For new and experienced traders navigating the intricate world of online trading, the question of risk is always in the back of the mind. Forex (foreign exchange) trading and cryptocurrency trading are two of the most popular trading markets today, but they are also dangerous in their own rights.
The purpose of this article is to interrogate both markets in great detail, to explain why forex trading is typically seen as having less risk than cryptocurrency trading.
At Goat Funded Trader, we know that understanding risk is critical to profitable trading, particularly when the markets are dynamic, such as forex and crypto, and that is what we are going to attempt to teach you in this article.
To better understand the risk profiles of forex and cryptocurrency trading, it is essential to explore the structural differences between the two markets.
The forex market is the largest and most liquid financial market in the world, with a daily trading volume exceeding $6.6 trillion. It operates as an over-the-counter (OTC) market, meaning that trades are conducted directly between participants, rather than through a centralized exchange. The market is open 24 hours a day during weekdays, allowing for continuous trading across various global financial centers.
Major participants in the forex market include central banks, commercial banks, hedge funds, and retail traders.
Currency trading occurs in pairs, such as EUR/USD or USD/JPY, with fluctuations driven by various factors including economic indicators, interest rates, and geopolitical events. The involvement of large institutional players helps to stabilize the market, providing a level of predictability that can be advantageous for traders.
In stark contrast, the cryptocurrency market is a relatively new phenomenon, emerging in 2009 with the introduction of Bitcoin. Since then, thousands of digital assets have entered the market, creating a complex landscape of options for investors.
Unlike forex, cryptocurrency operates on a decentralized blockchain system, and trading occurs 24/7 with no centralized regulatory authority overseeing transactions.
The decentralized nature of cryptocurrency can offer more freedom and privacy for traders but also introduces various risks. The absence of regulatory oversight leads to issues such as market manipulation, fraud, and security breaches, making the crypto environment less predictable. Moreover, the speed at which the market evolves presents challenges for both investors and regulators, often leaving traders vulnerable to unforeseen shifts in the landscape.
Having established a foundational understanding of both markets, let’s delve into the reasons why forex trading is generally considered less risky than cryptocurrency trading.
The forex market has a long history, dating back several decades if not centuries. Its stability is one of its core features, characterized by the existence of central banks that intervene when necessary to stabilize currency fluctuations. Such interventions are crucial for maintaining economic stability and investor confidence. The economic policies enacted by these banks are based on thorough research and historical data, providing a level of predictability in market movements.
In contrast, the cryptocurrency market is still in its infancy, lacking the stability that forex possesses. The rapid growth of digital currencies often leads to extreme volatility. Price swings of 20% or more in a single day can occur without warning, driven by factors such as regulatory announcements, technological changes, or shifts in public sentiment. This inherent volatility makes cryptocurrency trading riskier, particularly for inexperienced traders.
Forex trading is subject to regulation in most countries, with oversight from financial authorities such as the Financial Conduct Authority (FCA) in the UK, the Securities and Exchange Commission (SEC) in the US, and the Australian Securities and Investments Commission (ASIC) in Australia. These regulatory bodies implement strict guidelines that brokers must adhere to, ensuring transparency and fairness in trading practices.
The regulatory environment surrounding forex trading provides a level of protection for traders, significantly reducing the risk of fraud, market manipulation, and other unethical practices. Traders can feel more secure knowing that there are mechanisms in place to address any irregularities in the market.
On the other hand, the cryptocurrency market is characterized by its lack of regulation. While some countries have begun to establish frameworks for crypto trading, the market as a whole remains largely unregulated. This absence of oversight makes traders more susceptible to scams, fraud, and market manipulation. High-profile incidents of hacking and exchange collapses have plagued the crypto market, further heightening the risks for investors.
Liquidity is a crucial factor in determining the risk associated with trading. In financial markets, liquidity refers to how easily an asset can be bought or sold without causing a significant impact on its price.
The forex market is renowned for its high liquidity. Major currency pairs like EUR/USD, USD/JPY, and GBP/USD experience daily trading volumes in the billions, allowing traders to enter and exit positions with minimal slippage. High liquidity means that traders can execute large orders without significantly affecting the market price, thereby reducing their risk exposure.
Conversely, the liquidity of cryptocurrencies can vary significantly from one asset to another. While leading cryptocurrencies like Bitcoin and Ethereum enjoy relatively high liquidity, many altcoins (lesser-known digital currencies) can experience illiquidity. A lack of liquidity can lead to large price swings, making it difficult for traders to enter or exit positions without incurring substantial losses. In illiquid markets, even small trades can lead to significant price movements, adding another layer of risk for investors.
When discussing risk, it is essential to consider volatility—the degree to which the price of an asset fluctuates over time. High volatility can create profit opportunities, but it also amplifies the potential for loss.
The forex market does experience volatility, particularly during major economic releases or geopolitical events. However, significant fluctuations tend to be more subdued compared to the crypto market. For example, during significant events, the currency pairs may experience price movements of 1-2%, whereas the overall market remains stable due to the massive trading volume and institutional involvement.
Cryptocurrencies, by their nature, are highly volatile. It is not uncommon for a cryptocurrency's price to swing by 10-20% in a single day. This extreme volatility is fueled by speculative trading, social media influence, and the rapid pace of technological developments. A single tweet from a prominent figure can lead to substantial price changes, leaving investors vulnerable to sudden market shifts. Such volatility may attract short-term traders looking for quick profits, but it poses significant risks, especially for those not well-versed in the market dynamics.
Psychological factors play a significant role in trading, influencing decision-making and risk tolerance. Forex traders typically benefit from a more established and stable market, which can contribute to a more disciplined trading approach. The extensive availability of market data, analysis, and educational resources enables traders to make informed decisions based on empirical evidence.
Conversely, the cryptocurrency market is often driven by emotion and speculation, leading to impulsive trading behaviour. The hype surrounding new coins or projects can lead traders to make irrational decisions, often resulting in significant losses. The fear of missing out (FOMO) can compel traders to enter positions without adequate research or risk assessment, amplifying the potential for adverse outcomes.
Furthermore, the relatively smaller size of the cryptocurrency market compared to forex can create an environment where market sentiment can shift rapidly. In such scenarios, the fear and greed cycle can result in drastic price movements that may catch traders off-guard, exacerbating the risk of trading in this volatile landscape.
The forex market benefits from a well-established trading infrastructure that includes advanced trading platforms, market analysis tools, and real-time data feeds. This infrastructure allows traders to make informed decisions and execute trades quickly and efficiently.
In contrast, the cryptocurrency market is still developing its infrastructure. Many exchanges have faced technical issues, downtime, and security breaches, leading to significant losses for traders. Additionally, the proliferation of various exchanges, each with its own fee structures and trading policies, can confuse traders, complicating their ability to navigate the market effectively.
The crypto market has seen an alarming rise in scams and fraudulent schemes. Initial Coin Offerings (ICOs), Ponzi schemes, and fake exchanges are just a few examples of the scams that have proliferated in the space. New investors may struggle to distinguish legitimate projects from fraudulent ones, making them susceptible to significant financial losses.
While scams can occur in any financial market, the structured regulatory framework of the forex market provides more robust safeguards against such fraudulent activities. Retail forex traders can operate with a higher degree of confidence, knowing that there are strict laws and regulations in place to protect their interests.
The cryptocurrency market's high risk is further underscored by numerous scenarios where projects and coins have failed spectacularly. The rise and fall of various cryptocurrencies offer critical lessons for traders and investors alike. A few among them include:
1. BitConnect (2016-2018): BitConnect was a cryptocurrency investment platform that promised high returns through a lending program. It was widely regarded as a Ponzi scheme, attracting significant investments before ultimately collapsing in early 2018. Investors lost billions, highlighting the dangers of unregulated platforms.
2. Terra (LUNA) and TerraUSD (UST) Collapse (2022): TerraUSD, an algorithmic stablecoin, was designed to maintain its value pegged to the US dollar. However, the mechanism failed, leading to a rapid devaluation of both UST and its sister token, LUNA. The collapse wiped out approximately $60 billion in market value and had a significant impact on the broader cryptocurrency market.
3. Mt. Gox Hack (2014): Once the largest Bitcoin exchange, Mt. Gox filed for bankruptcy after losing 850,000 Bitcoins due to a security breach. The incident underscored the vulnerabilities of cryptocurrency exchanges and the risks traders face when entrusting their funds to third-party platforms.
4. OneCoin (2014-2017): Marketed as a revolutionary cryptocurrency, OneCoin was later revealed to be a fraudulent scheme led by Ruja Ignatova, dubbed the "Cryptoqueen." Investors lost billions in what has been described as one of the largest Ponzi schemes in history.
5. Slock. it and the DAO Hack (2016): The Decentralized Autonomous Organization (DAO), built on the Ethereum blockchain, raised $150 million in its ICO before being hacked, resulting in the loss of approximately $60 million worth of Ether. The incident led to a controversial hard fork in the Ethereum blockchain, creating Ethereum (ETH) and Ethereum Classic (ETC).
These examples illustrate the harsh realities of the cryptocurrency market, emphasizing the significant risks associated with investing in digital assets. Each case serves as a stark reminder that while the potential for high returns exists in cryptocurrency trading, the potential for substantial losses is equally pronounced. These real-life scenarios reinforce the notion that investing in cryptocurrencies is way riskier than investing in the forex market.
While it is evident that there are risks in both forex and cryptocurrency trading, a lot of evidence points towards forex trading being less risky. Forex has a well-established market, regulations, high liquidity and less volatile price momentum. The cryptocurrency market, however, also faces greater volatility, has no regulations, and boasts a high number of scams which make investing a daunting task.
Learning the risks of each market is very important for traders, and especially for those entering into the field. Successful trading consists of being educated correctly and having proper education, it includes risk management strategies and continuous learning. In this educational journey, prop firms like Goat Funded Trader are key by providing resources and support to traders in trading the complexities of both markets.
Finally, whichever way you decide to leap into forex or crypto trading, a balanced mindset around risk management and awareness of the particular issues of each market is key. It can help you better set yourself up for success in the world of trading on a long-term basis.
The primary difference lies in the markets themselves. Forex trading involves the exchange of traditional currencies and is governed by established regulations, liquidity, and stability. It operates through centralized financial institutions and has a long history. In contrast, cryptocurrency trading involves buying and selling digital currencies on decentralized platforms. The crypto market is relatively new, characterized by high volatility, less regulatory oversight, and the potential for significant price fluctuations.
Cryptocurrency is considered more volatile due to its speculative nature and the relatively low market capitalization of many digital assets. Prices can swing dramatically within short time frames due to factors like market sentiment, regulatory news, technological advancements, and social media influence. In comparison, forex markets have larger trading volumes and are influenced by macroeconomic factors, resulting in more stable price movements.
Regulatory oversight provides a layer of protection for traders in the forex market by ensuring that brokers adhere to strict guidelines, promoting transparency and fair practices. Regulatory bodies can intervene in cases of fraud or market manipulation, offering recourse for traders. In contrast, the cryptocurrency market lacks comprehensive regulation, leaving traders vulnerable to scams, hacks, and market abuses without the safety nets that exist in regulated markets.
Yes, it is possible to lose your entire investment in forex trading, particularly if proper risk management strategies are not employed. Forex trading involves leverage, which can amplify both gains and losses. Without a solid understanding of risk management, traders can face significant losses. However, because the forex market is more stable and regulated, the potential for catastrophic losses is generally lower compared to the crypto market.
i. Continuously learn about market dynamics, trading strategies, and risk management techniques.
ii. Set clear risk parameters, such as stop-loss orders and position sizing, to protect your capital.
iii. Avoid putting all your funds into one asset; instead, diversify your investments across different currency pairs or cryptocurrencies.
iv. Keep up with market news, economic indicators, and regulatory developments that can impact your trades.
v. Choose reputable brokers and exchanges that prioritize security and customer protection.