● Forex = Foreign Currency Exchange
● You can trade 24-hours
a day
● The Forex is larger than all other
financial markets COMBINED
The Foreign Exchange (Forex) Market is a cash, or “spot”,
interbank market established in 1971 when
floating exchange rates began to materialize. This market is the arena in which the currency of one
country is exchanged for those of another, and where international business is settled.
The Forex is a group of approximately thousands of
currency trading institutions that include international banks, government central banks, and
commercial companies. Payments for exports and
imports flow through the Foreign Exchange Market,
as well as payments for purchases and sales of assets. This is called the “Consumer Foreign Exchange Market.” There is also a “speculator” segment in
the Forex Market. Speculators have great financial exposure to overseas economies participating in the
Forex to offset the risks of international investing.
Historically, the Forex Interbank Market was not open to small speculators. With a previous, minimum
transaction size, and often stringent financial requirements, the small trader was excluded from participation in this market. Today, Market Maker brokers are
allowed to break down the larger
interbank units and offer small traders the opportunity to buy or sell any number of these smaller units
(lots).
Commercial Banks play two roles in the Forex Market:
(1) They facilitate transactions between two parties. For example, two companies wishing to exchange different currencies would seek the help of a commercial
bank.
(2) They speculate by buying and selling currencies. The banks take positions on certain currencies because they believe they will be worth more if, “long”, or less if, “short”,
in the future. It has been estimated that international banks generate up to 70% of their revenues from currency speculation. “Other” speculators include many of the worlds’ most
successful traders, like George Soros.
The Forex also includes central banks from
various countries, like the U.S. Federal Reserve. They participate in the Forex to serve the financial interests of their country. When a central bank buys and sells its own or a foreign
currency, the purpose is to stabilize their own country’s currency value.
The Forex is so
large and is composed of so many participants, that no one player, not even the government central banks, can control the market. In comparison to the daily
trading volume averages of the
$300 billion U.S. Treasury Bond market and the approximately $100 billion exchanged in the U.S.
stock markets, the Forex is huge, and has
grown in excess of $4 trillion daily.
The word “market” is a misnomer describing Forex trading. Unlike other markets,
there is not a
centralized location for trading activity.
Currency trading takes place via the Internet or over the phone.
A large portion of Forex trading is done by large, international banks. These banks will process
transactions for large companies, governments and their own accounts. These banks continually provide prices (“bid” to buy and “ask” to sell) for each other and the broader market. The market’s current price of a particular currency is the most recent quotation from one of these banks. The “live” price
information is reported through a variety of private data reporting services and is able via the
Internet.
There are numerous advantages to trading on
the Forex.
Liquidity
In the Forex Market, there is a buyer and a seller! The Forex absorbs trading volumes and per trade sizes
which dwarf the capacity of any other market. On the simplest level, liquidity is a powerful attraction to
any investor. It suggests the freedom to open or close a position 24 -hours
a day.
Once purchased, many other, high-return investments are difficult to sell at will. Forex traders don’t have to worry about being “stuck” in a position due to lack of market interest. In the nearly $3.5 trillion
U.S. per day market, major international banks have “bid” (buying) and “ask” (selling) prices for
currencies.
Access
The Forex is open 24 hours a day from about 5:00 PM ET Sunday to about 4:00 PM ET Friday. An individual trader can react to news when it breaks, rather than having to wait for the opening bell of other markets when everyone else has the same information. This timeliness allows traders to take positions before the news details are fully factored into the exchange rates. High liquidity and 24 hour
trading permit market participants to take positions, or exit, regardless of the hour. There are Forex dealers in every time zone and in every major market center; Tokyo, Hong Kong, Sydney, Paris, London,
United States, et al. willing to continually quote "buy"
and "sell" prices.
Since no money is left on the market table-referred to as a “Zero Sum Game” or “Zero-Sum Gain”- and providing the trader picks the right side, money can always be made.
Two-Way Market
Currencies are traded in pairs–for example: Euro/Dollar (EUR/USD), Dollar/Yen (USD/JPY) or Dollar/Swiss Franc (USD/CHF). Every position involves the selling of one currency and the buying of another. If a trader believes the Swiss Franc will appreciate against the Dollar, the trader can sell Dollars
and buy Francs. This position is called
"selling short".
If one holds the opposite belief, that trader can buy Dollars and sell Swiss Francs–“buying long”. The potential for profit exists because there is always movement in the exchange rates (prices). Forex trading permits the opportunity to capture pips
from both rising and falling currency values in relation to
the Dollar. In every currency trading transaction,
one side of the pair is always gaining, and the other
side is always losing.
Leverage
Trading on the Forex is done in currency “lots.” Each lot is approximately 100,000 U.S. dollars worth of a
foreign currency. To trade on the Forex market, a Margin Account must be established with a currency broker. This is, in
effect, a bank account into which profits may be deposited and losses may be deducted. These deposits and deductions
are made instantly upon exiting a position.
Brokers have differing Margin Account regulations, with many requiring a $1,000 deposit to “day-trade”
a currency lot. Day-trading is entering and exiting positions
during the same trading day. For longer-term positions, many require a $2,000 per lot deposit. In comparison to trading in stocks and other markets,
which may require a 50% margin account, a Forex
speculators' excellent leverage of 1% to 2% of the
$100,000 lot value means the trader can control
each lot for one to two cents on the
dollar.
Execution Quality
Because the Forex is so liquid, most trades can be executed at the current market price. In all fast moving markets (stocks, commodities, etc.), slippage is inevitable in all trading, but can be avoided with
some currency brokers' software that informs you of your exact entering price just prior to execution. You are given the option of avoiding or accepting the slippage. The Forex Market's huge liquidity offers
the ability for high quality execution.
Confirmations of trades are immediate and the Internet trader has only to print a copy of their
computer screen for a written record of all trading activities. Many individuals feel these features of Internet trading make it safer than using the telephone to trade. Respected firms such as Charles
Schwab, Quick & Reilly and T.D.
Waterhouse offer Internet trading. These companies
would not risk their reputations by offering Internet service if it were not reliable and safe. In the event of a temporary
technical computer problem with the broker’s ordering system,
the trader can telephone the broker 24 hours
a day to immediately get in or out of a trade.
Internet brokers’ computer systems are protected by firewalls to keep account information from prying
eyes. Account security is a broker’s highest concern. They take multiple steps to eliminate any risk
associated with financial transactions on the Internet.
A Forex Internet trader does not have to speak with a broker by telephone. The elimination of the middleman (broker/salesman) lowers expenses, makes the process of entering an order faster, and decreases the possibility of miscommunication.
Execution Costs
Unlike other markets, the Forex generally does not charge commissions.
The cost of a trade is represented in a Bid/Ask spread established by the
broker. (Approximately 4 pips)
Trendiness
Over long and short historical periods,
currencies have demonstrated substantial and identifiable trends.
Each individual currency has its own “personality,” and offers a unique, historical pattern of trends that provide diversified
trading opportunities within the spot Forex market.
Focus
Instead of attempting to choose a stock, bond, mutual fund, or commodity from the tens of thousands
available in other markets, Forex traders generally focus on one to four currencies. The most common
and most liquid are the US Dollar, Japanese Yen, British Pound, Swiss Franc, Euro and Canadian Dollar. Highly successful traders have always focused on a limited number of
investment options. Beginning Forex traders will usually focus on one currency and later incorporate one to three more into their trading activities.
