Forex Walkthrough

Level 2 Markets - The Risks

So far we've looked at the basics of the forex market and how to get started and have examined the role leverage plays in FX. Now we will examine some of the benefits and risks associated with forex trading.

The Good and the Bad
A number of factors such as the size, volatility and global structure of the foreign exchange market have all contributed to its rapid success. Given the high liquidity of the forex market, investors are able to place extremely large trades without directly affecting any given exchange rate. These large positions are made possible for forex traders because of the low margin requirements used by the majority of brokers. As we previously discussed, it is possible for a trader to have a position of US$100,000 by putting down as little as US$1,000 up front and borrowing the remainder from his or her forex broker. This amount of leverage acts as a double-edged sword because investors can realize large gains when exchange rates make a small favorable change, but they can also incur huge losses when the rates move against them. Despite the foreign exchange risks, the amount of leverage available in the forex market is what makes it attractive for many speculators. (For more on this, see Forex Leverage: A Double-Edged Sword.)

The currency market is also the only market that is open 24 hours a day with a high degree of liquidity throughout the day. For traders who may have a day job or just a busy schedule, it's a great market to start trading in. As you can see from the chart below, the major trading centers are spread throughout many different time zones, eliminating the need to wait for an opening or closing bell. As the U.S. trading closes, other markets in the east are opening, making it possible to trade at any time during the day.



Time Zone
Time (ET)
Tokyo Open
7:00 pm
Tokyo Close
4:00 am
London Open
3:00 am
London Close
12:00 pm
New York Open
8:00 am
New York Close
5:00 pm

While the forex market may offer more excitement to investors, the risks are also higher in comparison to trading stocks. The ultra-high leverage of the forex market means that huge gains can quickly turn to equally huge losses and can wipe out the majority of your account in a matter of minutes. This is important for all new traders to understand, because in the forex market - due to the large amount of money involved and the number of players - traders react quickly to information released into the market, leading to very quick moves in the price of the currency pair.

Although currencies don't tend to move as sharply as stocks on a percentage basis (unlike a company's stock that can lose a large portion of its value in a matter of minutes after a bad announcement), it is the leverage in the spot market that creates the volatility. For example, if you are using 100:1 leverage on $1,000 invested, you basically control $100,000 in capital. If you put $100,000 into a currency and that currency's price moves 1% against you, the value of the capital will have decreased to $99,000 - a loss of $1,000, or all of your original investment (that's a 100% loss!). In the stock market, most traders do not use leverage, therefore, a 1% loss in the stock's value on a $1,000 investment would only mean a loss of $10. That being said, it is important to take into account the risks involved in the forex market before diving in head first.




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