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

Forex Vs. Stocks

Related Articles
  1. Trading

    Top 5 Forex Risks Traders Should Consider

    With a long list of risks, losses associated with foreign exchange trading may be greater than initially expected. Here are the top 5 forex risks to avoid.
  2. Trading

    Forex or Stock Trading: Which Works For You?

    Even though the odds favor stock trading, forex trading has several advantages to offer a particular type of investor.
  3. Trading

    Forex Trading: A Beginner's Guide

    Learn about the forex market and some beginner trading strategies to get started.
  4. Trading

    Adding Leverage To Your Forex Trading

    The use of margin to trade in the foreign exchange market can magnify profit opportunities.
  5. Trading

    Why It's Important To Regulate Foreign Exchange

    In an increasingly globalized economy, the significance of the foreign exchange marketplace cannot be underestimated.
  6. Trading

    The Forex Market: Who Trades Currency And Why

    The forex market has a lot of unique attributes that may come as a surprise for new traders.
  7. Investing

    Leverage's "Double-Edged Sword" Need Not Cut Deep

    Learn to cut out losses quickly, leaving profits room to grow.
  8. Trading

    The Pros And Cons Of Trading Forex In An Overseas Account

    The Dodd-Frank Act of 2010 could impact whether overseas accounts benefit FX investors.
  9. Trading

    5 Tips For Selecting A Forex Broker

    Discover the best ways to find a broker who will help you succeed in the forex market.
Frequently Asked Questions
  1. What's considered to be a good debt-to-income (DTI) ratio?

    Your debt-to-income ratio helps lenders determine your credit worthiness. Find out how to calculate your score and how to ...
  2. What is the difference between a loan and a line of credit?

    Learn to differentiate between lines of credit and standard loans, and determine when you are likely to use each method of ...
  3. What does a Chief Financial Officer (CFO) do?

    A CFO is responsible for accurate reporting of a company's financial information, investing the company's money and identifying ...
  4. How did George Soros break the Bank of England?

    George Soros pocketed $1 billion by betting against the British pound, cementing his reputation as the premier currency speculator ...
Trading Center