Discussion Topic: Disadvantages of Forex
Previously we discussed the advantages of forex trading, and now we will discuss Disadvantages of Forex Trading (i.e. - Disadvantages of Currency trading). We'll discuss the ugly (but true) face of foreign exchange market which you must know before you actually get involved in forex currency trading. Moreover, we will discuss some big risks of trading forex.
Forex Trading Disadvantages:
Here's the list of Disadvantage that you may face while trading in the foreign exchange market. This list has been prepared by keeping in mind that you are going to trade mostly in spot forex market. So, the disadvantages of Forex Trading are as follows:
Disadvantages of Forex Trading 01 - Low Transparency
This is one of the biggest disadvantages of foreign exchange market. Due to the decentralized and de-regularized nature of the foreign exchange market, it is dominated by brokers. And you actually have to trade against professionals.
Being broker-driven implies that the forex market might not be fully transparent. A trader might not have any control over how his trade-order gets fulfilled, but you may not get the best price or may get limited views on trading quotes as furnished by your selected broker.
So a simple advice is to deal only with regulated brokers who fall within the purview of well-reputed regulators [List]. The market is not controlled by the regulators, but they can control the activities of brokers.
Disadvantages of Forex Trading 02 - Price Determination Process
The process of price determination of foreign currency is often believed to be complex because of the composite price determination process.
The fluctuations of exchange rates are influenced by multiple reasons and factors. The international politics and economy influence the rate of the currency the most, which creates uncertainty of the price.
The forex trading is usually done on the basis of technical analysis and indicators, which generally are not adequate to determine this type of fluctuation.
[See Also: How the Currency Exchange Rate is Determined?]
Forex Trading Disadvantages 03 - No Centralized Exchange
Unlike stocks or futures the spot Forex market does not have any centralized exchange or clearinghouse. Alternatively, each broker acts as its own exchange and the broker effectively becomes the market maker.
This, in fact, provides an opportunity to abuse on the part of the broker or worse. Because of the absence of a centralized exchange, we also see price variations from broker to broker.
When dealing with reputed brokers in well-regulated countries these differences will be small but you need to be well aware of this fact especially if your charting data provider is not the same as your broker, as this may lead to inconsistencies between the planned and actual execution of trades.
Forex Trading Disadvantages 04 - Self-Directed Learning Curve
While there is an advantage of getting tons of learning tools and materials available at no costs, it also implies a risk.
In the stock market, a trader may get professional assistance from portfolio managers, trade advisors, and relationship managers. Contrary to that, Forex traders have to trade on their own with little or no assistance.
That's why, a disciplined and continual self-directed learning is essential throughout the trading career.
Most beginners actually quit during the initial stage, mainly because of losses encountered due to limited forex trading knowledge and inappropriate trading.
Risks of Forex Trading:
As you have already gone through the Disadvantages of Currency Trading, Now it's the time to know the top Risks associated with Forex Trading:
Risk of Forex Trading 05 - High Leverage means High-Risk
Forex trading is known for providing high leverages, meaning you can get profit/loss exposure multiple times of your trading capital. Forex brokers allow leverage of as high as 200:1, so you need to have only $1 to take a forex position worth $200.
So while a trader can profit from the leverage, his risks of losses are also maximized. Thus currency trading can easily become a loss-making nightmare unless the trader takes calculated leverage and has strong money management in place.
One of the worst consequence of this is receiving a margin call from your broker.
[See Also: What is a Margin Call? How to Avoid One?]
Risk of Forex Trading 06 - High Volatility of Market
The high volatility of the Forex trading can either be an advantage or a disadvantage. The change in the global policies and economy may sometimes drastically change the forecast and makes it very difficult for the traders to judge the foreign exchange market and invest money.
It can cause a huge loss to the traders if the market suddenly goes down and there is no stop loss placed in the actual trading system.
Risk of Forex Trading 07 - Social Trading
Free exchange of information on the internet and social platform enables an individual to easily look up to the forex market's condition and invest without any deep analysis. This is called Social Trading.
Such kind of social trading imposes greater risk on your trading career. The main disadvantage of social trading is that you might unknowingly follow an inexperienced trader and face a decent loss over time.
So it’s desirable not to blindly follow anyone or to follow only experienced traders.
Risks in Forex Trading 08 - Interest Rate Risks
Variations in interest rates of a country have an effect on currency exchange rates.
Such as if a country’s interest rates rise, its currency will strengthen due to an increased inflow of investments in that country’s assets, as people would expect higher returns. Alternatively, if interest rates fall, its currency will weaken as investors would start to withdraw their investments.
Due to this relation of the interest rates and exchange rates, the differential between currency values can drive forex prices to change dramatically.
Risks in Forex Trading 09 - Risk from Scammers
One of the major risks or disadvantages of Forex market is that there are a lot of scammers who are ready to draw down the money from the investor. So you have to be very careful about choosing a trustworthy and reliable broker who won't cheat and can give better returns.
Risk of Currency Trading 10 - Country Risk
When considering the options to invest in currencies, you must evaluate the structure and stability of their issuing country.
In many developing countries, exchange rates are fixed to a leading currency such as the US dollar. In this condition, central banks must maintain adequate reserves to maintain a fixed exchange rate.
A deficiency in currency reserve can have substantial effects on forex prices. A solution to this problem is to trade only in major pairs or major crosses.
We hope that you have enjoyed the above article describing the disadvantages of Forex trading. Be with us to explore forex trading, stocks trading, and other money-making opportunities.
Leave us some comments if you have any questions or suggestions regarding the disadvantages or risks of Forex trading. Also, let us know which of the disadvantages you are most afraid of.