While Forex trading is becoming more popular in
the United States, the vast majority of
investors still do not understand the
significant advantages that the foreign currency
market offers, compared to equities or fixed
income trading. The following concepts, will
help you understand those advantages and may
motivate you to include Forex into your future
investment strategies.
1. Currency prices are not heavily influenced
by institutional investors. In stock
trading, there is a limited amount of volume on
a daily basis. Each stock has a specific number
of shares on the open market and trade prices
are governed by the number of people attempting
to buy or sell shares at a specific point in
time. This makes the market vulnerable to price
swings when a large investor is attempting to
buy up or unload large amounts of shares. For
example, if some pension fund owns 10% of a
company and suddenly decides to liquidate their
position, the market is now flooded with sell
orders. Since the amount of shares attempting to
be sold will outnumber the amount of buy orders,
the price of the stock will start to drop as the
number of buyers drys up. This creates losses
for the remaining shareholders. On the other
hand, the forex market is so massive and has so
many investors that no single investor can
possibly have a major impact on pricing. There
are too many units of Euros, Dollars, Yen, etc
for any single institution to hold even close to
a controlling interest in any currency.
2. Margin requirements are significantly
lower in forex trading than equity trading.
While the exact amount of margin allowed is
determined by each broker, the restrictions are
usually much less stringent when trading forex.
Margin allows the investor to "play with house
money." In essence, you're borrowing money from
the broker to invest in your own account. While
this can be risky, it can also be insanely
profitable. For example, let's say you have
$10,000 of your own money to invest. If you open
up a margin account at an equity broker, you can
usually margin up to 50% of the value of stock.
So if you buy $10,000 in Microsoft stock, you
can borrow another $5,000 to own a total of
$15,000 in value. With your forex account, the
margin requirement is often as low as 1%. Which
means that if you buy $10,000 in Euros, you can
use your broker's money to buy another
$1,000,000. So you now own over $1 million in
Euros. Now lets say that the value of each
investment increases 10%. Your $15,000 in
Microsoft stock is now worth $16,500. You sell
it, pay back the $5,000 you borrowed, and you
pocket $1,500 in profit (minus any fees or
interest). Your return on investment is 15%. If
your Euros went up 10%, your $1 million is now
worth $1.1 million. After selling and repaying
your broker, you profit $100,000 before any
interest. That's a return on investment of over
1,000%. Of course, you need to be extra careful
when trading on margin. Imagine if the
transaction went the other way. You'd be in a
much bigger hole in the forex scenario. But the
potential for enormous gain is there and is one
of the major reasons why forex trading is so
attractive to serious investors.
3. Forex trading is open 24 hours a day.
Unlike the U.S. stock markets, you can trade
forex any time of day from Monday through
Friday. If a major news story breaks when you're
holding stock, and it's after hours, you're
stuck holding onto your position until the
market opens the next day. By the time this
happens, everyone else knows the news and
there's thousands of buy/sell orders waiting
when the opening bell rings. This will
dramatically influence your trade price and
negate any advantage you might have had by being
one of the first to react. Keep in mind that
many corporations withhold major news such as
earnings reports and personnel moves until after
the market closes. They do this to minimize
emotional trading, which is smart for them to do
but also hurts savvy investors. Since Forex
trading is open 24 hours, you can place your
trade order whenever major events occur.
4. The foreign exchange market is more liquid
than the equity market. Forex is the largest
market in the world. Every day, an average of
$1.4 trillion dollars is traded, and the amount
of securities (foreign currencies) is minuscule
when compared to the number of companies traded
in the equities market. This means that there
are always buyers to be matched with sellers,
which means that you'll have a much better
chance to get a fair and accurate price on your
trade than if you were trading a low volume
stock where the bid and ask spreads can be very
large.
5. Forex trading offers the advantage of
limited risk. This is one of the large
advantages over the futures market. When you buy
a futures contract, you are obligated to buy or
sell a specific amount of a specific commodity
at a specific time for a specific price. Which
means that if disaster hits, you're out of luck.
For example, lets say you buy a futures contract
to sell corn. If news breaks that reports an
outbreak of deaths caused by a pesticide used in
corn crops, the price on your contracts will
drop through the floor, limits will drop, and
you could be stuck in your position and end up
taking massive losses. This would not happen in
the forex market since you can leave your
position at any time.
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