The foreign exchange market has become so vast and wealthy in a short period of time through a number of factors including market size and volatility.
When considering the risks and benefits of engaging trade in forex, and investor/broker should consider the highly liquid nature of this market. Investors operating in forex have the option of placing extremely large trades without affecting any given exchange rates due to the low margin requirements used by the majority of the industry’s brokers.
What does that mean? Essentially, leverage can be negotiable. It’s entirely possible for a trader to control a postion of $100,00 in U.S. dollar by putting down the relatively miniscule down payment of $1,000 and borrowing the rest from their broker, which would be comparable to renting a $500 suit for a gala event and only putting down $50 for the shoes and borrowing the rest from your roommate.
Care needs to be taken with this kind of leverage, however. Although investors can realize large gains when rates make a small favorable change, they also run the risk of a massive loss when the rates move against them. But those risks, coupled with the possibility of massive gains, stands as both the biggest appeal about the forex market and the primary reason for its continued success.
Forex’s hours of operation don’t hurt, either. Because of its 24-hour business period during the work week, the market experiences a state of near-constant decent liquidity. This makes forex an very attractive market for investors who have other obligations during the work week, such as days jobs, classes, or family commitments. Lacking the opening and closing bells of Wall Street, forex boasts a more flexible trading period that encompass larger and more varied markets.
But again, investors need to consider the risks inherent with the possible gains. Because the markets is wide and diverse, traders have to react quickly to information released into the market, which can create a trading atmosphere that can stop on a dime and do a 180-degree turn at whiplash speed. Gains can become losses at the drop of a hat and vice versa, which should give a new trader pause before diving into the market.
A big reason for that pace goes back to the leverage that can be influenced upon the market. Consider the example of purchasing $100,000 at the cost of $1,000, or a 100:1 leverage ration. If an investor puts the entirety of the $100,000 into one currency set and the currency’s price moves even one percent against the buyer, the value of the capital will subsequently decrease by $99,000. This would constitute a loss of $1,000, which was how much the investor actually purchased, thus creating a 100 percent loss for the investor.
However, that same volatility could work in the investor’s favor if the currency price were to go in the other direction. That uncertainty, coupled with the inherent volatility of forex, create a market filled with possibilities for the savvy investor.