The Benefits of Forex Trading
Foreign exchange (forex) or currency trading is a global market that's incredibly liquid, with an immense daily trading volume. As is the case with many investments, forex trading is not for the faint of heart or the inexperienced trader. That said, the forex market has some unique advantages over other markets after you've learned the ropes.
It's a 24-Hour Market for Five Days
The forex market is worldwide, so trading is pretty much continuous as long as there's a market open somewhere in the world. Trading hours start in the U.S. when the first major market opens, in Sydney, Australia, at 5 p.m. Eastern time on Sunday. Trading ends for the week when the last major market, in New York, closes on Friday at 5 p.m.
There's High Liquidity
Liquidity is the ability of an asset to be quickly converted into cash. In the world of forex, the high liquidity means large amounts of money can be moved into and out of currencies with generally small spreads—the differences between the bid prices for potential buyers and the ask prices for potential sellers.
Transaction Costs Are Low
The cost of a transaction is typically built into the price in the forex market in the form of the spread. Forex brokers pocket the spread as their payment for facilitating the trade.
Spreads are measured in pips. For most currencies, a pip is the fourth place after the decimal point, or 1/100 of a percent. (For trades involving the Japanese yen, a pip is the second place after the decimal point, or 1 percent.)
In a forex trade, if the bid price was 1.3244 and the ask price was 1.3246, the spread for the transaction was 2 pips.
Brokers may also charge a commission, either a flat fee or one based on a percentage of the amount of the transaction.
You Can Use Leverage
Forex brokers often allow traders to buy and sell in the market using significant amounts of leverage, which gives them the ability to trade with higher amounts of money than what is actually in their accounts. If you were to trade at 50:1 leverage, for instance, you could trade $50 for every $1 that was in your account. That means you could control a trade of $50,000 using only $1,000 of capital.
There's Profit Potential from Rising and Falling Prices
The forex market has no restrictions on directional trading. This means that if you think a currency pair is going to increase in value, you can buy it (or go long), and if you think it is going to decrease in value, you can sell it (or go short).
Because currencies trade in pairs, you're always actually buying one currency and selling the other no matter whether you're going long or short. Let's say you're trading the British pound/U.S. dollar (GBP/USD) currency pair. You would buy that pair—that is, buy the pound and sell the dollar—if you expected the value of the first currency, known as the base currency, to increase in value in comparison with the second currency, known as the quote currency. You would sell that pair—sell the pound and buy the dollar—if you expected the value of the pound to decrease in value in comparison with the dollar.
Unlike in the stock market, where you first borrow shares to sell short, in the forex market, selling a currency you don't own is a very simple process in which you just place a sell order.