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.

Forex Vs. Stocks
Related Articles
  1. Term

    Understanding Short Covering

    Short covering is buying back borrowed securities to close an open short position.
  2. Technical Indicators

    Explaining Autocorrelation

    Autocorrelation is the measure of an internal correlation with a given time series.
  3. Chart Advisor

    ChartAdvisor for October 9 2015

    Weekly technical summary of the major U.S. indexes.
  4. Economics

    The Effect of Fed Fund Rate Hikes on Gold

    Explore the historical relationship between interest rate increases and the price of gold, and consider what effect a fed funds rate hike might have on gold.
  5. Investing

    The ABCs of Bond ETF Distributions

    How do bond exchange traded fund (ETF) distributions work? It’s a question I get a lot. First, let’s explain what we mean by distributions.
  6. Mutual Funds & ETFs

    Passively Managed Vs. Actively Managed Mutual Funds: Which is Better?

    Learn about the differences between actively and passively managed mutual funds, and for which types of investors each management style is best suited.
  7. Investing Basics

    3 Alternative Investments the Ultra-Rich Usually Own

    Learn about the ultra rich and what normally comprises their net worth; understand the top three alternative investments usually owned by the ultra rich.
  8. Stock Analysis

    The 5 Best Dividend Stocks in the Healthcare Sector

    Learn about the top five dividend stocks of companies operating in the health care sector that generate substantial cash flows to afford high payouts.
  9. Investing

    Baby Boomer Philanthropy Shifts Wealth Adviser Focus

    Wealth advisers who integrate philanthropy and finance planning can stand out with baby boomer clients.
  10. Chart Advisor

    These Oil & Gas Stocks Have Reversed

    It's been a long downtrend for oil stock owners, but there's hope. These four oil and gas stocks have reversed and may keep trending to the upside.
  1. Qualitative Analysis

    Securities analysis that uses subjective judgment based on nonquantifiable ...
  2. Capitalization Rate

    The rate of return on a real estate investment property based ...
  3. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and ...
  4. Liquidity

    The degree to which an asset or security can be quickly bought ...
  5. Derivative

    A security with a price that is dependent upon or derived from ...
  6. Real Estate Investment Trust - ...

    A REIT is a type of security that invests in real estate through ...
  1. Does working capital measure liquidity?

    Working capital is a commonly used metric, not only for a company’s liquidity but also for its operational efficiency and ... Read Full Answer >>
  2. Can mutual funds only hold stocks?

    There are some types of mutual funds, called stock funds or equity funds, which hold only stocks. However, there are a number ... Read Full Answer >>
  3. How do I read and analyze an income statement?

    The income statement, also known as the profit and loss (P&L) statement, is the financial statement that depicts the ... Read Full Answer >>
  4. Do mutual funds pay interest?

    Some mutual funds pay interest, though it depends on the types of assets held in the funds' portfolios. Specifically, bond ... Read Full Answer >>
  5. Why have mutual funds become so popular?

    Mutual funds have become an incredibly popular option for a wide variety of investors. This is primarily due to the automatic ... Read Full Answer >>
  6. Do mutual funds pay dividends?

    Depending on the specific assets in its portfolio, a mutual fund may generate income for shareholders in the form of capital ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges ...
  2. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  3. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
  4. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  5. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  6. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!