Advantages and Disadvantages of Forex Market
Advantages of Forex Market
The biggest financial market in the world is the biggest market because it provides some advantages to its participants. Some of the major advantages offered are as follows:
Flexibility
Forex exchange markets provide traders with a lot of flexibility. This is because there is no restriction on the amount of money that can be used for trading. Also, there is almost no regulation of the markets. This combined with the fact that the market operates on a 24 by 7 basis creates a very flexible scenario for traders. People with regular jobs can also indulge in Forex trading on the weekends or in the nights. However, they cannot do the same if they are trading in the stock or bond markets or their own countries! It is for this reason that Forex trading is the trading of choice for part time traders since it provides a flexible schedule with least interference in their full time jobs.
Transparency: The Forex market is huge in size and operates across several time zones! Despite this, information regarding Forex markets is easily available. Also, no country or Central Bank has the ability to single handedly corner the market or rig prices for an extended period of time. Short term advantages may occur to some entities because of the time lag in passing information. However, this advantage cannot be sustained over time. The size of the Forex market also makes it fair and efficient!
Trading Options
Forex markets provide traders with a wide variety of trading options. Traders can trade in hundreds of currency pairs. They also have the choice of entering into spot trade or they could enter into a future agreement. Futures agreements are also available in different sizes and with different maturities to meet the needs of the Forex traders. Therefore, Forex market provides an option for every budget and every investor with a different appetite for risk taking.
Also, one needs to take into account the fact that Forex markets have a massive trading volume. More trading occurs in the Forex market than anywhere else in the world. It is for this reason that Forex provides unmatched liquidity to its traders who can enter and exit the market in a matter of seconds any time they feel like!
Transaction Costs
Forex market provides an environment with low transaction costs as compared to other markets. When compared on a percentage point basis, the transaction costs of trading in Forex are extremely low as compared to trading in other markets. This is primarily because Forex market is largely operated by dealers who provide a two way quote after reserving a spread for themselves to cover the risks. Pure play brokerage is very low in Forex markets.
Leverage
Forex markets provide the most leverage amongst all financial asset markets. The arrangements in the Forex markets provide investors to lever their original investment by as many as 20 to 30 times and trade in the market! This magnifies both profits and gains. Therefore, even though the movements in the Forex market are usually small, traders end up gaining or losing a significant amount of money thanks to leverage!
Disadvantages of Forex Market
It would be a biased evaluation of the Forex markets if attention was paid only to the advantages while ignoring the disadvantages. Therefore, in the interest of full disclosure, some of the disadvantages have been listed below:
Counterparty Risks
Forex market is an international market. Therefore, regulation of the Forex market is a difficult issue because it pertains to the sovereignty of the currencies of many countries. This creates a scenario wherein the Forex market is largely unregulated. Therefore, there is no centralized exchange which guarantees the risk free execution of trades. Therefore, when investors or traders enter into trades, they also have to be cognizant of the default risk that they are facing i.e. the risk that the counterparty may not have the intention or the ability to honor the contracts. Forex trading therefore involves careful assessment of counterparty risks as well as creation of plans to mitigate them.
Leverage Risks
Forex markets provide the maximum leverage. The word leverage automatically implies risk and a gearing ratio of 20 to 30 times implies a lot of risk! Given the fact that there are no limits to the amount of movement that could happen in the Forex market in a given day, it is possible that a person may lose all of their investment in a matter of minutes if they placed highly leveraged bets. Novice investors are more prone to making such mistakes because they do not understand the amount of risk that leverage brings along!
Operational Risks
Forex trading operations are difficult to manage operationally. This is because the Forex market works all the time whereas humans do not! Therefore, traders have to resort to algorithms to protect the value of their investments when they are away. Alternatively, multinational firms have trading desks spread all across the world. However, that can only be done if trading is conducted on a very large scale.
Therefore, if a person does not have the capital or the know how to manage their positions when they are away, Forex markets could cause a significant loss of value in the nights on weekends.
The Forex market caters to different types of investors with different risk appetites.
source:www.managementstudyguide.com