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Benefits and Risks of Foreign Exchange Trading
Just like any trading or business activity, trading in foreign exchange comes with a number of risks. As a trader or investor, you should be aware of these risks if you do not want to fall prey to them. Further, once you know about the risks associated with trading in foreign exchange, you can take steps to reduce them.
Corporations as Competition
Before we talk about individual risk factors, let us discuss what type of traders are involved in currency trading. Currency trading is big business, and on average $4 trillion worth of currency is traded in international exchanges every day. However, most of these traders are done by large institutions and central banks. If you are a retail trader, you are directly competing in a market that is dominated by big players who have a lot of support in the form of latest computers and trading algorithms. Unless you know what you are doing, it is likely that you will not be able to beat these institutional investors.
It has been estimated that only about 30% of trades made by retail investors are profitable. As a retail trader, you are treading thin ice when you trade in currencies. At the same time, if you do have some form of knowledge or technique that can help you trade online, then you should not hesitate to trade just because the scene is dominated by institutions. A lot of these corporations depend on algorithms, which may be experts at crunching numbers, but they often miss the larger patterns that a retail trader may notice and act on. The money is made with currency exchange rates fluctuating and trading at the right times, thus profiting off of the difference.
Benefits and Disadvantages of Leverage
Margin trading refers to the phenomenon where a trader is only required to put only a part of the money upfront to make a trade. For example, if the margin is 50%, then the trader only has to pay $500 to make a trade of $1000. The rest is normally paid for by the trader's brokerage firm. In stock trading, a margin of 50% is pretty common. However, in currency trading, it is common to see margins of as low as 1%. This allows you to pay only $10 to make a trade worth $1000.
The benefits of such a high leverage are that if you make just 1% profit on $1000, that actually translates as 100% profit on your investment of $10. Therefore, higher leverage improves your profits manifold. However, higher leverage is troublesome if you lose just 1% of your $1000. In that case, you would lose all of your initial investment of $10. That is a terrible trade, and you should be careful about trading with leverage in foreign exchange trading. Leverage has its benefits, but it can also completely devastate your trading account with just one bad trade.
Benefits and Risks of Forex Trading Programs
Even retail investors today use trading programs that can suggest trades to them. These programs can be useful if you do not delegate your trading decisions to them. The benefits from such programs are clear - they help improve your horizon, and may help you notice currency pairs that you otherwise may not have known. At the same time, if you are not careful, you may end up just acting on whatever the program is suggesting, converting you into just an executor of orders from an automated program. That is a recipe for disaster.
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