In this section, we’ll take a look at some of the benefits and risks associated with the forex market. We’ll also discuss how it differs from the equity market in order to get a greater understanding of how the forex market works.

The Good and the Bad
We already have mentioned that factors such as the size, volatility and global structure of the foreign exchangeآ market have all contributed to its rapid success. Given the highly liquid nature of this market, investors are able to place extremely large trades without affecting any given exchange rate. These large positions are made available to forexآ traders because of the low margin requirements used by the majority of the industry’s brokers. For example, it is possible forآ a traderآ to control a position of US$100,000 by putting down as little as US$1,000 up front and borrowing the remainder from his or her forex broker. This amount of leverage acts as a double-edged sword because investors can realize large gains when rates make a small favorable change, but they also run the risk of a massive loss when the rates move against them. Despite the foreign exchangeآ risks, the amount of leverage available in the forex market is what makes it attractive for many speculators.

The currency market is also the only market that is truly open 24 hours a day with decent liquidity throughout the day. For traders who may have a day job or just a busy schedule, it is an optimal market to trade in. As you can see from the chart below, the major trading hubs are spread throughout many different time zones, eliminating the need to wait for an opening or closing bell. As the U.S. trading closes, other markets in the East are opening, making it possible to trade at any time during the day.

While the forex market may offer more excitement to the investor, the risks are also higher in comparison to trading equities. The ultra-high leverage of the forex market means that huge gains can quickly turn to damaging losses and can wipe out the majority of your account in a matter of minutes. This is important for all new traders to understand, because in the forex market – due to the large amount of money involved and the number of players – traders will react quickly to information released into the market, leading to sharp moves in the price of the currency pair.

Though currencies don’t tend to move as sharply as equities on a percentage basis (where a company’s stock can lose a large portion of its value in a matter of minutes after a bad announcement), it is the leverage in the spot market that creates the volatility. For example, if you are using 100:1 leverage on $1,000 invested, you control $100,000 in capital. If you put $100,000 into a currency and the currency’s price moves 1% against you, the value of the capital will have decreased to $99,000 – a loss of $1,000, or all of your invested capital, representing a 100% loss. In the equities market, most traders do not use leverage, therefore a 1% loss in the stock’s value on a $1,000 investment, would only mean a loss of $10. Therefore, it is important to take into account the risks involved in the forex market before diving in.

Differences Between Forex and Equities
A major difference between the forex and equities markets is the number of traded instruments: the forex market has very few compared to the thousands found in the equities market. The majority of forex traders focus their efforts on seven different currency pairs: the four majors, which include (EUR/USD, USD/JPY, GBP/USD, USD/CHF); and the three commodity pairs (USD/CAD, AUD/USD, NZD/USD). All other pairs are just different combinations of the same currencies, otherwise known as cross currencies. This makes currency trading easier to follow because rather than having to cherry-pick between 10,000 stocks to find the best value, all that FX traders need to do is “keep upâ€‌ on the economic and political news of eight countries.

The equity markets often can hit a lull, resulting in shrinking volumes and activity. As a result, it may be hard to open and close positions when desired. Furthermore, in a declining market, it is only with extreme ingenuity that an equities investor can make a profit. It is difficult to short-sell in the U.S. equities market because of strict rules and regulations regarding the process. On the other hand, forex offers the opportunity to profit in both rising and declining markets because with each trade, you are buying and selling simultaneously, and short-selling is, therefore, inherent in every transaction. In addition, since the forex market is so liquid, traders are not required to wait for an uptick before they are allowed to enter into a short position – as they are in the equities market.

Due to the extreme liquidity of the forex market, margins are low and leverage is high. It just is not possible to find such low margin rates in the equities markets; most margin traders in the equities markets need at least 50% of the value of the investment available as margin, whereas forex traders need as little as 1%. Furthermore, commissions in the equities market are much higher than in the forex market. Traditional brokers ask for commission fees on top of the spread, plus the fees that have to be paid to the exchange. Spot forex brokers take only the spread as their fee for the transaction.

One of the essentials of trading in any investment market is establishing a risk management plan.آ  New traders often jump into the market head first with no real pre-determined trading plan.آ  The outcome can be disastrous in a short period time.آ  The Forex market, just like other investment markets such as the stock market and futures market, require a trading plan that’s free of emotion and heavy on discipline.آ  Only then can a trader’s hard earned money and valuable time translate into respectable profits.آ 

The risk-reward ratio

The risk-reward ratio is basically the risk you’re willing to take to make a certain profit.آ  Any risk management plan that’s worth its money has a decent risk-reward ratio of at least 1:3.آ  What exactly does a 1:3 ratio mean?آ  It means that for every unit of risk you take, you’ll reap three times that amount in reward.آ  A 1:4 ratio means that for every unit of risk you take, you’ll earn four times that amount.آ  The larger the ratio is, the greater reward you make.آ  However, with higher risk-ratios, you’ll have to wait longer to make that trade.آ  You might end up missing some lucrative trades in the interim, and your “idealâ€‌ trade might never show up.آ 

Here’s how it works

Let’s say you risk 50 pips (units) to make a deal worth 100 pips.آ  You’re risk-reward ratio is 50/100, or 1:2.آ  If your risk management plan limits your trades of at least a 1:3 ratio, then you shouldn’t make the trade.آ  However, if you risk 50 pips for a potential 150-pip gain (50/150 or 1:3), then it’s worth it.آ 

What about risking more than you can make?

Some investors don’t mind risking more than they can make on a deal.آ  Is this real good advice to follow though?آ  If you’re a real risk taker, then take the chance.آ  But if you’re in the market to make a real profit over the long run, then don’t do it.آ  It is just not sound risk management planning.آ 

Suppose you want to risk 100 pips to make a potential 50 pips.آ  Your risk-ratio is 100:50, or 2:1.آ  That means that you’re willing to give up more than you can make on the deal – not the best logic.آ  True, you can make 50 pips, but you’re risking more than you can even make on the trade.آ 

tip from golearnforex

In this post I want to discuss the merits of opening a forex account specifically to place high risk high reward positions. Now before you dismiss this idea out of hand, please hear me out because this concept may not be as crazy as it sounds.

What I’m actually suggesting is that you open two forex accounts. The primary one should be used to trade your main forex strategy and should hopefully accumulate regular profits over time as a result of taking controlled positions. You should treat this account like you would your pension fund in that your ultimate goal is to grow your account by taking safe low-risk trades which over time will give you some very healthy returns.

The secondary one should be your high risk account. This account should be a fraction of the size of your main trading account, and should be financed by money you can afford to lose. The goal of this account is to identify set-ups that have a large pay-off of at least 4:1. For example you are looking to trade positions which could potentially move 400 points in your favour whilst using a 100 point stop loss.

Furthermore you will be risking your whole account on this trade, or as much as you are allowed by using leverage. The worst case scenario is that you lose all or most of the cash in your account but remember that this account should be very small anyway and it should be money you can afford to lose. I usually start off with no more than آ£200 in this high-risk account.

With this account I am looking to make at least آ£800 from a winning trade and while this may sound fanciful, it is not actually that difficult because you only need a success rate of 20% (equivalent to 1 winning trade out of 5) just to break-even. However if you get a couple of consecutive winning trades, your account can grow substantially.

Although this is a high-risk account, you should still take this account seriously. Use technical analysis along with support and resistance lines to place the odds in your favour and only trade those positions that are most likely to pay off. For this particular system I suggest you use some kind of breakout system on the daily or weekly charts because these time frames are the ones that will give you these substantial gains.

If you get it right with an account size of say آ£200, you could grow this into آ£1000 with one winning trade, and then you can either withdraw your winnings and start again, withdraw the initial آ£200 and look for another opportunity with the remaining آ£800, or you could look for an opportunity to turn the آ£1000 into آ£5000 (I actually achieved this feat a couple of years ago). If you lose with the initial trade, you have only lost آ£200 and can simply reload your account if you have any spare cash that you can afford to lose.

This strategy of having two types of account isn’t for everyone of course, but as long as you have a primary low-risk account which contains the majority of your trading capital, then I don’t think there’s anything wrong with risking a tiny fraction of this capital in a high-risk account because you can make some substantial gains if you catch some of the sizeable moves that occur regularly on the daily or weekly charts.

tip from theforexarticles