Forex Trading: Risks and Disadvantages for Traders

Foreign exchange markets allow traders to buy and sell currency.

Foreign exchange currency trading, also known as forex trading, has become a popular investment choice. Unlike stocks, bonds or commodities, forex trading does not require an extensive education in individual businesses, specific industries or government regulations. However, it carries several disadvantages that can cause inexperienced traders to lose their money. Even well-schooled forex traders can suffer from the pitfalls of the unpredictable currency market.

High Leverage

Leverage means that investors can multiply their purchasing power through credit extended by their brokers. The increase in purchasing power allows the forex investor to make a substantial profit with very little cash in a brokerage accounts, but it also carries a corresponding increase in risk. A traders who use high leverage, as high as 500 to 1 in some cases, can wipe out an account balance with one bad trade.

Lack of Regulation

While stock trades are regulated by various stock exchanges and government agencies, the forex market has very little regulation. Government agencies in one country lack jurisdiction to enforce their regulations in another. Also, the lack of regulation leaves investors vulnerable to unethical brokers who may make trades against the wishes or best interests of their clients. When these brokers are caught making unethical trades, they rarely suffer severe punishment due to the lack of an enforcement agency.

High Volatility

Forex trading carries a degree of volatility that makes the most active stock market appear glacial by comparison. Market forces, central bank policies and economic catastrophes can cause huge swings in currency markets. As of the date of publication, nearly $4 trillion trades hands in forex markets every day, so a small ripple in one or more currencies can cause a tidal wave of buying and selling. Accounts of investors who are over-leveraged or under-educated in forex markets can take devastating hits.

24/7 Market

Forex markets have no closing bells or holiday breaks. Traders must be prepared for a 24/7/365 market. Forex traders on one side of the world can make and lose fortunes while they sleep, as traders on the other side of the globe attempt to improve their positions. The efforts of following the constant fluctuations of exchange rates, combined with the volatile nature of currency trading, can be a mentally exhausting exercise.