Table of Contents
Chapter 1: What is Forex Trading
Chapter 2: History of Money and Origins of Forex Trading
Chapter 3: Forex Trading Terminology
Chapter 4: Important Aspects of Forex Trading
Chapter 5: Players in The Forex Market
Chapter 6: Factors that Affect the Forex Market
Chapter 7: Risks Involved With Trading Forex
Chapter 8: Why Trade in the Forex Market
Chapter 9: How Forex Trading Works
Chapter 10: How to be a Successful Forex Trader
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Chapter 4: Important Aspects of Forex Trading
– No Exchange
– ‘Always On’ Trading
– No Clearing House
– No Intermediary Means No Commission
– Instant Trades
– Highly Speculative
– Enormous Leverage
– Access to International Markets
– Diversification to Spread Risk
– Gains Possible Even in a Declining Economy
– Limited Information to Keep Track Of
– Most Traded Currencies
– Lack of Government Regulation
– Unlimited Gains Possible
– Highly Liquid Market
– Use of Unpublicized Information
– Trade Volume Never Controls the Market
– Real Time Market Information
– Easier to Manage Transactions
Chapter 4: Important Aspects of Forex Trading
Forex transactions are very different from other kinds of financial transactions. Some key aspects set them apart and also contribute to the immense success that investors can enjoy from making accurate price movement predictions. Here are some key aspects of Forex Trading:
Forex is not traded through any exchange. The market can be considered a network of forex trade facilitators located in different parts of the globe. The trades are carried out electronically between the parties involved in a transaction. The forex market is an enormous OTC market with trades being carried out simultaneously in different countries all the time.
From another perspective, you can say that any channel which allows an exchange between currencies is a part of the forex market. Banks, forex trading businesses, forex brokers etc facilitate forex trading and the central location or office of any of these facilitators functions as a mini forex market.
An investor doesn’t have to wait until the exchange opens to trade in forex. Currencies can be traded 24 hours a day, on all weekdays. This gives enormous flexibility to investors who can carry out transactions even after office hours. The difference in time zones across the world is an important aspect to consider when conducting forex trades.
The forex market is largely an unsupervised one with no clearing houses or arbitrators to oversee settlement of terms. The two parties to the forex trade are bound by a code of ethics to ensure that they fulfill obligations. There are also practical considerations that helps keep the market organized and structured.
A broker or trader who has defaulted on a trade will be shunned by others and will have trouble finding buyers and sellers. In order to stay in the market, dealers and traders have to ensure that they adhere to the agreements.
No Intermediary Means No Commission
The investor deals directly with a market maker through electronic transactions to record and execute every deal in real time. Although there are brokers in the forex market, they function as dealers and not as intermediaries.
They do not charge commissions on the trades but make their profits from the difference between the bid and ask price or spread quoted on a currency pair. This means that the investor can invest all his funds in the trade without needing to set aside a portion for meeting brokerage costs.
The absence of an intermediary also makes the transaction quicker and lets the investor react quickly to price movements. As the transaction is executed quickly, there is very little chance of the price changing before the investor executes his decision. This makes it easy for the investor to implement his investment strategy and determine the exact time when he must buy or sell.
The forex market is highly speculative and most investors participate in it only for profit. No currency usually changing hands when positions are closed on trades. This, in combination with the huge leverage, makes forex an ideal tool for investors looking to make huge gains from small initial investments.
Enormous leverage is possible while conducting forex trades. A stock market investment has a leverage of about 2:1 which means that every $100,000 investment on margin has a $50,000 investment from the investor’s personal funds. Compare this with the $1,000 investment which a forex trader will usually need to carry out a trade of the same size of $100,000 – a 100:1 leverage.
The total capital put up by the forex trader is thus very small when compared to other investment options. This leverage is what makes forex trading very attractive and it is one reason why forex is the biggest financial market in the world. It is as accessible to small investors as to large institutions and lets every investor control a much larger share of the market than he can actually afford.
It makes it possible for a trader with a small investment to have a stake in a huge amount of currencies, and if the trade goes well, it translates to a huge profit. This kind of investment to gains ratio is very difficult to achieve with equities, futures or almost any other kind of investment.
Of course, leverage can also be a curse when the trade goes against the forex trader. The small investment which leads to huge gains can also cause losses to multiply just as easily.
Access to International Markets
Hardly any other mode of investment gives an investor as much access to international markets as easily as the forex market. The forex trader not only gets information about different currencies quickly and easily but can also trade in them just as simply.
The forex market determines the value of currencies globally and helps keep various currencies in balance through the demand and supply forces which act here. International trade and commerce is enabled through the forex market by allowing businesses to convert domestic currency into a foreign currency. Institutions can also gain huge profits by engaging in forex trade so they use these markets for both speculation and business growth.
Diversification to Spread Risk
A smart investor can diversify his overall investment portfolio by spreading his risk over many different currencies. Different economies react differently to various factors and some factors may affect only certain economies.
For instance, a drought in a country may suppress the economy and thus its currency but it will not affect other currencies. This variable influence can be used to advantage by investors to balance the risk in one currency with the stability in another.
Gains Possible Even in a Declining Economy
Various currency combinations can be used to turn virtually every economic circumstance into an opportunity for gains. A declining economy and currency value can be as much a basis for a profitable forex trade as a growing one. This is because the currency of one country is set off against that of another. The investor simply has to take the right long and short positions to make profits.
This unique application of the forex market helps an investor keep his portfolio safe in adverse economic conditions. Even during a general global downturn, this strategy may work well because the impact of the slowdown may be more strongly felt in some economies than in others.
Limited Information to Keep Track Of
Although there are enough currencies to give adequate diversification to an investor’s portfolio, the market is still limited by the number of currencies in the world. In order to make well informed decisions, an investor only needs to follow the markets, economy and currency of the country he wishes to trade in.
Forex is unlike the stock market where the number of possible investments can grow without limit with every new equity issue. An investor who is interested in a company’s shares will need to study the company’s prospects and its fundamentals to assess the risk. Currency of a country is more or less affected by the same few factors year after year and a basic understanding of these forms a solid foundation for forex trading.
This limited number of options lets the investor focus all his energies on one or two currencies that he is interested in so that he can build up enough expertise to make accurate price predictions. It is, however, critical for a forex trader to keep tabs on global events and factors that could affect the prices of currencies that he is interested in.
There is a very small number of currency pairs that a typical investor will want to track. The currency pairs traded most are EUR/USD, USD/JPY, GBP/USD, USD/CHF. Traders can also use different combinations of these currencies in the form of cross currency pairs to conduct trades.
In addition to these, the three commodity currencies – New Zealand dollar, Canadian dollar and Australian dollar are also traded heavily in the forex market. Thee currencies derive their value largely from the exports made by the home countries. As these exports are predominantly commodities like metals, oils etc, these currencies are called commodity currencies. These are paired just like any other forex currency pair and traded in a similar manner. Commodity price heavily influences the value of these currencies.
The lack of centralized government regulations gives traders considerable freedom in how, when and how much they trade. A forex trader may transact in as many lots of a currency pair as he wishes given his risk appetite and funds availability.
If you need a broker for transactions, you can choose from the many who deal with forex currencies. A broker with a smaller spread lets you match the market prices more closely and this means you stand to gain more from each transaction.
However, the lack of regulation need not put you at greater risk from unscrupulous brokers. Forex brokers are required to be registered with the Commodity Futures Trading Commission (CFTC). Most of the established brokerage houses and dealers also opt for membership with the National Futures Association (NFA) so that they can fall back on this agency for arbitration in case of disputes. The NFA has guidelines for its members and this ensures that all member firms follow a code of ethics and regulated practices.
The NFA is a self regulated, independent body which oversees the futures markets and regulates the participants. It is supervised by the Commodity Futures Trading Commission (CFTC) – a US federal agency. The CFTC came into being with the Commodity Futures Trading Act which deals with all aspects of futures trading in the US.
The forex market thus brings to the investor a dual advantage. The absence of stringent regulations gives greater freedom in how trades are carried out. On the other hand, the optional regulation brings in some structure and standards, which can be very helpful when choosing dealers and brokers.
The lack of regulation also makes it possible for an investor to make unlimited gains. Forex traders are not limited by uptick rules like their short selling counterparts. The currency prices are left to move in tandem with demand supply without any interference.
This lets investors make judgments about future prices and buy-sell decisions based on their experience, research and analysis. A savvy investor who puts the clues together to understand forex movements perfectly stands to make huge gains without fear of unknown factors influencing the markets.
Forex is the most liquid financial market with traders having the ability to convert any investment to cash at any point. The constant price movement and the enormous trading volumes make this market highly liquid. Investors have access to sellers and buyers to meet their needs at almost all times because of the huge number of traders who are actively trading at any given point of time.
Use of Unpublicized Information
Insider trading or using unpublicized information to make buy or sell decisions is actively practiced in forex trade. These trades are based on information which is continuously disseminated in one form or another and if an expert investor gleans some information from a private source which will affect currency prices, he can use his special knowledge to great advantage without legal repercussions.
Trade Volume Never Controls the Market
A stock market investor is sure to have experienced bad days when a stock was cornering the market or all activities were concentrated on one stock. Similarly, analyst opinions have a lot of influence on how the stocks are doing in the market. With forex trades, these factors are eliminated.
The sheer volume of trading that takes place in forex markets and the absence of geographical boundaries make it impossible for any one currency or market player to exert any significant influence on the market or even on a particular currency. Investors can rest assured that no artificial inflation or deflation is taking place at any time in the forex market.
The forex market always gives you real time price information unlike stock prices where the last traded price is quoted. The forex trader is always aware of exactly what price he can get from the market for his currency. This certainty is a great advantage to a forex trader as compared to someone trading in equities or futures.
The absence of intermediaries allows you to have greater control over your transaction in a forex trade. As all instructions can be executed by you directly using the trading platform, you can quickly react to losses and limit them. Stop loss instructions are executed instantly and automatically by the forex trading application you use. This ensures that there is no room for human error in managing your investment risk.
Next Chapter: Players in The Forex Market
