Opening A Forex Brokerage Account
Trading forex is similar to the equity market because individuals interested in trading need to open up a trading account. Like the equity market, each forex account and the services it provides differ, so it is important that you find the right one. Below we will talk about some of the factors that should be considered when selecting a forex account.
Leverage
Leverage is basically the ability to control large amounts of capital, using very little of your own capital; the higher the leverage, the higher the level of risk. The amount of leverage on an account differs depending on the account itself, but most use a factor of at least 50:1, with some being as high as 250:1. A leverage factor of 50:1 means that for every dollar you have in your account you control up to $50. For example, if a trader has $1,000 in his or her account, the broker will lend that person $50,000 to trade in the market. This leverage also makes your margin, or the amount you have to have in the account to trade a certain amount, very low. In equities, margin is usually at least 50%, while the leverage of 50:1 is equivalent to 2%.
Leverage is seen as a major benefit of forex trading, as it allows you to make large gains with a small investment. However, leverage can also be an extreme negative if a trade moves against you because your losses also are amplified by the leverage. With this kind of leverage, there is the real possibility that you can lose more than you invested - although most firms have protective stops preventing an account from going negative. For this reason, it is vital that you remember this when opening an account and that when you determine your desired leverage you understand the risks involved.
Commissions and Fees
Another major benefit of forex accounts is that trading within them is done on a commission-free basis. This is unlike equity accounts, in which you pay the broker a fee for each trade. The reason for this is that you are dealing directly with market makers and do not have to go through other parties like brokers.
This may sound too good to be true, but rest assured that market makers are still making money each time you trade. Remember the bid and ask from the previous section? Each time a trade is made, it is the market makers that capture the spread between these two. Therefore, if the bid/ask for a foreign currency is 1.5200/50, the market maker captures the difference (50 basis points).
If you are planning on opening a forex account, it is important to know that each firm has different spreads on foreign currency pairs traded through them. While they will often differ by only a few pips (0.0001), this can be meaningful if you trade a lot over time. So when opening an account make sure to find out the pip spread that it has on foreign currency pairs you are looking to trade.
Other Factors
There are a lot of differences between each forex firm and the accounts they offer, so it is important to review each before making a commitment. Each company will offer different levels of services and programs along with fees above and beyond actual trading costs. Also, due to the less regulated nature of the forex market, it is important to go with a reputable company. (For more information on what to look for when opening an account, read Wading Into The Currency Market. If you are not ready to open a "real money" account but want to try your hand at forex trading, read Demo Before You Dive In.)
How to Trade Forex
Now that you know some important factors to be aware of when opening a forex account, we will take a look at what exactly you can trade within that account. The two main ways to trade in the foreign currency market is the simple buying and selling of currency pairs, where you go long one currency and short another. The second way is through the purchasing of derivatives that track the movements of a specific currency pair. Both of these techniques are highly similar to techniques in the equities market.The most common way is to simply buy and sell currency pairs, much in the same way most individuals buy and sell stocks. In this case, you are hoping the value of the pair itself changes in a favorable manner. If you go long a currency pair, you are hoping that the value of the pair increases. For example, let's say that you took a long position in the USD/CAD pair - you will make money if the value of this pair goes up, and lose money if it falls. This pair rises when the U.S. dollar increases in value against the Canadian dollar, so it is a bet on the U.S. dollar.
The other option is to use derivative products, such as options and futures, to profit from changes in the value of currencies. If you buy an option on a currency pair, you are gaining the right to purchase a currency pair at a set rate before a set point in time. A futures contract, on the other hand, creates the obligation to buy the currency at a set point in time. Both of these trading techniques are usually only used by more advanced traders, but it is important to at least be familiar with them. (For more on this, try Getting Started in Forex Options and our tutorials, Option Spread Strategies and Options Basics Tutorial.)
Types of Orders
A trader looking to open a new position will likely use either a market order or a limit order. The incorporation of these order types remains the same as when they are used in the equity markets. A market order gives a forex trader the ability to obtain the currency at whatever exchange rate it is currently trading at in the market, while a limit order allows the trader to specify a certain entry price. (For a brief refresher of these orders, see The Basics of Order Entry.)
Forex traders who already hold an open position may want to consider using a take-profit order to lock in a profit. Say, for example, that a trader is confident that the GBP/USD rate will reach 1.7800, but is not as sure that the rate could climb any higher. A trader could use a take-profit order, which would automatically close his or her position when the rate reaches 1.7800, locking in their profits.
Another tool that can be used when traders hold open positions is the stop-loss order. This order allows traders to determine how much the rate can decline before the position is closed and further losses are accumulated. Therefore, if the GBP/USD rate begins to drop, an investor can place a stop-loss that will close the position (for example at 1.7787), in order to prevent any further losses.
As you can see, the type of orders that you can enter in your forex trading account are similar to those found in equity accounts. Having a good understanding of these orders is critical before placing your first trade.
Saturday, September 4, 2010
Forex History and Market Participants-2
Market Participants
Unlike the equity market - where investors often only trade with institutional investors (such as mutual funds) or other individual investors - there are additional participants that trade on the forex market for entirely different reasons than those on the equity market. Therefore, it is important to identify and understand the functions and motivations of the main players of the forex market.
Governments and Central Banks
Arguably, some of the most influential participants involved with currency exchange are the central banks and federal governments. In most countries, the central bank is an extension of the government and conducts its policy in tandem with the government. However, some governments feel that a more independent central bank would be more effective in balancing the goals of curbing inflation and keeping interest rates low, which tends to increase economic growth. Regardless of the degree of independence that a central bank possesses, government representatives typically have regular consultations with central bank representatives to discuss monetary policy. Thus, central banks and governments are usually on the same page when it comes to monetary policy.
Central banks are often involved in manipulating reserve volumes in order to meet certain economic goals. For example, ever since pegging its currency (the yuan) to the U.S. dollar, China has been buying up millions of dollars worth of U.S. treasury bills in order to keep the yuan at its target exchange rate. Central banks use the foreign exchange market to adjust their reserve volumes. With extremely deep pockets, they yield significant influence on the currency markets.
Banks and Other Financial Institutions
In addition to central banks and governments, some of the largest participants involved with forex transactions are banks. Most individuals who need foreign currency for small-scale transactions deal with neighborhood banks. However, individual transactions pale in comparison to the volumes that are traded in the interbank market.
The interbank market is the market through which large banks transact with each other and determine the currency price that individual traders see on their trading platforms. These banks transact with each other on electronic brokering systems that are based upon credit. Only banks that have credit relationships with each other can engage in transactions. The larger the bank, the more credit relationships it has and the better the pricing it can access for its customers. The smaller the bank, the less credit relationships it has and the lower the priority it has on the pricing scale.
Banks, in general, act as dealers in the sense that they are willing to buy/sell a currency at the bid/ask price. One way that banks make money on the forex market is by exchanging currency at a premium to the price they paid to obtain it. Since the forex market is a decentralized market, it is common to see different banks with slightly different exchange rates for the same currency.
Hedgers
Some of the biggest clients of these banks are businesses that deal with international transactions. Whether a business is selling to an international client or buying from an international supplier, it will need to deal with the volatility of fluctuating currencies.
If there is one thing that management (and shareholders) detest, it is uncertainty. Having to deal with foreign-exchange risk is a big problem for many multinationals. For example, suppose that a German company orders some equipment from a Japanese manufacturer to be paid in yen one year from now. Since the exchange rate can fluctuate wildly over an entire year, the German company has no way of knowing whether it will end up paying more euros at the time of delivery.
One choice that a business can make to reduce the uncertainty of foreign-exchange risk is to go into the spot market and make an immediate transaction for the foreign currency that they need.
Unfortunately, businesses may not have enough cash on hand to make spot transactions or may not want to hold massive amounts of foreign currency for long periods of time. Therefore, businesses quite frequently employ hedging strategies in order to lock in a specific exchange rate for the future or to remove all sources of exchange-rate risk for that transaction.
For example, if a European company wants to import steel from the U.S., it would have to pay in U.S. dollars. If the price of the euro falls against the dollar before payment is made, the European company will realize a financial loss. As such, it could enter into a contract that locked in the current exchange rate to eliminate the risk of dealing in U.S. dollars. These contracts could be either forwards or futures contracts.
Speculators
Another class of market participants involved with foreign exchange-related transactions is speculators. Rather than hedging against movement in exchange rates or exchanging currency to fund international transactions, speculators attempt to make money by taking advantage of fluctuating exchange-rate levels.
The most famous of all currency speculators is probably George Soros. The billionaire hedge fund manager is most famous for speculating on the decline of the British pound, a move that earned $1.1 billion in less than a month. On the other hand, Nick Leeson, a derivatives trader with England’s Barings Bank, took speculative positions on futures contracts in yen that resulted in losses amounting to more than $1.4 billion, which led to the collapse of the company.
Some of the largest and most controversial speculators on the forex market are hedge funds, which are essentially unregulated funds that employ unconventional investment strategies in order to reap large returns. Think of them as mutual funds on steroids. Hedge funds are the favorite whipping boys of many a central banker. Given that they can place such massive bets, they can have a major effect on a country’s currency and economy. Some critics blamed hedge funds for the Asian currency crisis of the late 1990s, but others have pointed out that the real problem was the ineptness of Asian central bankers. (For more on hedge funds, see Introduction To Hedge Funds - Part One and Part Two.)Either way, speculators can have a big sway on the currency markets, particularly big ones.
Now that you have a basic understanding of the forex market, its participants and its history, we can move on to some of the more advanced concepts that will bring you closer to being able to trade within this massive market. The next section will look at the main economic theories that underlie the forex market.
Unlike the equity market - where investors often only trade with institutional investors (such as mutual funds) or other individual investors - there are additional participants that trade on the forex market for entirely different reasons than those on the equity market. Therefore, it is important to identify and understand the functions and motivations of the main players of the forex market.
Governments and Central Banks
Arguably, some of the most influential participants involved with currency exchange are the central banks and federal governments. In most countries, the central bank is an extension of the government and conducts its policy in tandem with the government. However, some governments feel that a more independent central bank would be more effective in balancing the goals of curbing inflation and keeping interest rates low, which tends to increase economic growth. Regardless of the degree of independence that a central bank possesses, government representatives typically have regular consultations with central bank representatives to discuss monetary policy. Thus, central banks and governments are usually on the same page when it comes to monetary policy.
Central banks are often involved in manipulating reserve volumes in order to meet certain economic goals. For example, ever since pegging its currency (the yuan) to the U.S. dollar, China has been buying up millions of dollars worth of U.S. treasury bills in order to keep the yuan at its target exchange rate. Central banks use the foreign exchange market to adjust their reserve volumes. With extremely deep pockets, they yield significant influence on the currency markets.
Banks and Other Financial Institutions
In addition to central banks and governments, some of the largest participants involved with forex transactions are banks. Most individuals who need foreign currency for small-scale transactions deal with neighborhood banks. However, individual transactions pale in comparison to the volumes that are traded in the interbank market.
The interbank market is the market through which large banks transact with each other and determine the currency price that individual traders see on their trading platforms. These banks transact with each other on electronic brokering systems that are based upon credit. Only banks that have credit relationships with each other can engage in transactions. The larger the bank, the more credit relationships it has and the better the pricing it can access for its customers. The smaller the bank, the less credit relationships it has and the lower the priority it has on the pricing scale.
Banks, in general, act as dealers in the sense that they are willing to buy/sell a currency at the bid/ask price. One way that banks make money on the forex market is by exchanging currency at a premium to the price they paid to obtain it. Since the forex market is a decentralized market, it is common to see different banks with slightly different exchange rates for the same currency.
Hedgers
Some of the biggest clients of these banks are businesses that deal with international transactions. Whether a business is selling to an international client or buying from an international supplier, it will need to deal with the volatility of fluctuating currencies.
If there is one thing that management (and shareholders) detest, it is uncertainty. Having to deal with foreign-exchange risk is a big problem for many multinationals. For example, suppose that a German company orders some equipment from a Japanese manufacturer to be paid in yen one year from now. Since the exchange rate can fluctuate wildly over an entire year, the German company has no way of knowing whether it will end up paying more euros at the time of delivery.
One choice that a business can make to reduce the uncertainty of foreign-exchange risk is to go into the spot market and make an immediate transaction for the foreign currency that they need.
Unfortunately, businesses may not have enough cash on hand to make spot transactions or may not want to hold massive amounts of foreign currency for long periods of time. Therefore, businesses quite frequently employ hedging strategies in order to lock in a specific exchange rate for the future or to remove all sources of exchange-rate risk for that transaction.
For example, if a European company wants to import steel from the U.S., it would have to pay in U.S. dollars. If the price of the euro falls against the dollar before payment is made, the European company will realize a financial loss. As such, it could enter into a contract that locked in the current exchange rate to eliminate the risk of dealing in U.S. dollars. These contracts could be either forwards or futures contracts.
Speculators
Another class of market participants involved with foreign exchange-related transactions is speculators. Rather than hedging against movement in exchange rates or exchanging currency to fund international transactions, speculators attempt to make money by taking advantage of fluctuating exchange-rate levels.
The most famous of all currency speculators is probably George Soros. The billionaire hedge fund manager is most famous for speculating on the decline of the British pound, a move that earned $1.1 billion in less than a month. On the other hand, Nick Leeson, a derivatives trader with England’s Barings Bank, took speculative positions on futures contracts in yen that resulted in losses amounting to more than $1.4 billion, which led to the collapse of the company.
Some of the largest and most controversial speculators on the forex market are hedge funds, which are essentially unregulated funds that employ unconventional investment strategies in order to reap large returns. Think of them as mutual funds on steroids. Hedge funds are the favorite whipping boys of many a central banker. Given that they can place such massive bets, they can have a major effect on a country’s currency and economy. Some critics blamed hedge funds for the Asian currency crisis of the late 1990s, but others have pointed out that the real problem was the ineptness of Asian central bankers. (For more on hedge funds, see Introduction To Hedge Funds - Part One and Part Two.)Either way, speculators can have a big sway on the currency markets, particularly big ones.
Now that you have a basic understanding of the forex market, its participants and its history, we can move on to some of the more advanced concepts that will bring you closer to being able to trade within this massive market. The next section will look at the main economic theories that underlie the forex market.
Forex History and Market Participants
Given the global nature of the forex exchange market, it is important to first examine and learn some of the important historical events relating to currencies and currency exchange before entering any trades. In this section we’ll review the international monetary system and how it has evolved to its current state. We will then take a look at the major players that occupy the forex market - something that is important for all potential forex traders to understand.
The History of the Forex
Gold Standard System
The creation of the gold standard monetary system in 1875 marks one of the most important events in the history of the forex market. Before the gold standard was implemented, countries would commonly use gold and silver as means of international payment. The main issue with using gold and silver for payment is that their value is affected by external supply and demand. For example, the discovery of a new gold mine would drive gold prices down.
The underlying idea behind the gold standard was that governments guaranteed the conversion of currency into a specific amount of gold, and vice versa. In other words, a currency would be backed by gold. Obviously, governments needed a fairly substantial gold reserve in order to meet the demand for currency exchanges. During the late nineteenth century, all of the major economic countries had defined an amount of currency to an ounce of gold. Over time, the difference in price of an ounce of gold between two currencies became the exchange rate for those two currencies. This represented the first standardized means of currency exchange in history.
The gold standard eventually broke down during the beginning of World War I. Due to the political tension with Germany, the major European powers felt a need to complete large military projects. The financial burden of these projects was so substantial that there was not enough gold at the time to exchange for all the excess currency that the governments were printing off.
Although the gold standard would make a small comeback during the inter-war years, most countries had dropped it again by the onset of World War II. However, gold never ceased being the ultimate form of monetary value. (For more on this, read The Gold Standard Revisited, What Is Wrong With Gold? and Using Technical Analysis In The Gold Markets.)
Bretton Woods System
Before the end of World War II, the Allied nations believed that there would be a need to set up a monetary system in order to fill the void that was left behind when the gold standard system was abandoned. In July 1944, more than 700 representatives from the Allies convened at Bretton Woods, New Hampshire, to deliberate over what would be called the Bretton Woods system of international monetary management.
To simplify, Bretton Woods led to the formation of the following:
1. A method of fixed exchange rates;
2. The U.S. dollar replacing the gold standard to become a primary reserve currency; and
3. The creation of three international agencies to oversee economic activity: the International Monetary Fund (IMF), International Bank for Reconstruction and Development, and the General Agreement on Tariffs and Trade (GATT).
One of the main features of Bretton Woods is that the U.S. dollar replaced gold as the main standard of convertibility for the world’s currencies; and furthermore, the U.S. dollar became the only currency that would be backed by gold. (This turned out to be the primary reason that Bretton Woods eventually failed.)
Over the next 25 or so years, the U.S. had to run a series of balance of payment deficits in order to be the world’s reserved currency. By the early 1970s, U.S. gold reserves were so depleted that the U.S. treasury did not have enough gold to cover all the U.S. dollars that foreign central banks had in reserve.
Finally, on August 15, 1971, U.S. President Richard Nixon closed the gold window, and the U.S. announced to the world that it would no longer exchange gold for the U.S. dollars that were held in foreign reserves. This event marked the end of Bretton Woods.
Even though Bretton Woods didn’t last, it left an important legacy that still has a significant effect on today’s international economic climate. This legacy exists in the form of the three international agencies created in the 1940s: the IMF, the International Bank for Reconstruction and Development (now part of the World Bank) and GATT, the precursor to the World Trade Organization. (To learn more about Bretton Wood, read What Is The International Monetary Fund? and Floating And Fixed Exchange Rates.)
Current Exchange Rates
After the Bretton Woods system broke down, the world finally accepted the use of floating foreign exchange rates during the Jamaica agreement of 1976. This meant that the use of the gold standard would be permanently abolished. However, this is not to say that governments adopted a pure free-floating exchange rate system. Most governments employ one of the following three exchange rate systems that are still used today:
The History of the Forex
Gold Standard System
The creation of the gold standard monetary system in 1875 marks one of the most important events in the history of the forex market. Before the gold standard was implemented, countries would commonly use gold and silver as means of international payment. The main issue with using gold and silver for payment is that their value is affected by external supply and demand. For example, the discovery of a new gold mine would drive gold prices down.
The underlying idea behind the gold standard was that governments guaranteed the conversion of currency into a specific amount of gold, and vice versa. In other words, a currency would be backed by gold. Obviously, governments needed a fairly substantial gold reserve in order to meet the demand for currency exchanges. During the late nineteenth century, all of the major economic countries had defined an amount of currency to an ounce of gold. Over time, the difference in price of an ounce of gold between two currencies became the exchange rate for those two currencies. This represented the first standardized means of currency exchange in history.
The gold standard eventually broke down during the beginning of World War I. Due to the political tension with Germany, the major European powers felt a need to complete large military projects. The financial burden of these projects was so substantial that there was not enough gold at the time to exchange for all the excess currency that the governments were printing off.
Although the gold standard would make a small comeback during the inter-war years, most countries had dropped it again by the onset of World War II. However, gold never ceased being the ultimate form of monetary value. (For more on this, read The Gold Standard Revisited, What Is Wrong With Gold? and Using Technical Analysis In The Gold Markets.)
Bretton Woods System
Before the end of World War II, the Allied nations believed that there would be a need to set up a monetary system in order to fill the void that was left behind when the gold standard system was abandoned. In July 1944, more than 700 representatives from the Allies convened at Bretton Woods, New Hampshire, to deliberate over what would be called the Bretton Woods system of international monetary management.
To simplify, Bretton Woods led to the formation of the following:
1. A method of fixed exchange rates;
2. The U.S. dollar replacing the gold standard to become a primary reserve currency; and
3. The creation of three international agencies to oversee economic activity: the International Monetary Fund (IMF), International Bank for Reconstruction and Development, and the General Agreement on Tariffs and Trade (GATT).
One of the main features of Bretton Woods is that the U.S. dollar replaced gold as the main standard of convertibility for the world’s currencies; and furthermore, the U.S. dollar became the only currency that would be backed by gold. (This turned out to be the primary reason that Bretton Woods eventually failed.)
Over the next 25 or so years, the U.S. had to run a series of balance of payment deficits in order to be the world’s reserved currency. By the early 1970s, U.S. gold reserves were so depleted that the U.S. treasury did not have enough gold to cover all the U.S. dollars that foreign central banks had in reserve.
Finally, on August 15, 1971, U.S. President Richard Nixon closed the gold window, and the U.S. announced to the world that it would no longer exchange gold for the U.S. dollars that were held in foreign reserves. This event marked the end of Bretton Woods.
Even though Bretton Woods didn’t last, it left an important legacy that still has a significant effect on today’s international economic climate. This legacy exists in the form of the three international agencies created in the 1940s: the IMF, the International Bank for Reconstruction and Development (now part of the World Bank) and GATT, the precursor to the World Trade Organization. (To learn more about Bretton Wood, read What Is The International Monetary Fund? and Floating And Fixed Exchange Rates.)
Current Exchange Rates
After the Bretton Woods system broke down, the world finally accepted the use of floating foreign exchange rates during the Jamaica agreement of 1976. This meant that the use of the gold standard would be permanently abolished. However, this is not to say that governments adopted a pure free-floating exchange rate system. Most governments employ one of the following three exchange rate systems that are still used today:
How To Trade & Open A Forex Account-2
How to Trade Forex
Now that you know some important factors to be aware of when opening a forex account, we will take a look at what exactly you can trade within that account. The two main ways to trade in the foreign currency market is the simple buying and selling of currency pairs, where you go long one currency and short another. The second way is through the purchasing of derivatives that track the movements of a specific currency pair. Both of these techniques are highly similar to techniques in the equities market.The most common way is to simply buy and sell currency pairs, much in the same way most individuals buy and sell stocks. In this case, you are hoping the value of the pair itself changes in a favorable manner. If you go long a currency pair, you are hoping that the value of the pair increases. For example, let's say that you took a long position in the USD/CAD pair - you will make money if the value of this pair goes up, and lose money if it falls. This pair rises when the U.S. dollar increases in value against the Canadian dollar, so it is a bet on the U.S. dollar.
The other option is to use derivative products, such as options and futures, to profit from changes in the value of currencies. If you buy an option on a currency pair, you are gaining the right to purchase a currency pair at a set rate before a set point in time. A futures contract, on the other hand, creates the obligation to buy the currency at a set point in time. Both of these trading techniques are usually only used by more advanced traders, but it is important to at least be familiar with them.
Types of Orders
A trader looking to open a new position will likely use either a market order or a limit order. The incorporation of these order types remains the same as when they are used in the equity markets. A market order gives a forex trader the ability to obtain the currency at whatever exchange rate it is currently trading at in the market, while a limit order allows the trader to specify a certain entry price. (For a brief refresher of these orders,
Forex traders who already hold an open position may want to consider using a take-profit order to lock in a profit. Say, for example, that a trader is confident that the GBP/USD rate will reach 1.7800, but is not as sure that the rate could climb any higher. A trader could use a take-profit order, which would automatically close his or her position when the rate reaches 1.7800, locking in their profits.
Another tool that can be used when traders hold open positions is the stop-loss order. This order allows traders to determine how much the rate can decline before the position is closed and further losses are accumulated. Therefore, if the GBP/USD rate begins to drop, an investor can place a stop-loss that will close the position (for example at 1.7787), in order to prevent any further losses.
As you can see, the type of orders that you can enter in your forex trading account are similar to those found in equity accounts. Having a good understanding of these orders is critical before placing your first trade.
Now that you know some important factors to be aware of when opening a forex account, we will take a look at what exactly you can trade within that account. The two main ways to trade in the foreign currency market is the simple buying and selling of currency pairs, where you go long one currency and short another. The second way is through the purchasing of derivatives that track the movements of a specific currency pair. Both of these techniques are highly similar to techniques in the equities market.The most common way is to simply buy and sell currency pairs, much in the same way most individuals buy and sell stocks. In this case, you are hoping the value of the pair itself changes in a favorable manner. If you go long a currency pair, you are hoping that the value of the pair increases. For example, let's say that you took a long position in the USD/CAD pair - you will make money if the value of this pair goes up, and lose money if it falls. This pair rises when the U.S. dollar increases in value against the Canadian dollar, so it is a bet on the U.S. dollar.
The other option is to use derivative products, such as options and futures, to profit from changes in the value of currencies. If you buy an option on a currency pair, you are gaining the right to purchase a currency pair at a set rate before a set point in time. A futures contract, on the other hand, creates the obligation to buy the currency at a set point in time. Both of these trading techniques are usually only used by more advanced traders, but it is important to at least be familiar with them.
Types of Orders
A trader looking to open a new position will likely use either a market order or a limit order. The incorporation of these order types remains the same as when they are used in the equity markets. A market order gives a forex trader the ability to obtain the currency at whatever exchange rate it is currently trading at in the market, while a limit order allows the trader to specify a certain entry price. (For a brief refresher of these orders,
Forex traders who already hold an open position may want to consider using a take-profit order to lock in a profit. Say, for example, that a trader is confident that the GBP/USD rate will reach 1.7800, but is not as sure that the rate could climb any higher. A trader could use a take-profit order, which would automatically close his or her position when the rate reaches 1.7800, locking in their profits.
Another tool that can be used when traders hold open positions is the stop-loss order. This order allows traders to determine how much the rate can decline before the position is closed and further losses are accumulated. Therefore, if the GBP/USD rate begins to drop, an investor can place a stop-loss that will close the position (for example at 1.7787), in order to prevent any further losses.
As you can see, the type of orders that you can enter in your forex trading account are similar to those found in equity accounts. Having a good understanding of these orders is critical before placing your first trade.
How To Trade & Open A Forex Account
So, you think you are ready to trade? Make sure you read this section to learn how you can go about setting up a forex account so that you can start trading currencies. We'll also mention other factors that you should be aware of before you take this step. We will then discuss how to trade forex and the different types of orders that can be placed.
Opening A Forex Brokerage Account
Trading forex is similar to the equity market because individuals interested in trading need to open up a trading account. Like the equity market, each forex account and the services it provides differ, so it is important that you find the right one. Below we will talk about some of the factors that should be considered when selecting a forex account.
Leverage
Leverage is basically the ability to control large amounts of capital, using very little of your own capital; the higher the leverage, the higher the level of risk. The amount of leverage on an account differs depending on the account itself, but most use a factor of at least 50:1, with some being as high as 250:1. A leverage factor of 50:1 means that for every dollar you have in your account you control up to $50. For example, if a trader has $1,000 in his or her account, the broker will lend that person $50,000 to trade in the market. This leverage also makes your margin, or the amount you have to have in the account to trade a certain amount, very low. In equities, margin is usually at least 50%, while the leverage of 50:1 is equivalent to 2%.
Leverage is seen as a major benefit of forex trading, as it allows you to make large gains with a small investment. However, leverage can also be an extreme negative if a trade moves against you because your losses also are amplified by the leverage. With this kind of leverage, there is the real possibility that you can lose more than you invested - although most firms have protective stops preventing an account from going negative. For this reason, it is vital that you remember this when opening an account and that when you determine your desired leverage you understand the risks involved.
Commissions and Fees
Another major benefit of forex accounts is that trading within them is done on a commission-free basis. This is unlike equity accounts, in which you pay the broker a fee for each trade. The reason for this is that you are dealing directly with market makers and do not have to go through other parties like brokers.
This may sound too good to be true, but rest assured that market makers are still making money each time you trade. Remember the bid and ask from the previous section? Each time a trade is made, it is the market makers that capture the spread between these two. Therefore, if the bid/ask for a foreign currency is 1.5200/50, the market maker captures the difference (50 basis points).
If you are planning on opening a forex account, it is important to know that each firm has different spreads on foreign currency pairs traded through them. While they will often differ by only a few pips (0.0001), this can be meaningful if you trade a lot over time. So when opening an account make sure to find out the pip spread that it has on foreign currency pairs you are looking to trade.
Other Factors
There are a lot of differences between each forex firm and the accounts they offer, so it is important to review each before making a commitment. Each company will offer different levels of services and programs along with fees above and beyond actual trading costs. Also, due to the less regulated nature of the forex market, it is important to go with a reputable company. (For more information on what to look for when opening an account.
Opening A Forex Brokerage Account
Trading forex is similar to the equity market because individuals interested in trading need to open up a trading account. Like the equity market, each forex account and the services it provides differ, so it is important that you find the right one. Below we will talk about some of the factors that should be considered when selecting a forex account.
Leverage
Leverage is basically the ability to control large amounts of capital, using very little of your own capital; the higher the leverage, the higher the level of risk. The amount of leverage on an account differs depending on the account itself, but most use a factor of at least 50:1, with some being as high as 250:1. A leverage factor of 50:1 means that for every dollar you have in your account you control up to $50. For example, if a trader has $1,000 in his or her account, the broker will lend that person $50,000 to trade in the market. This leverage also makes your margin, or the amount you have to have in the account to trade a certain amount, very low. In equities, margin is usually at least 50%, while the leverage of 50:1 is equivalent to 2%.
Leverage is seen as a major benefit of forex trading, as it allows you to make large gains with a small investment. However, leverage can also be an extreme negative if a trade moves against you because your losses also are amplified by the leverage. With this kind of leverage, there is the real possibility that you can lose more than you invested - although most firms have protective stops preventing an account from going negative. For this reason, it is vital that you remember this when opening an account and that when you determine your desired leverage you understand the risks involved.
Commissions and Fees
Another major benefit of forex accounts is that trading within them is done on a commission-free basis. This is unlike equity accounts, in which you pay the broker a fee for each trade. The reason for this is that you are dealing directly with market makers and do not have to go through other parties like brokers.
This may sound too good to be true, but rest assured that market makers are still making money each time you trade. Remember the bid and ask from the previous section? Each time a trade is made, it is the market makers that capture the spread between these two. Therefore, if the bid/ask for a foreign currency is 1.5200/50, the market maker captures the difference (50 basis points).
If you are planning on opening a forex account, it is important to know that each firm has different spreads on foreign currency pairs traded through them. While they will often differ by only a few pips (0.0001), this can be meaningful if you trade a lot over time. So when opening an account make sure to find out the pip spread that it has on foreign currency pairs you are looking to trade.
Other Factors
There are a lot of differences between each forex firm and the accounts they offer, so it is important to review each before making a commitment. Each company will offer different levels of services and programs along with fees above and beyond actual trading costs. Also, due to the less regulated nature of the forex market, it is important to go with a reputable company. (For more information on what to look for when opening an account.
Foreign Exchange Risk and Benefits
The Good and the Bad
We already have mentioned that factors such as the size, volatility and global structure of the foreign exchange market have all contributed to its rapid success. Given the highly liquid nature of this market, investors are able to place extremely large trades without affecting any given exchange rate. These large positions are made available to forex traders because of the low margin requirements used by the majority of the industry's brokers. For example, it is possible for a trader to control a position of US$100,000 by putting down as little as US$1,000 up front and borrowing the remainder from his or her forex broker. This amount of leverage acts as a double-edged sword because investors can realize large gains when rates make a small favorable change, but they also run the risk of a massive loss when the rates move against them. Despite the foreign exchange risks, the amount of leverage available in the forex market is what makes it attractive for many speculators.
The currency market is also the only market that is truly open 24 hours a day with decent liquidity throughout the day. For traders who may have a day job or just a busy schedule, it is an optimal market to trade in. As you can see from the chart below, the major trading hubs are spread throughout many different time zones, eliminating the need to wait for an opening or closing bell. As the U.S. trading closes, other markets in the East are opening, making it possible to trade at any time during the day.
Time Zone Time (ET)
Tokyo Open 7:00 pm
Tokyo Close 4:00 am
London Open 3:00 am
London Close 12:00 pm
New York Open 8:00 am
New York Close 5:00 pm
While the forex market may offer more excitement to the investor, the risks are also higher in comparison to trading equities. The ultra-high leverage of the forex market means that huge gains can quickly turn to damaging losses and can wipe out the majority of your account in a matter of minutes. This is important for all new traders to understand, because in the forex market - due to the large amount of money involved and the number of players - traders will react quickly to information released into the market, leading to sharp moves in the price of the currency pair.
Though currencies don't tend to move as sharply as equities on a percentage basis (where a company's stock can lose a large portion of its value in a matter of minutes after a bad announcement), it is the leverage in the spot market that creates the volatility. For example, if you are using 100:1 leverage on $1,000 invested, you control $100,000 in capital. If you put $100,000 into a currency and the currency's price moves 1% against you, the value of the capital will have decreased to $99,000 - a loss of $1,000, or all of your invested capital, representing a 100% loss. In the equities market, most traders do not use leverage, therefore a 1% loss in the stock's value on a $1,000 investment, would only mean a loss of $10. Therefore, it is important to take into account the risks involved in the forex market before diving in.
Differences Between Forex and Equities
A major difference between the forex and equities markets is the number of traded instruments: the forex market has very few compared to the thousands found in the equities market. The majority of forex traders focus their efforts on seven different currency pairs: the four majors, which include (EUR/USD, USD/JPY, GBP/USD, USD/CHF); and the three commodity pairs (USD/CAD, AUD/USD, NZD/USD). All other pairs are just different combinations of the same currencies, otherwise known as cross currencies. This makes currency trading easier to follow because rather than having to cherry-pick between 10,000 stocks to find the best value, all that FX traders need to do is “keep up” on the economic and political news of eight countries.
The equity markets often can hit a lull, resulting in shrinking volumes and activity. As a result, it may be hard to open and close positions when desired. Furthermore, in a declining market, it is only with extreme ingenuity that an equities investor can make a profit. It is difficult to short-sell in the U.S. equities market because of strict rules and regulations regarding the process. On the other hand, forex offers the opportunity to profit in both rising and declining markets because with each trade, you are buying and selling simultaneously, and short-selling is, therefore, inherent in every transaction. In addition, since the forex market is so liquid, traders are not required to wait for an uptick before they are allowed to enter into a short position - as they are in the equities market.
Due to the extreme liquidity of the forex market, margins are low and leverage is high. It just is not possible to find such low margin rates in the equities markets; most margin traders in the equities markets need at least 50% of the value of the investment available as margin, whereas forex traders need as little as 1%. Furthermore, commissions in the equities market are much higher than in the forex market. Traditional brokers ask for commission fees on top of the spread, plus the fees that have to be paid to the exchange. Spot forex brokers take only the spread as their fee for the transaction. (For a more in-depth introduction to currency trading, see Getting Started in Forex and A Primer On The Forex Market.)
By now you should have a basic understanding of what the forex market is and how it works. In the next section, we'll examine the evolution of the current foreign exchange system.
We already have mentioned that factors such as the size, volatility and global structure of the foreign exchange market have all contributed to its rapid success. Given the highly liquid nature of this market, investors are able to place extremely large trades without affecting any given exchange rate. These large positions are made available to forex traders because of the low margin requirements used by the majority of the industry's brokers. For example, it is possible for a trader to control a position of US$100,000 by putting down as little as US$1,000 up front and borrowing the remainder from his or her forex broker. This amount of leverage acts as a double-edged sword because investors can realize large gains when rates make a small favorable change, but they also run the risk of a massive loss when the rates move against them. Despite the foreign exchange risks, the amount of leverage available in the forex market is what makes it attractive for many speculators.
The currency market is also the only market that is truly open 24 hours a day with decent liquidity throughout the day. For traders who may have a day job or just a busy schedule, it is an optimal market to trade in. As you can see from the chart below, the major trading hubs are spread throughout many different time zones, eliminating the need to wait for an opening or closing bell. As the U.S. trading closes, other markets in the East are opening, making it possible to trade at any time during the day.
Time Zone Time (ET)
Tokyo Open 7:00 pm
Tokyo Close 4:00 am
London Open 3:00 am
London Close 12:00 pm
New York Open 8:00 am
New York Close 5:00 pm
While the forex market may offer more excitement to the investor, the risks are also higher in comparison to trading equities. The ultra-high leverage of the forex market means that huge gains can quickly turn to damaging losses and can wipe out the majority of your account in a matter of minutes. This is important for all new traders to understand, because in the forex market - due to the large amount of money involved and the number of players - traders will react quickly to information released into the market, leading to sharp moves in the price of the currency pair.
Though currencies don't tend to move as sharply as equities on a percentage basis (where a company's stock can lose a large portion of its value in a matter of minutes after a bad announcement), it is the leverage in the spot market that creates the volatility. For example, if you are using 100:1 leverage on $1,000 invested, you control $100,000 in capital. If you put $100,000 into a currency and the currency's price moves 1% against you, the value of the capital will have decreased to $99,000 - a loss of $1,000, or all of your invested capital, representing a 100% loss. In the equities market, most traders do not use leverage, therefore a 1% loss in the stock's value on a $1,000 investment, would only mean a loss of $10. Therefore, it is important to take into account the risks involved in the forex market before diving in.
Differences Between Forex and Equities
A major difference between the forex and equities markets is the number of traded instruments: the forex market has very few compared to the thousands found in the equities market. The majority of forex traders focus their efforts on seven different currency pairs: the four majors, which include (EUR/USD, USD/JPY, GBP/USD, USD/CHF); and the three commodity pairs (USD/CAD, AUD/USD, NZD/USD). All other pairs are just different combinations of the same currencies, otherwise known as cross currencies. This makes currency trading easier to follow because rather than having to cherry-pick between 10,000 stocks to find the best value, all that FX traders need to do is “keep up” on the economic and political news of eight countries.
The equity markets often can hit a lull, resulting in shrinking volumes and activity. As a result, it may be hard to open and close positions when desired. Furthermore, in a declining market, it is only with extreme ingenuity that an equities investor can make a profit. It is difficult to short-sell in the U.S. equities market because of strict rules and regulations regarding the process. On the other hand, forex offers the opportunity to profit in both rising and declining markets because with each trade, you are buying and selling simultaneously, and short-selling is, therefore, inherent in every transaction. In addition, since the forex market is so liquid, traders are not required to wait for an uptick before they are allowed to enter into a short position - as they are in the equities market.
Due to the extreme liquidity of the forex market, margins are low and leverage is high. It just is not possible to find such low margin rates in the equities markets; most margin traders in the equities markets need at least 50% of the value of the investment available as margin, whereas forex traders need as little as 1%. Furthermore, commissions in the equities market are much higher than in the forex market. Traditional brokers ask for commission fees on top of the spread, plus the fees that have to be paid to the exchange. Spot forex brokers take only the spread as their fee for the transaction. (For a more in-depth introduction to currency trading, see Getting Started in Forex and A Primer On The Forex Market.)
By now you should have a basic understanding of what the forex market is and how it works. In the next section, we'll examine the evolution of the current foreign exchange system.
Spot Market and the Forwards and Futures Markets
Spot Market and the Forwards and Futures Markets
There are actually three ways that institutions, corporations and individuals trade forex: the spot market, the forwards market and the futures market. The forex trading in the spot market always has been the largest market because it is the "underlying" real asset that the forwards and futures markets are based on. In the past, the futures market was the most popular venue for traders because it was available to individual investors for a longer period of time. However, with the advent of electronic trading, the spot market has witnessed a huge surge in activity and now surpasses the futures market as the preferred trading market for individual investors and speculators. When people refer to the forex market, they usually are referring to the spot market. The forwards and futures markets tend to be more popular with companies that need to hedge their foreign exchange risks out to a specific date in the future.
What is the spot market?
More specifically, the spot market is where currencies are bought and sold according to the current price. That price, determined by supply and demand, is a reflection of many things, including current interest rates, economic performance, sentiment towards ongoing political situations (both locally and internationally), as well as the perception of the future performance of one currency against another. When a deal is finalized, this is known as a "spot deal". It is a bilateral transaction by which one party delivers an agreed-upon currency amount to the counter party and receives a specified amount of another currency at the agreed-upon exchange rate value. After a position is closed, the settlement is in cash. Although the spot market is commonly known as one that deals with transactions in the present (rather than the future), these trades actually take two days for settlement.
What are the forwards and futures markets?
Unlike the spot market, the forwards and futures markets do not trade actual currencies. Instead they deal in contracts that represent claims to a certain currency type, a specific price per unit and a future date for settlement.
In the forwards market, contracts are bought and sold OTC between two parties, who determine the terms of the agreement between themselves.
In the futures market, futures contracts are bought and sold based upon a standard size and settlement date on public commodities markets, such as the Chicago Mercantile Exchange. In the U.S., the National Futures Association regulates the futures market. Futures contracts have specific details, including the number of units being traded, delivery and settlement dates, and minimum price increments that cannot be customized. The exchange acts as a counterpart to the trader, providing clearance and settlement.
Both types of contracts are binding and are typically settled for cash for the exchange in question upon expiry, although contracts can also be bought and sold before they expire. The forwards and futures markets can offer protection against risk when trading currencies. Usually, big international corporations use these markets in order to hedge against future exchange rate fluctuations, but speculators take part in these markets as well. (For a more in-depth introduction to futures, see Futures Fundamentals.)
Note that you'll see the terms: FX, forex, foreign-exchange market and currency market. These terms are synonymous and all refer to the forex market.
There are actually three ways that institutions, corporations and individuals trade forex: the spot market, the forwards market and the futures market. The forex trading in the spot market always has been the largest market because it is the "underlying" real asset that the forwards and futures markets are based on. In the past, the futures market was the most popular venue for traders because it was available to individual investors for a longer period of time. However, with the advent of electronic trading, the spot market has witnessed a huge surge in activity and now surpasses the futures market as the preferred trading market for individual investors and speculators. When people refer to the forex market, they usually are referring to the spot market. The forwards and futures markets tend to be more popular with companies that need to hedge their foreign exchange risks out to a specific date in the future.
What is the spot market?
More specifically, the spot market is where currencies are bought and sold according to the current price. That price, determined by supply and demand, is a reflection of many things, including current interest rates, economic performance, sentiment towards ongoing political situations (both locally and internationally), as well as the perception of the future performance of one currency against another. When a deal is finalized, this is known as a "spot deal". It is a bilateral transaction by which one party delivers an agreed-upon currency amount to the counter party and receives a specified amount of another currency at the agreed-upon exchange rate value. After a position is closed, the settlement is in cash. Although the spot market is commonly known as one that deals with transactions in the present (rather than the future), these trades actually take two days for settlement.
What are the forwards and futures markets?
Unlike the spot market, the forwards and futures markets do not trade actual currencies. Instead they deal in contracts that represent claims to a certain currency type, a specific price per unit and a future date for settlement.
In the forwards market, contracts are bought and sold OTC between two parties, who determine the terms of the agreement between themselves.
In the futures market, futures contracts are bought and sold based upon a standard size and settlement date on public commodities markets, such as the Chicago Mercantile Exchange. In the U.S., the National Futures Association regulates the futures market. Futures contracts have specific details, including the number of units being traded, delivery and settlement dates, and minimum price increments that cannot be customized. The exchange acts as a counterpart to the trader, providing clearance and settlement.
Both types of contracts are binding and are typically settled for cash for the exchange in question upon expiry, although contracts can also be bought and sold before they expire. The forwards and futures markets can offer protection against risk when trading currencies. Usually, big international corporations use these markets in order to hedge against future exchange rate fluctuations, but speculators take part in these markets as well. (For a more in-depth introduction to futures, see Futures Fundamentals.)
Note that you'll see the terms: FX, forex, foreign-exchange market and currency market. These terms are synonymous and all refer to the forex market.
Investopedia explains Mini Forex Account
Mini forex accounts are commonly used by beginner traders who are looking to gain experience in the forex markets. Traders are not limited to only trading one lot at a time, so these accounts are ideal for increasing exposure as trading confidence builds. To make an equivalent trade to one standard lot, a trader can just trade 10 mini lots. By using mini lots instead of standard lots, a trader is able to customize the trade and obtain greater control of his or her risk.
What Does Mini Forex Account Mean?
A type of forex account that allows the trader to enter positions that are one-tenth the size of the standard lot of 100,000 units. A one-pip change in a currency pair (based in U.S. dollars), is equal to $1 when trading a mini lot, compared to $10 for a standard-lot trade. Mini lots are available to trade if you open a mini account with a forex dealer.
How to Get Started
People are introduced to the exciting world of foreign exchange in many ways: friends, current events, newspapers, television, and many others. For those of you who are new to forex, the following guidelines cover the basics of currency trading.
Step 1: "Practice makes perfect"
Demo trade. The demo account was designed to help traders gain familiarity with the speed and movements of the market. When you are demo trading, you should learn how to: 1) place market orders to enter a trade, 2) place stop-loss orders to protect your positions, and limit orders to take profits, 3) place OCO orders and If Done Orders to execute more advanced strategies.
Step 2: "Study, Study, Study".
Forex traders use fundamental analysis, technical analysis, quantitative analysis and sometimes a combination of all three to make their trading decisions. Fundamental analysis involves the use of economic, financial and political news to determine trading decisions. Technical analysis involves the study of Charts to predict future price movements based on past price patterns and trends. Quantitative analysis consists of the use of preset statistical models and properties in quantifying price formations such as averages, retracements as well as identifying oversold and undersold situations.
In order to help novice and experienced traders alike, MG has developed www.forexnews.com, a leading site on foreign exchange analysis, news and education. Comprehensive previews and summaries updated 4 times per day, insightful editorials covering the latest market developments and an open forum for discussing trading tips and ideas, are just some of the many features of Forexnews.com and MG's commitment to educating and informing Forex participants.
Step 3: Manage your money wisely.
You should always be aware of the amount of money in your account before placing a trade. If you think a long-term trend is developing, then you should consider whether you have enough funds to maintain your margin and withstand any movements against your position(s) that may occur. We encourage everyone who opens an account with us to ask themselves the following questions prior to entering each trade:
1) How much am I willing to risk?
2) What is my upside and downside potential?
3) What are the market conditions? (Is the market volatile or calm?)
4) What is the logic behind entering this trade?
5) When can I conclude if the assumptions/logic behind the trade are/is correct or wrong?
Before entering an order, you should consider both your entry and exit points. One of the mistakes most commonly made by traders, especially new traders, is letting emotions get in the way of their strategy.
Step 4: Stay Connected:
It is impossible to follow the forex market 24 hours day, 7 days a week. For better management of your account, we encourage you to use our Wireless Service and alert!FX™.
Step 5: Open a Live Account.
If you feel ready to trade this market, fill out our application forms and submit them today. Since the emotional factor may be higher than it was when you were demo-trading (as you are now committing real money), it is essential that you develop an effective strategy while demo-trading and plan to abide by it when trading your live account.
We hope you enjoy trading with us and wish you the best of luck!
Source: mgforex.com
Step 1: "Practice makes perfect"
Demo trade. The demo account was designed to help traders gain familiarity with the speed and movements of the market. When you are demo trading, you should learn how to: 1) place market orders to enter a trade, 2) place stop-loss orders to protect your positions, and limit orders to take profits, 3) place OCO orders and If Done Orders to execute more advanced strategies.
Step 2: "Study, Study, Study".
Forex traders use fundamental analysis, technical analysis, quantitative analysis and sometimes a combination of all three to make their trading decisions. Fundamental analysis involves the use of economic, financial and political news to determine trading decisions. Technical analysis involves the study of Charts to predict future price movements based on past price patterns and trends. Quantitative analysis consists of the use of preset statistical models and properties in quantifying price formations such as averages, retracements as well as identifying oversold and undersold situations.
In order to help novice and experienced traders alike, MG has developed www.forexnews.com, a leading site on foreign exchange analysis, news and education. Comprehensive previews and summaries updated 4 times per day, insightful editorials covering the latest market developments and an open forum for discussing trading tips and ideas, are just some of the many features of Forexnews.com and MG's commitment to educating and informing Forex participants.
Step 3: Manage your money wisely.
You should always be aware of the amount of money in your account before placing a trade. If you think a long-term trend is developing, then you should consider whether you have enough funds to maintain your margin and withstand any movements against your position(s) that may occur. We encourage everyone who opens an account with us to ask themselves the following questions prior to entering each trade:
1) How much am I willing to risk?
2) What is my upside and downside potential?
3) What are the market conditions? (Is the market volatile or calm?)
4) What is the logic behind entering this trade?
5) When can I conclude if the assumptions/logic behind the trade are/is correct or wrong?
Before entering an order, you should consider both your entry and exit points. One of the mistakes most commonly made by traders, especially new traders, is letting emotions get in the way of their strategy.
Step 4: Stay Connected:
It is impossible to follow the forex market 24 hours day, 7 days a week. For better management of your account, we encourage you to use our Wireless Service and alert!FX™.
Step 5: Open a Live Account.
If you feel ready to trade this market, fill out our application forms and submit them today. Since the emotional factor may be higher than it was when you were demo-trading (as you are now committing real money), it is essential that you develop an effective strategy while demo-trading and plan to abide by it when trading your live account.
We hope you enjoy trading with us and wish you the best of luck!
Source: mgforex.com
Foreign exchange market
The foreign exchange market (forex, FX, or currency market) is a worldwide decentralized over-the-counter financial market for the trading of currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends. The foreign exchange market determines the relative values of different currencies.
The primary purpose of the foreign exchange market is to assist international trade and investment, by allowing businesses to convert one currency to another currency. For example, it permits a US business to import British goods and pay Pound Sterling, even though the business's income is in US dollars. It also supports speculation, and facilitates the carry trade, in which investors borrow low-yielding currencies and lend (invest in) high-yielding currencies, and which (it has been claimed) may lead to loss of competitiveness in some countries.
In a typical foreign exchange transaction a party purchases a quantity of one currency by paying a quantity of another currency. The modern foreign exchange market started forming during the 1970s when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.
The foreign exchange market is unique because of its
* huge trading volume, leading to high liquidity
* geographical dispersion
* continuous operation: 24 hours a day except weekends, i.e. trading from 20:15 GMT on Friday until 22:00 GMT Sunday
* the variety of factors that affect exchange rates
* the low margins of relative profit compared with other markets of fixed income
* the use of leverage to enhance profit margins with respect to account size
As such, it has been referred to as the market closest to the ideal of perfect competition, notwithstanding market manipulation by central banks.[citation needed] According to the Bank for International Settlements,[3] average daily turnover in global foreign exchange markets is estimated at $3.98 trillion, as of April 2007.
The $3.21 trillion break-down is as follows:
* $1.005 trillion in spot transactions
* $362 billion in outright forwards
* $1.714 trillion in foreign exchange swaps
* $129 billion estimated gaps in reporting
The primary purpose of the foreign exchange market is to assist international trade and investment, by allowing businesses to convert one currency to another currency. For example, it permits a US business to import British goods and pay Pound Sterling, even though the business's income is in US dollars. It also supports speculation, and facilitates the carry trade, in which investors borrow low-yielding currencies and lend (invest in) high-yielding currencies, and which (it has been claimed) may lead to loss of competitiveness in some countries.
In a typical foreign exchange transaction a party purchases a quantity of one currency by paying a quantity of another currency. The modern foreign exchange market started forming during the 1970s when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.
The foreign exchange market is unique because of its
* huge trading volume, leading to high liquidity
* geographical dispersion
* continuous operation: 24 hours a day except weekends, i.e. trading from 20:15 GMT on Friday until 22:00 GMT Sunday
* the variety of factors that affect exchange rates
* the low margins of relative profit compared with other markets of fixed income
* the use of leverage to enhance profit margins with respect to account size
As such, it has been referred to as the market closest to the ideal of perfect competition, notwithstanding market manipulation by central banks.[citation needed] According to the Bank for International Settlements,[3] average daily turnover in global foreign exchange markets is estimated at $3.98 trillion, as of April 2007.
The $3.21 trillion break-down is as follows:
* $1.005 trillion in spot transactions
* $362 billion in outright forwards
* $1.714 trillion in foreign exchange swaps
* $129 billion estimated gaps in reporting
Foreign exchange market
The foreign exchange market (forex, FX, or currency market) is a worldwide decentralized over-the-counter financial market for the trading of currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends. The foreign exchange market determines the relative values of different currencies.[1]
The primary purpose of the foreign exchange market is to assist international trade and investment, by allowing businesses to convert one currency to another currency. For example, it permits a US business to import British goods and pay Pound Sterling, even though the business's income is in US dollars. It also supports speculation, and facilitates the carry trade, in which investors borrow low-yielding currencies and lend (invest in) high-yielding currencies, and which (it has been claimed) may lead to loss of competitiveness in some countries.[2]
In a typical foreign exchange transaction a party purchases a quantity of one currency by paying a quantity of another currency. The modern foreign exchange market started forming during the 1970s when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.
The foreign exchange market is unique because of its
* huge trading volume, leading to high liquidity
* geographical dispersion
* continuous operation: 24 hours a day except weekends, i.e. trading from 20:15 GMT on Friday until 22:00 GMT Sunday
* the variety of factors that affect exchange rates
* the low margins of relative profit compared with other markets of fixed income
* the use of leverage to enhance profit margins with respect to account size
As such, it has been referred to as the market closest to the ideal of perfect competition, notwithstanding market manipulation by central banks.[citation needed] According to the Bank for International Settlements,[3] average daily turnover in global foreign exchange markets is estimated at $3.98 trillion, as of April 2007.
Source: wikipedia
The primary purpose of the foreign exchange market is to assist international trade and investment, by allowing businesses to convert one currency to another currency. For example, it permits a US business to import British goods and pay Pound Sterling, even though the business's income is in US dollars. It also supports speculation, and facilitates the carry trade, in which investors borrow low-yielding currencies and lend (invest in) high-yielding currencies, and which (it has been claimed) may lead to loss of competitiveness in some countries.[2]
In a typical foreign exchange transaction a party purchases a quantity of one currency by paying a quantity of another currency. The modern foreign exchange market started forming during the 1970s when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.
The foreign exchange market is unique because of its
* huge trading volume, leading to high liquidity
* geographical dispersion
* continuous operation: 24 hours a day except weekends, i.e. trading from 20:15 GMT on Friday until 22:00 GMT Sunday
* the variety of factors that affect exchange rates
* the low margins of relative profit compared with other markets of fixed income
* the use of leverage to enhance profit margins with respect to account size
As such, it has been referred to as the market closest to the ideal of perfect competition, notwithstanding market manipulation by central banks.[citation needed] According to the Bank for International Settlements,[3] average daily turnover in global foreign exchange markets is estimated at $3.98 trillion, as of April 2007.
Source: wikipedia
Basic Concepts For The Forex Market-2
Carry Trades
Currency values never remain stationary and it is this dynamic that gave birth to one of the most popular trading strategies of all time, the carry trade. Carry traders hope to earn not only the interest rate differential between the two currencies, but also look for their positions to appreciate in value. There have been plenty of opportunities for big profits in the past. Let's take a look at some historical examples.
Between 2003 and the end of 2004, the AUD/USD currency pair offered a positive yield spread of 2.5%. Although this may seem very small, the return would become 25% with the use of 10:1 leverage. During that same time, the Australian dollar also rallied from 56 cents to close at 80 cents against the U.S. dollar, which represented a 42% appreciation in the currency pair. This means that if you were in this trade - and many hedge funds at the time were - you would have not only earned the positive yield, but you would have also seen tremendous capital gains in your underlying investment.
The carry trade opportunity was also seen in USD/JPY in 2005. Between January and December of that year, the currency rallied from 102 to a high of 121.40 before ending at 117.80. This is equal to an appreciation from low to high of 19%, which was far more attractive than the 2.9% return in the S&P 500 during that same year. In addition, at the time, the interest rate spread between the U.S. dollar and the Japanese yen averaged around 3.25%. Unleveraged, this means that a trader could have earned as much as 22.25% over the course of the year. Introduce 10:1 leverage, and that could be as much as 220% gain.
Carry Trade Success
The key to creating a successful carry trade strategy is not simply to pair up the currency with the highest interest rate against a currency with the lowest rate. Rather, far more important than the absolute spread itself is the direction of the spread. In order for carry trades to work best, you need to be long a currency with an interest rate that is in the processes of expanding against a currency with a stationary or contracting interest rate. This dynamic can be true if the central bank of the country that you are long is looking to raise interest rates or if the central bank of the country that you are short is looking to lower interest rates.
In the previous USD/JPY example, between 2005 and 2006, the U.S. Federal Reserve was aggressively raising interest rates from 2.25% in January to 4.25%, an increase of 200 basis points. During that same time, the Bank of Japan sat on its hands and left interest rates at zero. Therefore, the spread between U.S. and Japanese interest rates grew from 2.25% (2.25% - 0%) to 4.25% (4.25% - 0%). This is what we call an expanding interest rate spread.
The bottom line is that you want to pick carry trades that benefit not only from a positive and growing yield, but that also have the potential to appreciate in value. This is important because just as easily as currency appreciation can increase the value of your carry trade earnings, currency depreciation could erase all of your carry trade gains and then some.
Getting to Know Interest Rates
Knowing where interest rates are headed is important in forex trading and requires a good understanding of the underlying economics of the country in question. Generally speaking, countries that are performing very well, with strong growth rates and increasing inflation will probably raise interest rates to tame inflation and control growth. On the flip side, countries that are facing difficult economic conditions ranging from a broad slowdown in demand to a full recession will consider the possibility of reducing interest rates.
Conclusion
Thanks to the widespread availability of electronic trading networks, forex trading is now more accessible than ever. The largest financial market in the world offers a world of opportunity for investors who take the time to get to understand it and learn how to mitigate the risk of trading here.
By Kathy Lien and Boris Schlossberg Investopedia.com
Currency values never remain stationary and it is this dynamic that gave birth to one of the most popular trading strategies of all time, the carry trade. Carry traders hope to earn not only the interest rate differential between the two currencies, but also look for their positions to appreciate in value. There have been plenty of opportunities for big profits in the past. Let's take a look at some historical examples.
Between 2003 and the end of 2004, the AUD/USD currency pair offered a positive yield spread of 2.5%. Although this may seem very small, the return would become 25% with the use of 10:1 leverage. During that same time, the Australian dollar also rallied from 56 cents to close at 80 cents against the U.S. dollar, which represented a 42% appreciation in the currency pair. This means that if you were in this trade - and many hedge funds at the time were - you would have not only earned the positive yield, but you would have also seen tremendous capital gains in your underlying investment.
The carry trade opportunity was also seen in USD/JPY in 2005. Between January and December of that year, the currency rallied from 102 to a high of 121.40 before ending at 117.80. This is equal to an appreciation from low to high of 19%, which was far more attractive than the 2.9% return in the S&P 500 during that same year. In addition, at the time, the interest rate spread between the U.S. dollar and the Japanese yen averaged around 3.25%. Unleveraged, this means that a trader could have earned as much as 22.25% over the course of the year. Introduce 10:1 leverage, and that could be as much as 220% gain.
Carry Trade Success
The key to creating a successful carry trade strategy is not simply to pair up the currency with the highest interest rate against a currency with the lowest rate. Rather, far more important than the absolute spread itself is the direction of the spread. In order for carry trades to work best, you need to be long a currency with an interest rate that is in the processes of expanding against a currency with a stationary or contracting interest rate. This dynamic can be true if the central bank of the country that you are long is looking to raise interest rates or if the central bank of the country that you are short is looking to lower interest rates.
In the previous USD/JPY example, between 2005 and 2006, the U.S. Federal Reserve was aggressively raising interest rates from 2.25% in January to 4.25%, an increase of 200 basis points. During that same time, the Bank of Japan sat on its hands and left interest rates at zero. Therefore, the spread between U.S. and Japanese interest rates grew from 2.25% (2.25% - 0%) to 4.25% (4.25% - 0%). This is what we call an expanding interest rate spread.
The bottom line is that you want to pick carry trades that benefit not only from a positive and growing yield, but that also have the potential to appreciate in value. This is important because just as easily as currency appreciation can increase the value of your carry trade earnings, currency depreciation could erase all of your carry trade gains and then some.
Getting to Know Interest Rates
Knowing where interest rates are headed is important in forex trading and requires a good understanding of the underlying economics of the country in question. Generally speaking, countries that are performing very well, with strong growth rates and increasing inflation will probably raise interest rates to tame inflation and control growth. On the flip side, countries that are facing difficult economic conditions ranging from a broad slowdown in demand to a full recession will consider the possibility of reducing interest rates.
Conclusion
Thanks to the widespread availability of electronic trading networks, forex trading is now more accessible than ever. The largest financial market in the world offers a world of opportunity for investors who take the time to get to understand it and learn how to mitigate the risk of trading here.
By Kathy Lien and Boris Schlossberg Investopedia.com
Basic Concepts For The Forex Market-1
You don't have to be a daily trader to take advantage of the forex market - every time you travel overseas and exchange your money into a foreign currency, you are participating in the foreign exchange (forex) market. According to the 2007 Triennial Central Bank Survey of Foreign Exchange and Derivative Market Activity conducted by the Bank for International Settlements, the forex market generated $3.2 trillion dollars worth of transactions each day. This makes the forex market the quiet giant of finance, dwarfing over all other capital markets in its world.
Despite this market's overwhelming size, when it comes to trading currencies, the concepts are simple. Let's take a look at some of the basic concepts that all forex investors need to understand.
Eight Majors
Unlike the stock market, where investors have thousands of stocks to choose from, in the currency market, you only need to follow eight major economies and then determine which will provide the best undervalued or overvalued opportunities. These following eight countries make up the majority of trade in the currency market:
1. United States
2. Eurozone (the ones to watch are Germany, France, Italy and Spain)
3. Japan
4. United Kingdom
5. Switzerland
6. Canada
7. Australia
8. New Zealand
These economies have the largest and most sophisticated financial markets in the world. By strictly focusing on these eight countries, we can take advantage of earning interest income on the most credit worthy and liquid instruments in the financial markets.
Economic data is released from these countries on an almost daily basis, allowing investors to stay on top of the game when it comes to assessing the health of each country and its economy.
Yield and Return
When it comes to trading currencies, the key to remember is that yield drives return.
When you trade in the foreign exchange spot market, you are actually buying and selling two underlying currencies. All currencies are quoted in pairs, because each currency is valued in relation to another. For example, if the EUR/USD pair is quoted as 1.3500 that means it takes $1.35 to purchase one euro.
In every foreign exchange transaction, you are simultaneously buying one currency and selling another. In effect, you are using the proceeds from the currency you sold to purchase the currency you are buying. Furthermore, every currency in the world comes attached with an interest rate set by the central bank of that currency's country. You are obligated to pay the interest on the currency that you have sold, but you also have the privilege of earning interest on the currency that you have bought.
As an example, let's look at the New Zealand dollar/Japanese yen pair (NZD/JPY). Let's assume that New Zealand has an interest rate of 8% and that Japan has an interest rate of 0.5% In the currency market, interest rates are calculated in basis points. A basis point is simply 1/100th of 1%. So, New Zealand rates are 800 basis points and Japanese rates are 50 basis points. If you decide to go long NZD/JPY you will earn 8% in annualised interest, but have to pay 0.50% for a net return of 7.5%, or 750 basis points.
Leveraging Returns
The forex market also offers tremendous leverage - often as high as 100:1 - which means that you can control $10,000 worth of assets with as little as $100 of capital. However, leverage can be a double-edged sword; it can create massive profits when you are correct, but may also generate huge losses when you are wrong.
Clearly, leverage should be used judiciously, but even with relatively conservative 10:1 leverage, the 7.5% yield on NZD/JPY pair would translate into a 75% return on an annual basis. So, if you were to hold a 100,000 unit position in NZD/JPY using $5,000 worth of equity, you would earn $9.40 in interest every day. That's $94 dollars in interest after only 10 days, $940 worth of interest after three months, or $3,760 annually. Not too shabby given the fact that the same amount of money would only earn you $250 in a bank savings account (with a rate of 5% interest) after a whole year. The only positive over having the bank account earn you interest is that the return would be risk-free.
The use of leverage basically exacerbates any sort of market movements. As easily as it increases profits, it can just as quickly cause large losses. However, these losses can be capped through the use of stops. Furthermore, almost all forex brokers offer the protection of a margin watcher - a piece of software that watches your position 24 hours a day, five days per week and automatically liquidates it once margin requirements are breached. This process insures that your account will never post a negative balance and your risk will be limited to the amount of money in your account.
Despite this market's overwhelming size, when it comes to trading currencies, the concepts are simple. Let's take a look at some of the basic concepts that all forex investors need to understand.
Eight Majors
Unlike the stock market, where investors have thousands of stocks to choose from, in the currency market, you only need to follow eight major economies and then determine which will provide the best undervalued or overvalued opportunities. These following eight countries make up the majority of trade in the currency market:
1. United States
2. Eurozone (the ones to watch are Germany, France, Italy and Spain)
3. Japan
4. United Kingdom
5. Switzerland
6. Canada
7. Australia
8. New Zealand
These economies have the largest and most sophisticated financial markets in the world. By strictly focusing on these eight countries, we can take advantage of earning interest income on the most credit worthy and liquid instruments in the financial markets.
Economic data is released from these countries on an almost daily basis, allowing investors to stay on top of the game when it comes to assessing the health of each country and its economy.
Yield and Return
When it comes to trading currencies, the key to remember is that yield drives return.
When you trade in the foreign exchange spot market, you are actually buying and selling two underlying currencies. All currencies are quoted in pairs, because each currency is valued in relation to another. For example, if the EUR/USD pair is quoted as 1.3500 that means it takes $1.35 to purchase one euro.
In every foreign exchange transaction, you are simultaneously buying one currency and selling another. In effect, you are using the proceeds from the currency you sold to purchase the currency you are buying. Furthermore, every currency in the world comes attached with an interest rate set by the central bank of that currency's country. You are obligated to pay the interest on the currency that you have sold, but you also have the privilege of earning interest on the currency that you have bought.
As an example, let's look at the New Zealand dollar/Japanese yen pair (NZD/JPY). Let's assume that New Zealand has an interest rate of 8% and that Japan has an interest rate of 0.5% In the currency market, interest rates are calculated in basis points. A basis point is simply 1/100th of 1%. So, New Zealand rates are 800 basis points and Japanese rates are 50 basis points. If you decide to go long NZD/JPY you will earn 8% in annualised interest, but have to pay 0.50% for a net return of 7.5%, or 750 basis points.
Leveraging Returns
The forex market also offers tremendous leverage - often as high as 100:1 - which means that you can control $10,000 worth of assets with as little as $100 of capital. However, leverage can be a double-edged sword; it can create massive profits when you are correct, but may also generate huge losses when you are wrong.
Clearly, leverage should be used judiciously, but even with relatively conservative 10:1 leverage, the 7.5% yield on NZD/JPY pair would translate into a 75% return on an annual basis. So, if you were to hold a 100,000 unit position in NZD/JPY using $5,000 worth of equity, you would earn $9.40 in interest every day. That's $94 dollars in interest after only 10 days, $940 worth of interest after three months, or $3,760 annually. Not too shabby given the fact that the same amount of money would only earn you $250 in a bank savings account (with a rate of 5% interest) after a whole year. The only positive over having the bank account earn you interest is that the return would be risk-free.
The use of leverage basically exacerbates any sort of market movements. As easily as it increases profits, it can just as quickly cause large losses. However, these losses can be capped through the use of stops. Furthermore, almost all forex brokers offer the protection of a margin watcher - a piece of software that watches your position 24 hours a day, five days per week and automatically liquidates it once margin requirements are breached. This process insures that your account will never post a negative balance and your risk will be limited to the amount of money in your account.
What is Forex (Foreign Exchange)?
Foreign Exchange (FOREX) is the arena where a nation's currency is exchanged for that of another. The foreign exchange market is the largest financial market in the world, with the equivalent of over $1.9 trillion changing hands daily; more than three times the aggregate amount of the US Equity and Treasury markets combined. Unlike other financial markets, the Forex market has no physical location and no central exchange (off-exchange). It operates through a global network of banks, corporations and individuals trading one currency for another. The lack of a physical exchange enables the Forex market to operate on a 24-hour basis, spanning from one zone to another in all the major financial centers.
Traditionally, retail investors' only means of gaining access to the foreign exchange market was through banks that transacted large amounts of currencies for commercial and investment purposes. Trading volume has increased rapidly over time, especially after exchange rates were allowed to float freely in 1971. Today, importers and exporters, international portfolio managers, multinational corporations, speculators, day traders, long-term holders and hedge funds all use the FOREX market to pay for goods and services, transact in financial assets or to reduce the risk of currency movements by hedging their exposure in other markets.
MG Financial, now operating in over 100 countries, serves all manner of clients, comprising speculators and strategic traders. Whether it’s day-traders looking for short-term gains, or fund managers wanting to hedge their non-US assets, MG's DealStation™ allows them to participate in FOREX trading by providing a combination of live quotes, Real-Time charts, and news and analysis that attracts traders with an orientation towards fundamental and/or technical analysis.
Traditionally, retail investors' only means of gaining access to the foreign exchange market was through banks that transacted large amounts of currencies for commercial and investment purposes. Trading volume has increased rapidly over time, especially after exchange rates were allowed to float freely in 1971. Today, importers and exporters, international portfolio managers, multinational corporations, speculators, day traders, long-term holders and hedge funds all use the FOREX market to pay for goods and services, transact in financial assets or to reduce the risk of currency movements by hedging their exposure in other markets.
MG Financial, now operating in over 100 countries, serves all manner of clients, comprising speculators and strategic traders. Whether it’s day-traders looking for short-term gains, or fund managers wanting to hedge their non-US assets, MG's DealStation™ allows them to participate in FOREX trading by providing a combination of live quotes, Real-Time charts, and news and analysis that attracts traders with an orientation towards fundamental and/or technical analysis.
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