several factors to consider. The value of a currency can be affected by multiple factors like global politics or economics that can be difficult to analyze and understand. This is why most traders take years before becoming consistently profitable.
3 Reasons Why People Engage in Forex Trading
1 Convenient Trading Hours
The 24-hour access to the forex market attracts a lot of traders around the world. This helps them decide the best trading hours for them and plan their schedules accordingly. Other financial assets like stocks can only be traded for a limited number of hours and the trading period depends on the stock exchange and the stockbroker being used. There are 3 main forex trading sessions; the London, New York, and Asian sessions.
The trading day begins with the Asian session. This session is the least volatile and comprises the Sydney and Tokyo sessions. The Japanese yen, Australian dollar, and New Zealand dollar are highly traded in this session. The liquidity of the Asian session is also less than other sessions, but news reports during the session hours can inject significant volatility and significant price swings.
The London and New York sessions are the more volatile and liquid sessions. The London session begins before the Asian session ends, and the New York session begins before the London session ends. This creates a loop that ensures the forex market can be traded all day long.
2 Source of Income
Forex trading can be a viable source of active and passive income. Some traders trade full time while others prefer a passive trading environment in which most of their trading activities are automated. This automation can be done by using tools like expert advisors, robots, virtual private several, etc.
3 Flexibility
The forex market is flexible because it gives room for individuals with different trading styles and strategies to thrive. Scalpers, position traders, and seeing traders can find ample trading opportunities in the currency market. They can make profits by buying and selling – this means their trading opportunities are independent of the trend since most strategies can be applied to uptrends and downtrends.
Experience the pros of Forex trading with Decode Global
Now that you’ve understood the pros and cons of forex trading, you should sign up on a trading platform and explore these for yourself. If you’re not sure whether trading is right for you, you can trade on a demo account while you learn.