Pros and cons of trading forex

Forex trading refers to the exchange of currencies, and it is also known as ‘fx’ or ‘foreign exchange’ trading. Just like stock and bond trading, it comes with its own set of advantages and disadvantages. If you are on the fence about whether or not to participate in the forex market and would like to make an informed decision, below are some pros and cons of forex trading.

Pros of trading forex

Some advantages of forex trading are as follows:

1. High liquidity

One of the main advantages of forex trading is that many currencies have high liquidity due to the fact that the forex market is the largest financial market globally. Daily trades amount to trillions of dollars, and out of all the currencies in circulation, the seven major ones (the US dollar, the Euro, the Great Britain pound, the Japanese yen, the Australian dollar, the Canadian dollar, and the Swiss franc) are bought and sold constantly.

Other currencies from first world regions, such as the Singaporean dollar, the Hong Kong dollar, and the Norwegian krone also have decent liquidity and can be bought and sold with relative ease. Therefore, many currency pairs out there can be traded efficiently.

2. Long market hours

The forex market is, on paper, open for 24 hours a day, 5 days a week. In real life, traders can participate in the market for over 120 hours per week. This is because the market is divided into four major trading sessions – Sydney, Tokyo, London, and New York – and they open for seven to eight hours in accordance with each local time zone, overlapping at times and extending into weekends.

Forex traders can participate in any session they wish, regardless of where they are located. This means that American traders can participate in the forex market on Sunday afternoon when the Sydney sessions opens on Monday morning in Australia. Similarly, Australian traders can participate in the forex market on Saturday afternoon just before the New York session closes on a Friday evening.

3. Leverage can be used

Leverage can be used in forex trading which can boost potential profits. Leverage is a trading method that allows traders to put down only a small fee to open a large position. It is expressed in ratios, such as 1:50. In this case, for a $1,000 trade, the trader only has to put down a margin of $20 and their broker will loan them the rest of the $980. Leverage is a useful tool as it can be used to generate much greater profits.

4. Low transaction costs

Generally, forex trading does not require too much capital as many brokers offer flexible purchase of lots. A lot is a way to measure units of a currency, and a standard lot is 100,000 units of a currency. For example, a standard lot of the Great Britain pound will be £100,000. Many brokers allow retail traders to buy and sell mini lots (10,000 units) and micro lots (1,000) to accommodate different traders’ needs.

One thing that a trader has to pay is the spread of a currency pair when they trade forex. This is the price difference between the bid (sell) price and the ask (buy) price of a currency pair, paid to the broker when a trader opens a position. Spread fees are relatively low and do not require much capital.

The only other type of fee that could be incurred in forex trading will be brokerage fees, such as commission, yet these are variable depending on the broker you choose and the type of account you open.

Cons of trading forex

However, forex trading comes with disadvantages too.

1. The forex market is not open on weekends

As mentioned, the forex market is open only on weekdays. Even as trading sessions stretch into the weekend, traders will ultimately not be allowed to trade for the 24 hours in the middle of each weekend, between Saturday and Sunday. This is not ideal for traders who prefer to trade over the weekend.

Additionally, currency rates can continue to move and fluctuate even when the market is closed to retail traders. Therefore, traders who like to leave their positions open overnight may be exposed to more risk than usual.

2. Volatility

Even though the forex market is generally stable, it is at the end of the day a decentralised exchange that is very much driven by supply and demand. With that said, demand for certain currencies can decrease drastically in times of economic, political, and social conflict between countries. In this case, currencies can depreciate very quickly and suddenly.

3. No dividends or regular pay-out

Unlike investing in stocks and bonds, forex traders do not receive dividends and therefore have no regular pay-outs. This is a relatively small disadvantage, however, for traders with lots of capital, many would prefer to invest in stocks and bonds for this reason alone, as dividends can add up heftily.

In conclusion

Trading is a personal endeavour, and it takes patience and discipline to become skilful. However, understanding how the forex market works and knowing its pros and cons should give you an idea of what to expect when trading and allow you to make an informed choice.

Writer, trader, husband, and dad- Ludovic Gauthier, is the author of more than 2500 finance-related blogs for various FX and Stock trading sites.