The Forex market is booming in popularity worldwide. Traders are abandoning the traditional stock and future markets and moving to Forex in surprising numbers. Just what is the attraction and is the Forex market right for you? This article will seek to answer this question by systematically laying out both the advantageous and disadvantageous of the world’s largest financial market.
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Let’s begin by talking about the advantageous of Forex.
- Ease of entry- In my opinion, this is the number one reason for the explosion of interest in Forex. The barriers to entry are much lower than the traditional financial markets. The SEC requires you to keep a minimum of $25,000.00 in your account to day trade the stock market. Futures brokers require traders to post margins and maintain minimum account sizes generally in the 1000’s of dollars to gain access into their arena. Forex is much different. There are several FX dealers that will allow you to trade micro lots with as little as $1.00 in your account! The more traditional FX dealers offer mini lots with sometimes as much as 400/1 leverage allowing a $10,000.00 lot size to be controlled by as little as $40.00 in the account. Accounts can often be funded by credit cards and opened/traded the same day. Truly, anyone with the desire to trade can get a start in the Forex market.
- True 24-hour trading- The active Forex market basically follows the sun around the world. At anytime of the day or night, you can find an active pair to trade. The market is open 24-hours a day/ 5 1/2 days a week. Those with full time jobs are able to trade Forex after work, before work and on Sunday evening. This is a real advantage for many traders.
- Free trading software/analysis tools/quotes- Stock and futures traders are use to paying for their Technical Analysis software and quotes. In fact, some futures traders even pay for their order entry platform on a monthly basis. All of the major Forex dealers offer fantastic market analysis/order entry/news platforms at no cost to the trader. These tools generally cost $100.00 plus per month on the equity trading e with full access are also available at no cost.
- No Commissions- Traders merely pay the bid/ask spread to enter the market. This spread can be wide and is a significant cost of trading. However, it is the only “mark up” from the dealer, generally.
You will hear others talk about liquidity, the interbank market, and the shear size of the FX market as advantageous. These factors are relevant for the institutional side of the business but have little meaning for the retail trader. It’s important to keep in mind that retail traders are trading via retail dealers in the FX market. Your trades are kept on the books of the dealer, who is the counterparty, and never actually go into the true interbank marketplace.
Now let’s talk about several disadvantageous of the Forex market.
- Unregulated with no central marketplace– The retail FX market is truly the wild west of finance. There is very little regulation and no central marketplace or clearing firm. Dealers have been accused of all kinds of nefarious activities against their traders. Things like stop running, moving prices just to cause losses, and placing successful traders on manual execution in this wild and crazy market. I don’t have direct experience with any of these claims, but do know that your losses directly enrich the dealer. A reputable, well capitalized retail dealer would likely be your best bet to avoid much of the shenanigans. In addition there is talk of a centralized FX marketplace being built within the next 2 years which should end any dealer trickery.
- Wide bid/ask spreads- Most retail dealers have spreads around 3 pips for the major pairs. This means to trade the standard retail lot size of $100,000.00 one needs to pay $30.00. Therefore, the trader is already 3 pips in the hole upon entering the trade. The trade needs to move 4 pips in the right direction just for you to make dollar one on the trade. This is a huge disadvantage for the day trader. The swing trader can absorb the spread due to greater gains but it is still a major stumbling block for successful FX trading. Several brokers have begun to offer tight spreads with commissions, but they are the minority.
- Interest rate differentials or negative rolls- Although this can be an advantage, depending on the pair you are trading, it is often an disadvantage as your forced to pay interest daily to maintain your position. Some pairs pay interest to you, however, not all dealers allows you to collect particularly in the mini/micro accounts. Negative rolls cause major friction while swing trading, it is crucial to know your dealers roll policy.
The above goes over several of the primary advantageous and disadvantageous of trading Forex. It is an exciting market full of change and new ideas. Despite the disadvantageous, I personally enjoy trading the FX market and believe you will also. Educating yourself is the best way to counteract the disadvantageous of the market. Good Luck!
David Goodboy is Vice President of Business Development for a New York City based multi-strategy fund. Read David’s latest thoughts on his blog, www.marketsurfer.com.