Finance > Currency Trading > What Forex is and Why YOU should trade it.
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Article rating : 0.00, 0 votes. Author : Gary Martin
If you were wondering; forex trading is nothing more than direct access
trading of different types of foreign currencies. In the past, foreign
exchange trading was mostly limited to large banks and institutional traders
however; recent technological advancements have made it so that small
traders can also take advantage of the many benefits of forex trading just
by using the various online trading platforms to trade.
The currencies of the world are on a floating exchange rate, and they are
always traded in pairs Euro/Dollar, Dollar/Yen, etc. About 85 percent of all
daily transactions involve trading of the major currencies.
Four major currency pairs are usually used for investment purposes. They
are: Euro against US dollar, US dollar against Japanese yen, British pound
against US dollar, and US dollar against Swiss franc. Right now I will show
you how they look in the trading market: EUR/USD, USD/JPY, GBP/USD, and
USD/CHF. As a note you should know that no dividends are paid on currencies.
If you think one currency will appreciate against another, you may exchange
that second currency for the first one and be able to stay in it. In case
everything goes as you plan it, eventually you may be able to make the
opposite deal in that you may exchange this first currency back for that
other and then collect profits from it.
Transactions on the FOREX market are performed by dealers at major banks or
FOREX brokerage companies. FOREX is a necessary part of the world wide
market, so when you are sleeping in the comfort of your bed, the dealers in
Europe are trading currencies with their Japanese counterparts.
Therefore, it is reasonable for you to believe that the FOREX market is
active 24 hours a day and dealers at major institutions are working 24/7 in
three different shifts. Clients may place take-profit and stop-loss orders
with brokers for overnight execution.
Price movements on the FOREX market are very smooth and without the gaps
that you face almost every morning on the stock market. The daily turnover
on the FOREX market is somewhere around $1.2 trillion, so a new investor can
enter and exit positions without any problems.
The fact is that the FOREX market never stops, even on September 11, 2001
you could still get your hands on two-side quotes on currencies. The
currency market is the largest and oldest financial market in the world. It
is also called the foreign exchange market, FX market for short. It is the
biggest and most liquid market in the world, and it is traded mostly through
the 24 hour-a-day inter-bank currency market.
When you compare them, you will see that the currency futures market is only
one per cent as big. Unlike the futures and stock markets, trading
currencies is not centered on an exchange. Trading moves from major banking
centers of the U.S. to Australia and New Zealand, to the Far East, to Europe
and finally back to the U.S. it is truly a full circle trading game.
In the past, the forex inter-bank market was not available to small
speculators because of the large minimum transaction sizes and strict
financial requirements.
Banks, major currency dealers and sometimes even very large speculator were
the principal dealers. Only they were able to take advantage of the currency
market's fantastic liquidity and strong trending nature of many of the
world's primary currency exchange rates.
Today, foreign exchange market brokers are able to break down the larger
sized inter-bank units, and offer small traders like you and me the
opportunity to buy or sell any number of these smaller units. These brokers
give any size trader, including individual speculators or smaller companies,
the option to trade at the same rates and price movements as the big players
who once dominated the market.
So why should you trade Forex? The cash/spot FOREX markets possess certain
unique attributes that offer an unmatched potential for profitable trading
in any market condition or any stage of the business cycle. It leaves one to
wonder why bother? The answer to that is very simple. It boasts:
A 24-hour market: A trader has the chance to take advantage of all of the
profitable market conditions at any time which means that there is no
waiting for the 'opening bell' like the exchange.
Highest liquidity: The FOREX market is the most liquid market in the world.
That means that a trader can enter or exit the market whenever they want
during almost any market condition minimal execution barriers or risk and no
daily trading limit.
High leverage: A leverage ratio of up to 400 is normal when compared to a
leverage ratio of 2 (50% margin requirement) in the equity markets. Of
course, this makes trading in the cash/spot forex market awkward a swell
because it makes the risk of the down side loss much higher in the same way
that it makes the profit potential on the upside much prettier.
Low transaction cost: The retail transaction cost (the bid/ask spread) is
actually less than 0.1% (10 pips) under the normal market conditions. At
larger dealers, the spread could be less than 5 pips, and may expand a great
deal in fast moving markets.
Always a bull market: A trade in the FOREX market means selling or buying
one currency against another. In essence, a bull market or a bear market for
a currency is defined in terms of the outlook for value against other
currencies. If the outlook is positive, you get a bull market where a trader
profits by buying the currency against other currencies. However, if the
outlook is negative, we have a bull market for other currencies and a trader
profits being forced to selling the currency against other currencies.
In either case, there is always a bull market trading opportunity for a
trader.
Inter-bank market: The foundation of the FOREX market consists of a global
network of dealers that communicate and trade with their clients through
electronic networks and telephones. There are no organized exchanges like in
futures that are there to serve as a central location to facilitate
transactions the way the New York Stock Exchange serves the equity markets.
The FOREX market actually works a lot like the way the NASDAQ market in the
United States operates, and because of this, it is also referred to as an
over the counter or OTC market.
No one can corner the market: The FOREX market is so large and has so many
participants that no single trader, even a central bank, can control the
market price for an extended period of time. Even when interventions are
conducted by mighty central banks are getting to be increasingly ineffectual
and short-lived. This means that central banks are becoming less and less
inclined to intervene to manipulate market prices.
It is Unregulated: The FOREX market is seen as an unregulated market
although the operations of major dealers like commercial banks in money
centers are regulated under the banking laws.
The daily operations of retail FOREX brokerages are not regulated under any
laws or regulations that are specific to the FOREX market, and in fact, many
of these types of establishments in the United States do not even report to
the Internal Revenue Service.
The currency futures and options that are actually traded on exchanges like
Chicago Mercantile Exchange (CME) are under the regulation in the same
manner that other exchange-traded derivatives are regulated.
There are many different advantages to trading forex instead of futures or
stocks, such as:
1. Lower Margin
Just like futures and stock speculation, a forex trader has the ability to
control a large amount of the currency basically by putting up a small
amount of margin. However, the margin requirements that are needed for
trading futures are usually around 5% of the full value of the holding, or
50% of the total value of the stocks, the margin requirements for forex is
about 1%. For example, margin required to trade foreign exchange is $1000
for every $100,000.
What this means is that trading forex, a currency trader's money can play
with 5-times as much value of product as a futures trader's, or 50 times
more than a stock trader's.
When you are trading on margin, this can be a very profitable way to create
an investment strategy, but it's important that you take the time to
understand the risks that are involved as well.
You should make sure that you fully understand how your margin account is
going to work. You will want to be sure that you read the margin agreement
between you and your clearing firm. You will also want to talk to your
account representative if you have any questions.
The positions that you have in your account could be partially or completely
liquidated on the chance that the available margin in your account falls
below a predetermined amount.
You may not actually get a margin call before your positions are liquidated.
Because of this, you should monitor your margin balance on a regular basis
and utilize stop-loss orders on every open position to limit downside risk.
2. No Commission and No Exchange Fees
When you trade in futures, you have to pay exchange and brokerage fees.
Trading forex has the advantage of being commission free. This is far better
for you. Currency trading is a worldwide inter-bank market that lets buyers
to be matched with sellers in an instant.
Even though you do not have to pay a commission charge to a broker to match
the buyer up with the seller, the spread is usually larger than it is when
you are trading futures.
For example, if you are trading a Japanese Yen/US Dollar pair, forex trade
would have about a 3 point spread (worth $30). Trading a JY futures trade
would most likely have a spread of 1 point (worth $10) but you would also be
charged the broker's commission on top of that. This price could be as low
as $10 in-and-out for self-directed online trading, or as high as $50 for
full-service trading. It is however, all inclusive pricing though.
You are going to have to compare both online forex and your specific futures
commission charge to see which commission is the greater one.
3. Limited Risk and Guaranteed Stops
When you are trading futures, your risk can be unlimited. For example, if
you thought that the prices for Live Cattle were going to continue their
upward trend in December 2003, just before the discovery of Mad Cow Disease
found in US cattle.
The price for it after that fell dramatically, which moved the limit down
several days in a row. You would not have been able to leave your position
and this could have wiped out the entire equity in your account as a result.
As the price just kept on falling, you would have been obligated to find
even more money to make up the deficit in your account.
4. Rollover of Positions
When futures contracts expire, you have to plan ahead if you are going to
rollover your trades. Forex positions expire every two days and you need to
rollover each trade just so that you can stay in your position.
5. 24-Hour Marketplace
With futures, you are generally limited to trading only during the few hours
that each market is open in any one day. If a major news story breaks out
when the markets are closed, you will not have a way of getting out of it
until the market reopens, which could be many hours away.
Forex, on the other hand, is a 24/5 market. The day begins in New York, and
follows the sun around the globe through Europe, Asia, Australia and back to
the US again. You can trade any time you like Monday-Friday.
6. Free market place
Foreign exchange is perhaps the largest market in the world with an average
daily volume of US$1.4 trillion. That is 46 times as large as all the
futures markets put together! With the huge number of people trading forex
around the globe, it is very hard for even governments to control the price
of their own currency.
CopyRight 2005 Gary Martin
www.forex-trading-elite.com
Gary Martin, an avid computer user and internet entrepreneur.
http://www.spyware-away.com
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