The pros and cons of forex trading

Since the global financial crisis tore a hole in many stock portfolios in 2008, the rise of forex trading among retail traders has been phenomenal. The ability to trade in large size with only a small deposit for margin (leverage) has no doubt contributed to the growth, though as outlined below this can be a double-edged sword for beginners. If you are considering trading the forex market, below is a summary of the pros and cons that might help influence your decision.

Six 'Pros'
  1. A technical market: 'technical analysis' is the study of price action to guide trading decisions. The only 'edge' that retail traders can expect to attain in liquid FX markets is by studying price action intently for low risk-high return 'setups'. If you enjoy technical analysis, there is no better market for utilising your skills. Because of the 24 hour nature of the market, this means less 'gaps' on charts. The deep liquidity means there are many thousands of traders all using technical levels to guide their decisions on where to enter and exit. Knowing where this order flow lies can give you an edge.
  2. Liquidity: the deep liquidity in the major FX pairs allow for our strategies to remain effective as the size of our positions grow. Although less of a problem for retail traders, if you plan to scale your strategy one day (perhaps by raising money from investors), the FX markets will allow you to enter big orders that have negligible impact on the price.
  3. 24 hour market: we have listed this as both a pro and a con. FX trades almost 24/5 during the week, which is great if you work during the day and want to trade the more volatile European session when you get home.  Flexibility in when to trade is a benefit.
  4. Low transaction costs: the cost of trading in and out of currencies is low. Most brokers make their commission by widening the 'spread' between the natural bid and ask. This spread is still very small, meaning we can choose almost any trading style that suits us – long term or short term.
  5. Trending market: FX is known for producing trends. With different central banks pursuing different policies, there is the opportunity to profit from the resulting trends in price. By aligning our trades with the dominant trend, we can tilt the odds in our favour.
  6. Leverage: this one is also both a pro and a con. The benefit of leverage is that we can make sizeable trades on a small account size that is used for margin purposes. If we properly understand our risk and use strict discipline, this is a major benefit. The bulk of your savings can be sitting in a bank account earning interest or invested elsewhere.
Four 'Cons'
  1. 24 hour market: listed as a pro above, this is also a con. Depending on your trading style, you may be holding positions while you are asleep. Given the extra liquidity in the European and US sessions, this can mean we miss important moves, or worse we are not at the screen to manage an existing position properly.  The good news is that you can tailor your strategy to minimise the overnight risk.
  2. A market dominated by big players: Forex markets are very competitive. Big players often know where the order flow lies and can trade accordingly. They also analyse the fundamentals of currencies using sophisticated models. Retail traders have traditionally been seen as 'dumb money', though this is changing as more education leads to better trading decisions.
  3. Leverage: listed as a pro above, leverage can also be to the detriment of an unprepared beginner. Trading position sizes not appropriate to the account size is common-place amongst retail traders. Beginners often think to themselves "if I just double my position size I can make back what I just lost, plus more". This is faulty thinking but extremely commonplace. Beginners are encouraged to seek the mentoring of an expert who can guide them on how best to establish risk controls. With so much leverage available to traders today, this can blow up your account quicker than you can say "holy smokes".
  4. A psychological game: with rapid price moves in FX affecting a leveraged position, this can freak a lot of new traders out who are not prepared for the unexpected. Ask any trader who has been in the markets for a decent amount of time and they will tell you trading is mostly a psychological game. FX is no different in that respect to other markets – but failing to stick to your strategy is a recipe for disaster. With many beginners not understanding what is driving price changes in FX, this can lead to a lot of (avoidable) confusion and stress.

When the pros are balanced against the cons listed above, it is clear that forex trading holds great opportunity for those who wish to do their homework and treat this as a business. Like any business, this one takes years and years to truly master and see profits. The 'go slow' approach is an absolute must if you choose to begin FX trading. Like all trading, it is part art and part science. Experience counts for a lot, so do the time and make sure you are one of the few that are around in 5 years time still trading. When you have experience and discipline, the money can flow into your account at a rapid pace.

Complex product warning

This article contains information about foreign exchange contracts, which are considered complex financial products. Please click here to read ASIC's foreign exchange trading article before considering an investment in foreign exchange contracts. 
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