Monday, August 6, 2012

Introduction about the FOREX market

Forex is an abbreviation for Foreign Exchange, also known as FX.   Although currency trading has been around for many years in the futures markets, the smaller trader typically didn’t have enough size to trade them without using extreme leverage.With the introduction and popularity of the Forex market/brokers (and more importantly mini and micro lots), the small trader can easily participate now in currency pair trading.     Many brokers even allow you to open an account with as little as $100 using micro lots.This is a great way to test your strategies or participate in the process if you trade an extremely small account. In addition, it is a step above paper trading where there is no consequence to your actions. Most traders will not treat or view $100 the same as $100,000, but the process of entering real orders and seeing actual fill prices is still beneficial.

I won’t pretend that trading in the spot market (and through brokers that may be trading against your positions) does not have risks; however, I think for the most part the true risk gets blown out or proportion.   That being said, the degree to which traders are promised untold riches in Forex is somewhat comical.      With the leverage available you can make some amazing percentage returns on trades (as with futures), but I view leverage differently than most. Instead of enticing me to take unnecessary risks on individual trades, it allows efficient use of capital.What I mean by that is even if I want to trade a $100,000 account in the Forex market, I can keep a much smaller amount in the actual brokerage account but still trade it based on my allocation.This is not possible with normal stock trading (assuming you trade shares vs. only options).
Let’s talk about some of the advantages and disadvantages that are unique to Forex. In future articles we will delve into the mechanics of trading FX, including tracking profits and losses based on the pair being traded.


From a trading perspective, there are some advantages to trading FX on the spot market.
- 24 hour market
This can be beneficial for several reasons.   Although certain trading session have higher volume, you can trade based on your own schedule and participate in the markets in a seamless way. In addition, it eliminates gaps to a large degree (trading hours Sunday 5:15pm – Friday 4:55pm) if a position goes against you.

- Trade long/short
Going long or short a currency pair is easy. There are no uptick rules (as with stocks) or limit days (as with futures). There is no advantage to trading long or short, and more importantly no disadvantage if going short.

- Liquidity
Foreign Exchange trades in the trillions on a daily basis. Getting into and out of positions, even with a very large account, is not a problem.

- Great training ground for smaller accounts
Although liquidity is favorable from a large account perspective, with the availability of mini and micro lots there is no account too small to participate in the FX markets.
- No commissions
The brokers do mark up from the rate they receive, but all you pay as a trader is the spread between the bid/ask price.    There is no standard commission on top of the spread as with stocks/futures.
- No Rollover Issues
Contracts are rolled over automatically, so you do not have to worry about expirations as with futures trading.

- Ability to earn leveraged interest
In the forex market when you make a transaction you are effectively borrowing one currency to purchase another.  Interest rate differentials are a useful source of profit in long term trading.
The difference between the currency you are borrowing and the currency you are purchasing is a profit that is made irrespective of the direction the pair moves.
Buying GBP/USD is in effect borrowing USD at 4.5% and purchasing GBP at 5.5% (using those rates for illustration purposes).   In this scenario, you would earn 1% interest times your leverage (100:1 or 50:1)*, which theoretically gives you a 100% return per annum. For obvious reasons we can’t exclude the directional profit/loss of our position, but you can see if the interest rate is net positive you will gain additional profits from interest. If the differential is negative it would have the opposite effect.


I like to present both sides when discussing trading, so let’s also discuss some of the risks associated with foreign exchange on the spot market.

- Some questionable brokers
Don’t get me wrong, there are some reputable FX brokers out there (and you honestly shouldn’t even consider trading this market unless you use one), but there are also some questionable firms with respect to spreads on the pairs.    During NFP reports and other volatile times (interest rate adjustments) using a questionable broker can cost you thousands of dollars.   Make sure to do your homework/research before you open up an account!

- Prior lack of regulation and no centralized exchange
The FX industry (compared to the stock and futures industries) is lightly regulated and offers no centralized exchanges.  It also had virtually no regulation on advertising technique and claims.    Not that the SEC and CFTC have necessarily provided protection to their own traders (cough………MF Global), but at least there were agencies out there designated with that task. The CFTC has now instituted some requirements with regard to leverage maximums and treatment of funds that trade FX as a CPO/CTA.
No centralized exchange also means Trader A and Trader B can get entirely different price quotes/spreads for the same pair.

- For chartists, time zone choice provides some interesting nuances
In addition to there being no accurate way to use or analyze volume in FX, depending on which time zone / platform you are using you will get different charts. Even though Cartist Joe and Chartist Tom may be looking at the same Eur/Usd pair for trading opportunities, they could each get different looking charts.
Different feeds have opening and closing bars at different times, so there is no universal chart that all the same traders see.

- Leverage is a double edged sword
As with any approach that offers high leveraged investments, the focus is always on how that could enhance your returns vs. the potential risk associated with levered losses. At one time FX allowed 100:1 and in some cases 200:1 leverage. This was changed to 50:1 for the major pairs and 20:1 for the exotics (for retail clients).
Overall leverage is not limited to only trading FX.   The same opportunities and risks exist in trading futures or any leveraged investment for that matter.Now that we have covered the advantages and risks associated with FX trading, the next article in the series will tackle the mechanics of trading forex, understanding the pairs and determining price fluctuations in dollar terms.

FOREX is the largest and most liquid market in the world

Forex is the largest and most liquid market in the world where trillions of dollars exchanges take place every day. That’s an enormous money flow. No stock market exchange in the world come close to these numbers.
Currencies in the Forex market are traded 24 hours a day 7 days a week. Market literally follows the sun around the world. Trading moves from major banking centers of the United States to Australia and New Zealand, then to the Far East, gets to Europe and finally returns back to the States.


Trading FOREX is all about exchanging currencies

Trading on Foreign exchange market simply means buying of one currency and selling another at the same time. In other words, the currency of one country is exchanged for currency of another country at the current exchange rates.
Foreign currencies are always traded in pairs - EUR/USD, GBP/USD, EUR/JPY etc. Around 70% of all transactions made with major currencies like U.S. dollar, Australian Dollar, British Pound, Swiss Franc and Japanese Yen.


Nowadays FOREX is available to small investors

While in the past Forex market was not available to small investors (individuals) due to large minimum transaction sizes, today Forex brokers are able to break those large sizes into a smaller unit lots and thus offer small investors an opportunity to buy or sell currencies side by side with regular core Forex market investors such as large banks, central banks, multinational corporations, hedge funds and other financial institutions.


Being incompetent in FOREX can be expensive

Forex market is huge and plunging into trading without knowing its rules, will be equal to swimming in the pool with ocean sharks. The dominant Forex players such as banks and hedge funds have a power to influence market moves and currencies exchange rates. For inexperienced traders investing own money in such game is as risky and uncertain as gambling. It could turn into a million fortune only in a couple of weeks or become a disaster for those who was ignorant in learning.
Forex brokers offer very big leverage to individual investors. A trader can trade at huge leverage as much as 300 to 1, meaning that for every dollar trader puts in for trading he can trade $300. For example, having an account equal to $1,000 trader can trade as much as $300,000.

It is a huge opportunity, but it also is very dangerous. No experienced trader will ever trade with such big leverage unless he has a really strong argument for a particular trade, and even after that it is an enormous risk.


Is trading FOREX profitable?

Trading in the Forex market is profitable, but only for 5% out of all beginner traders who start trading Forex. New traders need to learn the basics of trading well, and practice a lot on demo accounts before going real.
Like in every business, when trading money in Forex, trader gets paid depending on his knowledge and trading experience.


Watch a video: "What is the FOREX market?"

It tells in simple words what Forex market is, describes why people choose to trade Forex,

and what are advantages and disadvantages of trading Forex.

*The video "What is Forex" is brought by a third party.

We do not promote or try to recommend any products mentioned in the video.

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