FX MARKET OVERVIEW
Forex refers to the foreign currency exchange market in which over 4,600 international banks and thousands of small and large speculators participate. Everyday this worldwide market exchanges more than $3.6 trillion in dozens of different currencies. This exciting and rapidly growing financial market provides the entrepreneur with an opportunity to generate profits in the largest market in the world.
The Forex market is more than three times the size of the United States Equity and Treasury markets combined. Unlike other financial markets, the Forex market has no physical location and no central exchange. It operates through an electronic network of banks, corporations, institutional investors 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 across the major global financial centers.
Individual investors now have the opportunity to trade the largest, most liquid financial market in the world and have the financial advantages enjoyed by major institutions for years.
WHY TRADE FX?
There are many benefits and advantages to trading Forex.* Here are just a few reasons why so many people are choosing this market as a business opportunity:
• 24 hours, 6 days per week
• Liquidity
• Leverage
• Opportunities in both rising and falling markets
• Low transaction cost
• Uncorrelated to the stock market
• Interbank market
• No one can corner the market
24 HOURS, 6 DAYS PER WEEK
The Forex market never sleeps. A currency trader may take advantage of all market conditions at any time. There is no waiting for an opening bell as in the case of trading stocks. It is a 24-hour, continuous currency exchange that almost never closes (normal hours of operation are Sunday 1 p.m. through Friday 2 p.m. Pacific Time). This is very desirable for those who want to trade on a part-time basis, because you can choose when you want to trade: morning, noon or night.
LIQUIDITY
With $1.9 trillion changing hands daily, the FX market is also extremely liquid. This means that with a click of a mouse you can instantaneously buy and sell. Whether it’s 6 p.m. or 6 a.m., somewhere in the world there are always buyers and sellers actively trading foreign currencies. You are never ‘stuck’ in a trade. You can even set the online trading platform to automatically close your position at your desired profit level (limit order), and/or close a trade if a trade is going against you (stop order) under normal market conditions.
LEVERAGE
Forex investors are permitted to trade foreign currencies on a highly leveraged basis – up to 50 times their investment. A small margin deposit can control a much larger total contract value. Leverage gives the trader the ability to succeed and at the same time keep risk capital to a minimum. Please note that increasing leverage may also increase losses.
OPPORTUNITIES IN BOTH RISING AND FALLING MARKETS
Trading currency allows traders to succeed during rising and falling markets. One can just as easily ‘short’ (sell) a particular currency as go ‘long’ because currencies trade in ‘pairs.’ Thus, when you buy a particular currency, you are actually simultaneously selling the other currency in that particular pair. As the market moves, one of the currencies will increase in value versus the other. Of course, it is up to you to choose the correct one to be long or short.*
LOW TRANSACTION COST
There are no brokerage commission fees for each FX transaction. The retail transaction cost (the bid/ask spread) is typically less than 0.1 percent (10 pips or points) under normal market conditions. For all the major currency pairs, the spread could be 4-5 pips. *Please note that your broker of choice is compenstation through the spread which varies depending on which currencies you trade and the broker you choose. ForexInteractive is not a broker. The spread is the difference between the current bid and curent ask price on a specific currency.
UNCORRELATED TO THE STOCK MARKET
A trader in the Forex market is involved in selling or buying one currency against another. Thus, there is no correlation between the foreign currency market and the stock market. A bull market or a bear market for a currency is defined in terms of the outlook for its relative value against other currencies. If the outlook is positive, we have a bull market in which a trader succeeds by buying the currency against other currencies. Conversely, if the outlook is pessimistic, we have a bull market for other currencies and traders succeed by selling the currency against other currencies. In either case, there is always a good market trading opportunity for a trader.
INTERBANK MARKET
The backbone of the Forex market consists of a global network of dealers. They are mainly major commercial banks that communicate and trade with one another and with their clients through electronic networks and telephones. There are no organized exchanges to serve as a central location to facilitate transactions the way the New York Stock Exchange serves the equity markets. The Forex market operates in a manner similar to the way the NASDAQ market in the United States operates, thus it is also referred to as an over-the-counter (OTC) market.
NO ONE CAN CORNER THE MARKET
The Forex market is so vast and has so many participants that no single entity, not even a central bank, can control the market price for an extended period of time. Even interventions by mighty central banks are becoming increasingly ineffectual and short lived.
CURRENCY BASICS
CURRENCY PAIRS
An exchange rate is simply the ratio of one currency valued against another. The first currency is referred to as the ‘base currency’ and the second as the counter or ‘quoted currency’. For instance, the USD/JPY exchange rate specifies how many U.S. Dollars are required to buy a Japanese Yen, or conversely, how many Japanese Yen are needed to purchase a U.S. Dollar.
ISO CODES
All currencies are assigned an International Standards Organization (ISO) code abbreviation. In currency trading, these codes are often used to express which specific currencies make up a currency pair. For example, USD/JPY refers to two currencies: the U.S. Dollar and the Japanese Yen.
MOST ACTIVELY TRADED CURRENCIES:
• EUR – Euro
• USD – U.S. Dollar
• GBP – Great British Pound
• CHF – Swiss Franc
• JPY – Japanese Yen
• CAD – Canadian Dollar
• AUD – Australian Dollar
BID/ASK PRICE
A currency exchange rate is typically given as a bid price and an ask price. The ‘bid price’ is always lower than the ask price. The bid price represents what will be obtained in the quoted currency when selling one unit of the base currency. The ‘ask price’ represents what has to be paid in the quote currency to obtain one unit of the base currency. The following USD/JPY price quote is an example of bid/ask notation:
USD/JPY: 116.10/15
The first component (before the slash) refers to the bid price (what you obtain in JPY when you sell USD). In this example, the bid price is 116.10. The second component (after the slash) is used to obtain the ask price (what you have to pay in JPY if you buy USD). In this example, the ask price is 116.15.
SPREAD
The difference between the bid and the ask price is referred to as the ‘spread’. In the example above, the spread is .05 or 5 pips. A ‘pip’ stands for the smallest unit of measurement denoting price movement. One basis point (0.0001 or .01 percent) but depends on the currency pair in reference. Unlike the USD/JPY, most currency pair quotes are carried out to the 4th decimal place (example: USD/CAD may be quoted at 1.4517/22), in which case 5 pips represents a difference of .0005. Although a pip may seem small, a movement of one pip in either direction can translate into thousands of dollars in gains or losses in the interbank market.
INTEREST ROLLOVER
In the spot FX market, trades must be settled in two business days. If a trader sells 100,000 euros on Tuesday, the trader must deliver 100,000 euros on Thursday, unless the position is rolled over. All open positions are automatically rolled over to the next settlement date at 5 p.m. ET. Rollover involves exchanging the position being held for a position expiring the following settlement date. The positions being exchanged are usually not valued at the same price. The amount of the difference varies greatly based on the currency pair and the interest rate differential between the two currencies, and fluctuates day-to-day with the movement of prices. For instance, on any given day, the rollover can be $2 per lot for USD/JPY and $15 per lot for GBP/JPY.
At 5 p.m. ET, funds are subtracted or added to accounts with open positions because of the automatic rollover. For accounts that have a margin requirement of 2 percent or more, funds are added to the account for positions in which the client is long (holding) the currency bearing the higher interest rate. Funds are deducted in the opposite circumstance. For accounts that do not have a 2 percent margin requirement, the rollover amount is deducted from the account for each position, regardless of the account’s holdings. This 2 percent margin requirement is the most generous policy available to traders in the FX industry, as many firms require 3 – 5 percent minimum margin before traders can benefit from rollover.
Note: On Wednesdays, the amount added or subtracted to an account as a result of rolling over a position tends to be around three times the usual amount. This ’3-Day’ rollover accounts for settlement of trades through the weekend period.
FOREX VS. STOCKS
On the forex, there are only six major currencies. This allows a trader to focus and concentrate on which currencies to trade. In the equities market, there are over 40,000 stocks to choose from. Which stocks do you choose?
On the stock markets, most people make money when shares are rising, but in economic recessions and falling ‘bear’ markets, there is little chance of making serious money. In the Forex market there is a big difference.
One of the most exciting advantages of FX trading is the ability to generate profits* whether a currency pair is ‘up’ or ‘down’. A trader can succeed by taking a ‘long’ position (buying the currency pair at one price and selling it later at a higher price) or a ‘short’ position (selling the currency pair and buying it back at a lower price). In either case, there is always a good market trading opportunity for a trader. The ability to sell currencies without any limitations is a distinct advantage over equity trading.
For example: If you think the U.S. Dollar will increase in value versus the Japanese Yen, then you will buy Dollars and sell the Yen (go long). If you think the Yen will increase in value against the Dollar then you will sell Dollars and buy Yen (go short). As long as the trader picks the right direction, the potential to succeed exists.
FOREX VS. FUTURES
The spot Forex market is a $1.9 trillion daily market, making it the largest and most liquid market in the world. This market can absorb trading volume and transaction sizes that dwarf the capacity of any other market. If you compare this to the $437.4 billion per day futures market, it becomes clear that the futures markets provide only limited liquidity. The spot FX market is always liquid, meaning positions can be liquidated and stop orders executed without slippage.
EXECUTION QUALITY AND SPEED
The futures market is known for inconsistent execution, both in terms of pricing and execution time. Every futures trader has experienced a half hour wait for a market order to be filled that has been executed at a price far away from where the market was supposed to be trading. Even with electronic trading and limited guarantees of execution speed, the price for fills on market orders is far from certain.
The FX market offers instantaneous execution and price certainty. On an FX trading station, traders execute directly off real-time streaming prices. There is no discrepancy between the displayed price and the execution price. This holds true even during volatile times and fast moving markets. In the futures market, execution is uncertain because all orders must be done on the exchange. This creates a situation where liquidity is limited by the number of participants, which in turn limits quantities that can be traded at a given price. Real-time streaming prices ensure that market orders, stops, and limits are executed without slippage and/or partial fills.
VIRTUALLY COMMISSION FREE TRADING
In the futures market, traders must pay a spread and a commission. All traded financial products have a ‘bid’ (buy) price, and an ‘ask’ (sell) price, with the difference defining the spread, or cost of execution. Up until recently, lack of transparency in the futures market has disguised the spread. Now online trading platforms, which show the depth of the market by including both the buy and sell price, allow traders to see the real cost of the trade. Because the currency market offers round-the-clock liquidity, traders receive tight, competitive spreads both intra-day and night. Futures traders are more vulnerable to liquidity risk and typically receive wider dealing spreads, especially during after-hours trading.
FX day trading charges no commission or transactions fees to trade currencies online or over the phone. The over-the-counter structure of the currency market eliminates exchange and clearing fees, which in turn lowers transaction costs. Costs are further reduced by the efficiencies created by a purely electronic market place that allows clients to deal directly with the market maker, eliminating both ticket costs and middlemen. All clients have access to dealable bid/ask quotes. In the futures market, the prices represent the last trade, not necessarily the price for which the contract will be filled. This lack of transparency hides the true cost of the trade. Your broker of choice is compensated through the spread which varies depending on which currencies you trade and the broker you choose. ForexInteractive is not a broker. The spread is the difference between the current bid and current ask price on a specific currency.
REPORTING CAPABILITIES
In the spot Forex market, traders can see the value of their positions and account equity move up and down with the market in real time. The key information for every account is re-calculated and updated every time the exchange rates change. Traders have immediate access to detailed information regarding every open position, open order, and the generated P/L per trade. Traders also have 24-hour access to full, real-time snapshots of their account statement since inception, or on a daily, weekly, monthly or yearly basis. As a trader, this means you never have to approximate your account equity or be uncertain in regards to available margin.
MARGIN/RISK MANAGEMENT
For the purpose of risk management, traders must have position limits. This number is set relative to the money in a trader’s account. Risk is minimized in the spot FX market because the online capabilities of the trading platform will automatically generate a margin call if the required margin amount exceeds the dollar value of the account as a result of trading losses. All open positions will be closed immediately regardless of the size or the nature of positions held within the account. If the futures market moves against you, your position may be liquidated at a loss and you will be liable for any resulting deficit in the account.*
