During the early days, forex can only be accessed by big corporations and institutions to facilitate hedging purposes. However, with today’s advanced technology, forex trading can now be accessed by any trade around the world.
Basically, forex trading is just buying and selling currencies. But, before you decide to open your own forex trading account, here are some of the things you should know:
- Transaction Cost
If you’ve ever traded stocks, you’ll have to pay a commission and the spread on it. Spread is the difference between the offer and the bid. In foreign exchange trading, you just have one transaction cost to cover, which is the spread. You won’t be charged any commission unless you’re trading on ECN. That is the reason why foreign exchange trading has a lesser transaction cost in comparison to stock trading.
- Leverage Instrument
Currency trading is basically a leveraged instrument. It’s not uncommon to see broker providing 1:100 on the capital. It only means that once you deposit a thousand dollar, you may trade up to a hundred thousand dollar. However, leverage is usually a double edged sword. It may either boost your profits or could amplify your losses. This is why some traders bust their trading account. They’re leveraging excessively relative to their account size. A small movement on the price against them is enough for wiping out their trading capital.
- You Don’t Own Physical Shares
Once you purchase stocks, you’re actually a part owner of the company shares. However, when it comes to forex trading, you do not own anything at all. Even the currencies you sell or buy because you’re trading in the spot market and it doesn’t take delivery of currencies compared to futures market. Each of your orders is recorded electronically by your broker with losses and profits reflected in accordance to the market price. If you’re lucky and you have made profits, your equity will increase.
- Carry Trade
In terms of forex trading, there’s something known as carry trade. If you have a positive carry trade, this only means that the currency you’re long pays a bigger interest rate than the currency you’re short.
- Not Exchange Traded
When compared to futures or stocks whereby they’re traded over a centralized exchange, currency trading is actually traded over the counter. So there’s always a possibility of counter party risks. As a retail trader, your counter party risks are typically your broker. The size of your transaction in the forex market is very small to reach interbank market. Therefore, what occurs most of the time is your broker could take the trade’s opposite site. After which brokers would pool such retail orders and hedge this on interbank market wherein institutions and bankds trade with each other.
At a glance, forex trading is very attractive, yet you have to understand that it’s vastly different from the traditional stock trading. It has greater counterparty risk and leverage, yet it has reduced transaction cost.