There are a lot of people who hear the phrase “trading the markets” and the only thing they think of is the New York Exchange or the S&P 500. They have never heard of the Forex market before, and even if they have, it’s no guarantee they know any specifics about it.
The Forex is the largest financial market in the world. Trillions of dollars are traded on the Forex every day by traders from all over the world. Money is made by choosing whether to buy or sell the value of one nation’s currency versus another. This is called a currency pair, and just like the stock exchange uses stocks as its tradable asset, the Forex uses these currency pairs.
The Forex features many advantages over a stock exchange, too many to be listed here, but there are a few aspects of currency trading which really prove its worth.
Reason 1: The Forex Market has Incredible Leverage
It can be argued the most beneficial part of the Forex is the incredible leverage it provides. The amount of foreign currency you control per trade is much higher than the amount of shares you control on a stock market.
Leverage isn’t necessarily how much money you have, but rather what you do with that money. A trading balance of $5,000 is worth the same in both a stock exchange and the Forex, but the leverage that $5,000 carries is much different. $5,000 could maybe purchase 50 shares of a company, or it can control upwards of $50,000 in foreign currency.
Taking into consideration a 1% margin for your broker, $100,000 worth of currency is controlled with a deposit of only $1,000. This provides a massive 100:1 leverage ratio. If you compare this amount of leverage to equities (2:1) and futures (15:1) and you can see it isn’t even a contest.
Reason 2: Forex Risk is Manageable
Along with Forex trading’s incredible leverage, there is very manageable risk as well. However, relying too much on the Forex’s favorable leverage can get a trader into trouble. Headstrong traders will feel invincible and can quickly find themselves losing their trading account before they know it.
So how much should be risked per trade? The ultimate answer to this question is, “however much you’re willing to lose,” but we recommend trading anywhere between 2 and 5% of your total trading allowance. If you have $5,000 in your account your maximum loss should be, at most, $250 per trade.
The most effective way to manage risk is to create a stop-loss. A stop-loss is where you are automatically pulled from the market before losing too much money on a trade. Plenty of theories exist telling you where to set your stop-loss, and most of them depend on the time frame you are trading, but a good rule of thumb is to set a stop-loss 10 pips below the nearest market low.
Diligently sticking with your risk management strategy prevents not only the total loss of a trading account, but keeps your trading strategy on track as well.
Reason 3: The Forex Market has More Opportunities to Trade
When you own stock in a company, the ups and downs of that stock happen in a vacuum. Economic forces affect how a company’s stock performs, but, barring a sale or takeover, something a different company does won’t affect that stock. For example, Apple’s stock rises and falls based on how well Apple does as a business. The stock won’t, usually, rise and fall based on what Ford is doing.
This is different in the Forex because you’re trading the currencies in pairs. When one nation is experiencing a strong economy, it affects every currency pair that nation is a part of. If a good economic report is causing the USD to rise, it will be shown in the USD/GBP, the USD/JPY and more. The same theory holds when an economy is struggling. A flailing economy will be reflected across all its currency pairs.
The Forex also gives you the opportunity to trade in baskets. Basket trading is when you trade both sides of the market on a single currency. You aren’t trading both sides of the same currency pair, but rather, you’re trading the same currency in two different directions.
Take the surging US economy from the previous example, for instance. When the USD is strong you will want to buy on the currency pairs where the dollar is listed first, and sell on the currency pairs where the dollar is listed second. Your basket trade consists of buying on the USD/GBP and selling on the EUR/USD. This is where your research really comes into play. If you know how a single currency is trending you can ride that currency across the entire market through basket trading.
Reason 4: Practice Before You Play
When dealing with something as serious as personal finances, you want to be absolutely sure of what you’re doing before you do it. The Forex allows this because of broker demo accounts. Almost all brokers provide a few thousand dollars of fake money which can be used in the real market.
This fake account allows you to perfect your strategy before risking any real cash. Practice a stop-loss strategy, hone your research and become a Forex expert before dipping your toes into the real market with actual cash.
Future market traders find themselves in a dilemma. They want to make the extra money a market provides, but they don’t know which market is best for them. Each market has its positives and negatives, but after looking into what makes each one unique it becomes evident the low-risk/high-reward ratio of Forex trading make it the ideal market for a trader to use.