Foreign Exchange Risk and Benefits

Forex market is typically associated with risks. But, if you know how to trade then you can surely reap the benefits of this market. Let’s know about the various risks and benefits of Forex market.

Both sides of the FX market

Factors such as the size, volatility and global structure of the FX market have contributed immensely towards its growth and success. It is highly liquid nature of this market and that is why investors are able to place extremely large trades without affecting any said exchange rate.

Lets’ take an example; a trader can control a position of US$100,000 by putting down an amount of USD 1,000 up front and rest he can borrow from his FX broker. The investor can gain a large amount of money when the rates change in his favor. However, the loss can be as massive if the rates move against him. This speculative quality of currency trading makes it so popular among the traders and investors.

Since the major hubs for currency trading are located in different time zones and are open 24 hours for 5 days a week, these markets have a good liquidity at any time of the day. Since, the gains from a Forex markets are huge, the losses can be as quick and severely damaging. Because of the volume of the market and money involved, the market reacts quickly to any information released leading to sharp moves.

The leverage in the spot market is the reason for its volatility. Say for a 100:1 leverage on $1,000 invested amount, you control $100,000 in capital. If you put $100,000 into a currency and the currency's price moves 2% against you, the value of the capital will have decreased to $98,000 - a loss of $2,000 and this is twice your invested capital, representing a 200% loss. So, you must weigh your risks before taking the plunge in the FX market.

Differences between Forex and Equities

The biggest difference between Forex and Equities is the number of instruments that can be traded. While an equity market has thousands of equities that can be traded, a FX market’s 95% trade comes from the trade of seven major traded currency pairs which constitutes of (EUR/USD, USD/JPY, GBP/USD, USD/CHF); and the three commodity pairs (USD/CAD, AUD/USD, NZD/USD). Hence, managing the currency trading becomes easier as compared to the equity trading.

The equity market can hit a low and all trading activity will be diminished. But, Forex being the most liquid market offers opportunity to profit in both rising and declining markets. This is because with each trade, a trader is buying and selling simultaneously.

In Forex market, margins are low and leverage is high. Such situations are not found in the equity markets. Commissions in the equities market are much higher than in the Forex market. In Forex market dealers make their money through the bid-ask spread.

Hope this article helped you to have a basic understanding of the Forex market and its risks and benefits.