| The Benefits of Trading The Forex Market
Historically, the FX market was available most to major banks, multinational
corporations and other participants who traded in large transaction sizes
and volumes. Small-scale traders including individuals like you and I, had
little access to this market for such a long time. Now with the advent of
the Internet and technology, FX trading is becoming an increasingly popular
investment alternative for the general public.
The benefits of trading the currency market:
It is open 24-hours and it closes only on the weekends;
It is very liquid and efficient;
It is very volatile;
It has very low transaction costs;
You can use a high level of leverage (borrowed money) with ease; and
You can profit from a bull or a bear market.
Continuous, 24-Hour Trading
The currency exchange is a 24-hour market. You may decide to trade after
you come home from work. Regardless of what time-frame you want to trade at
whatever time of the day, there would be enough buyers and sellers to take
the other side of your trade. This feature of the market gives you enough
flexibility to manage your trading around your daily routine.
Liquidity And Efficiency:
When there are a lot of buyers and a lot of sellers, you can expect to buy
or sell at a price that is very close to the last market price. The currency
market is the most liquid market in the world. Trading volume in the
currency markets can be between 50 and 100 times larger than the New York
Stock Exchange (Source: Oanda.)
When you are trading stocks, you may have experienced events where one piece
of news accelerates or decelerates the price of the underlying stock you may
have bought into. Perhaps a director has been kicked out by the shareholders
of a company or the company has just released a new product and big
investors are buying the shares of a particular company. Share prices can be
drastically affected by the actions or inactions of one or a few
individuals. So if you are relying on television reports and newspapers to
get your news, most of the opportunities or warnings will have come too late
for you to take advantage by the time you get them.
The value of currencies on the other hand is affected by so many factors and
so many participants that the likelihood of any one individual or group of
individuals drastically affecting the value of a currency is minute. Because
of its sheer size, the currency market is hard to manipulate. The ability
for people to engage in ‘insider trading' is virtually eliminated. As an
average trader, you are less disadvantaged. You are likely to be playing on
relatively equal ground along with all the other traders and investors whom
you are competing against.
Note about price gaps:
For those people who have already traded other markets, you probably know
about price ‘gaps'. ‘Gaps' occur when prices ‘jump' from one price level to
another without having taken any incremental steps to get there. For
example, you may be trading a share that closes at $10 at the end of today
but due to some event that happens overnight; it opens tomorrow at $5 and
continues to go downwards for the rest of the day. Gaps bring about another
degree of uncertainty that may meddle with a trader's strategy. Probably one
of the most worrying aspects of this is when a trader uses stop-losses. In
this case, if a trader puts a stop-loss at $7 because he no longer wants to
be in a trade if the share price hits $7, his trade will remain open
overnight and the trader wakes up tomorrow with a loss bigger than he may
have been prepared for. After looking at a couple of forex charts, you will
realize that there are little price ‘gaps' or none at all, especially on the
longer-term charts like the 3-hour, 4-hour or the daily charts.
Volatility:
Trading opportunities exist when prices fluctuate. If you buy a share for $2
and it stays there, there is no opportunity to make a profit. The magnitude
of level of this fluctuation and its frequency is referred to as volatility.
As a trader, it is volatility that you profit from. Large volume
transactions and high liquidity combined with fewer trading instruments
generate greater intra-day volatility in the currency market that can be
exploited by day-traders. The high volatility of the currency market
indicates that a trader can potentially earn 5 times more money from
currency trading than trading the most liquid shares. Volatility is a
measure of maximum return that a trader can generate with perfect foresight.
Volatility for the most liquid stocks are between 60 to 100. Volatility for
currency trading is 500. (Source: Oanda.) In this respect, currencies make a
better trading vehicle for day-traders than the equity markets.
Low Transaction Costs:
A currency transaction typically incurs no commission or transaction fees.
For a forex trader, the spread is the only cost he or she needs to cover in
taking on a position. In addition, because of the currency market's
efficiency, there is little or no ‘slippage' costs. ‘Slippage' is the cost
involved when traders enter the market at a price worse than the level they
wanted to get into. For example, a trader wants to buy a share at $2.00 but
by the time, the order gets executed, his gets to buy the shares at $2.50.
That fifty cents difference is his slippage cost. Slippage cost affects
large-volume traders a lot. When they buy large quantities of a commodity,
it oversupplies the market with buy orders. This applies a pressure for the
price to go up. By the time they get to buy all the quantities they wanted,
the average price they got their commodities would be higher than the price
they intended to get them for. Conversely, when they sell large quantities
of a commodity, they oversupply the market with sell orders. This applies a
pressure for the price to go down. By the time they finish selling all their
commodities, their average selling price is less than what they initially
intended to sell them for.
Due to lower transaction costs, minimum slippage and strong intra-day
volatility, individuals can trade frequently at small costs. As an
approximate, you may only expect to have a spread of 0.03% of your position
size. To give you an example, you can buy and sell 10,000 US Dollars and
this will only incur a 3-point spread, equivalent to $3.
Leverage:
There are not a lot of banks or people who would lend you money so that you
can use it to trade shares. And if there are, it would be very hard for you
to convince them to invest in you and in your idea that a certain share is
going to go up or down. Therefore, most of the time, if you have a $10,000
account, you can only really afford to buy $10,000 worth of stocks.
In currency trading however, because you use ‘borrowed money', you can trade
$10,000 of a currency and you only need anywhere between fifty (For a margin
lending ratio of 200:1) to two hundred dollars ( For a margin lending ratio
of 50:1) in your trading account. This makes it possible for an average
trader with a small trading account, under $10,000 to be able to profit
sufficiently from the movements of the currency exchange rates. This concept
is explained further in The Part-Time Currency Trader.
Profit From A Bull And Bear Market:
When you are trading shares, you can only profit when the price of a stock
goes up. When you suspect that it is about to go down or that it is just
going to be moving sideways, then the only thing you can do is sell your
shares and stand aside. One of the frustrations of trading shares is that an
individual cannot profit when prices are going down. In the currency market,
it is easy for you to trade a currency downward so that you can profit when
you think it is going to lose value. This is easy to do because currency
trading simply involves buying one currency and selling another, there is no
structural bias that makes it difficult to trade ‘downwards'. This is why
the currency market has been occasionally referred to as the eternal bull
market. |