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 of Currency Trading

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$3,000 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.)

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 33:1 leverage on $3,000 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 one third your original investment (that's a 33% loss due to a 1% move in the underlying currency pair!). 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. Understanding the risk of loss is a strong step in ensuring that you protect capital in such a way that it will allow you to keep trading currencies for years to come. (For more, see: Top 5 Forex Risks Traders Should Consider

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