The Digital Marketplace
The arena of online trading offers many advantages and disadvantages to individuals interested in engaging the world's financial markets. The marketplace has evolved over time from an open-outcry auction system to a predominantly digital format.
The modern incarnations of currency, equity and derivatives markets have given people from around the globe the opportunity to participate in what was once limited to the privileged few. All that is needed to enter today's most popular financial venues is risk capital, computing power and internet connectivity.
The largest marketplaces in the world conduct the lion's share of their business operations online. Listed below are a few of the most prominent:
- Equities: Led by established exchanges and over-the-counter (OTC) entities, the majority of stock trade is conducted online. While traditional financial centers such as the New York Stock Exchange (NYSE) maintain a physical floor, others such as the Euronext rely on an exclusively digital infrastructure.
- Currency: By far the largest market in the world, the forex is responsible for upwards of US$5 trillion in value per day. Currency trading on the OTC forex is easily conducted through an online brokerage firm via software trading platform.
- Derivatives: Over the past decade, the online trade of futures and options has flourished. Dating back to its origins at the Dojima Rice Exchange, and remaining until the 1990s, the trade of derivative products has been conducted through the open-outcry auction system. Today, the world's largest derivatives markets operate online. The CME Group, Eurex and Intercontinental Exchange (ICE) are the industry leaders.
Whether one is a small retail trader chasing profit within the market, or an institutional player looking to manage a vast portfolio of holdings, online trading is typically the vehicle by which these undertakings are managed.
The Pros Of Online Trading
Although the online trading of financial instruments for profit is commonly viewed as a daunting task, there are several advantages afforded to the individual. It is through these advantages that value-added areas may be identified and incorporated into the trading approach.
The degree of each advantage varies depending upon the specific situation, but the following aspects of online trading represent the upside realised by traders in the digital marketplace:
As stated earlier, the prerequisites to begin trading securities online are limited. Risk capital, computing power and internet connectivity are all that's needed to begin. Upon the selection of an online brokerage firm and successful open of a trading account, market access is assured.
Limited Transaction Costs
In the 1980s, the cost of making a trade on the NYSE ranged anywhere from £50 to £1,000s according to the size and type of order desired. Today, discount online equities brokers commonly offer trade execution for under £10. Online currency and futures brokers have followed suit with greatly reduced trade-related commissions and fees.
Online trading has increased market participation exponentially, with an abundance of traders willing to buy or sell at any given price. In turn, bid/ask spreads have tightened, slippage is more readily quantified and the process of entering and exiting an open position within the market has been streamlined.
**Availability Of Leverage******
The use of financial leverage has always been an integral part of trading securities. Online trading has increased its availability. For instance, forex brokerage firms commonly enable clients to implement upwards of 100:1 leverage on the account balance, making larger returns possible.
Traditional trading schedules have been eliminated by the ascension of online trading. While it is true that optimal trading hours are relatively constant, most markets now function on a 24 hour, 5 day per week basis. For instance, the CME Globex is open from Sunday afternoon to Friday afternoon, taking a daily 45-minute break for settlement. The forex remains open 24/5 without any cease in trading. These extended market hours create many more trading opportunities for the individuals that pursue them.
The Cons Of Online Trading
While online trading does have many potential advantages, there are also several drawbacks. There is very little debate that the trading of securities online (or otherwise) is challenging at best and dangerous at worst. The industry accepted wash-out rate for new short-term traders hovers around 90%, with 80% giving up within the first two years.
Online trading presents several unique pitfalls related to active trade, while contributing to the many psychological challenges assumed by the individual involved in the marketplace:
Online trading provides access to many different markets and makes available high degrees of leverage on a 24/5 basis. A trader's emotional state is constantly being addressed, with fear and greed often driving impulsive behaviour.
As a product of larger volumes and market participation attributable to electronic trading, periodic spikes in pricing volatility have grown in frequency and magnitude. The ability for traders and investors to enter a given market at near-light speeds has created the possibility of sudden, sometimes unpredictable, swings in price. For example, the release of unexpected news may spike volatility and cause measurable damage to vulnerable traders.
Trade is conducted in the electronic marketplace through a vast technological infrastructure. A myriad of routers, mainframes and servers all play their role in a trade being executed from mouse-click to market. Unfortunately, some participants experience varying degrees of unavoidable latency involved in their trade.
Scams and outright fraud have been a part of the financial world since the roots of exchange. The world of online trading is no exception. The sale of "get-rich-quick" trading systems, negligent analysis and outright market manipulation are ever-present in the online trading environment.
The vast majority of unsuccessful online traders have fallen victim to at least one of many factors that make the achievement of consistent profit a challenge.
Online trading has an extensive list of advantages and disadvantages, well eclipsing the topics covered by this article. While the digital markets of today provide a wealth of opportunities, they also pose many unique risks. It is up to the individual to decide if the pros outweigh the cons, and if online trading is an appropriate course of action given capital and risk considerations.
Any opinions, news, research, analyses, prices, other information, or links to third-party sites are provided as general market commentary and do not constitute investment advice. FXCM will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…