The Problem With Forex Trade And How It Compares To Options

The Problem With Forex Trade

Forex trade is undoubtedly the undisputed champion when it comes to liquidity. With a global average daily turnover of over 5 trillion USD, there is no other market on the planet with such a high liquidity. But this much liquidity can be as much a curse as it is a blessing.

First of all, we need to understand the meaning of the term liquidity in terms of the forex market. Liquidity is defined as the easiness with which a currency pair can be traded. When trading currency pairs, the trader must always be mindful that they are in a very liquid market. However, the liquidity of currency changes with the currency pair being traded. High liquidity pairs are currency pairs that can be bought and sold with minimum variation in exchange rate. These include EUR/USD, EUR/GBP, JPY/USD etc. However, there are low liquidity currency pairs as well such as PLN/JPY that are considered exotic and have large variations in price levels.

The problem with forex trading arises when traders are trading high liquidity currency pairs. When trading, there are two types of trends: the uptrend and the downtrend. The uptrend is when the price of a currency pair increases steadily. Since the forex market is a 24 hour market, there is hardly any gap in the trading process. A down trend is when the currency slides due to various factors. What investors must try to do is work their way up an uptrend and exit before a downtrend. But here is where the problem starts.

How It Compares With Options

To illustrate this problem, an example may be taken. In a Roulette game, there is a 50% chance that the ball may land on red or black. Ideally the outcome should be red after black after red and so on, but the outcome may be a large cluster of red followed by a short cluster of black. The same thing happens with forex trading. When riding an uptrend, it takes an amount if time to realise that you are on one, and when a downtrend begins, the trader should stop. But again, to recognise that the trader is on a downtrend it takes some time. This is the most dangerous problem with forex.

How It Compares With Options

In Options trading, the liquidity is much less and therefore the losses that the trader may incur due to a downtrend is comparatively low compared to forex. Similarly, when trading in Options, there are gaps in trading because the stock exchange only operates from 9 am to 4.30 pm. This means that even if due to some political or economic force the price of stock comes down, they will be informed about it. So it is much safer to trade options, but it is much easier to make (and lose) greater with forex.

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