The Disadvantages of Foreign Exchange

  • Print this article
The Disadvantages of Foreign Exchange thumbnail
The foreign exchange has unique pitfalls

The foreign exchange market, or Forex, has unique disadvantages not found in other trading environments. Without understanding the pitfalls you are almost guaranteed to lose money.

  1. Central Bank Intervention

    • Many government central banks intervene in the markets in order to preserve the value of their currency, unbeknown to the average investor. This intervention is usually camouflaged to keep the market from knowing. For example, the central bank may use a network of smaller banks to buy or sell on their behalf. Regardless of the camouflage used, the result is the same: the currency value is artificially strengthened or weakened, making it difficult to make trades based on market fundamentals.

    Timing Difficulties

    • The foreign exchange market is a bartering based system. This means that one item (a given currency) is exchanged directly for another item (a second currency). These trades are usually made through a third "vehicle" currency. So, for example, if an investor wants to trade from the Brazilian Real into the British Pound, holdings of Real are usually converted into the U.S. Dollar and then reconverted into the Pound.

      In such a complex arrangement, it can be difficult to time when the vehicle currency will remain stable and the currency to be bought will appreciate against the base currency all within the same time frame.

    Differences Between Retail and Wholesale Pricing

    • Roughly two-thirds of all trades on the foreign exchange are made between dealers and large organizations such as hedge funds and banks. Organizations that make trades of this size operate at wholesale prices (known as interbank trading). The investor, on the other hand, is forced to buy and sell at the retail price (known as client trading).

      The difference is known as the spread, and shows itself in the form of commissions and fees paid to the investor's broker. When dealing with spreads, it becomes a challenge to compete against the larger organizations that start with a lower entry point and can sell profitably with far less market fluctuation.

    24 Hour Trading

    • Unlike organized trading exchanges with a central location, the foreign exchange market is open for trading 24 hours a day. With currency fluctuations being triggered from traders across the globe, it's a never-ending challenge to stay profitable. This makes forex trading time intensive and constantly hectic.

    Platform Freezes

    • Certain forex brokers build price freezes into their platforms that are triggered by major news events or large fluctuations in the market. This keeps investors from trading during the most profitable moments.

Related Searches

References

  • Photo Credit exchange fluctuations image by Raimundas from Fotolia.com

Comments

You May Also Like

Related Ads

Featured
View Mobile Site