WHAT IS FOREX?
The Foreign Exchange market (also referred to as the Forex or FX market) is the largest financial market in the world, with over $1.5 trillion changing hands every day. That is larger than all US equity and Treasury markets combined! Unlike other financial markets that operate at a centralized location (i.e. stock exchange), the worldwide Forex market has no central location. It is a global electronic network of banks, financial institutions and individual traders, all involved in the buying and selling of national currencies. Another major feature of the Forex market is that it operates 24 hours a day, corresponding to the opening and closing of financial centers in countries all across the world, starting each day in Sydney, then Tokyo, London and New York. At any time, in any location, there are buyers and sellers, making the Forex market the most liquid market in the world.
Whether you are aware of it or not, you already play a role in the Forex market. The simple fact that you have money in your pocket makes you an investor in currency, particularly in the US Dollar. By holding US Dollars, you have elected not to hold the currencies of other nations. Your purchases of stocks, bonds or other investments, along with money deposited in your bank account, represent investments that rely heavily on the integrity of the value of their denominated currency ¨C the US Dollar. Due to the changing value of the US Dollar and the resulting fluctuations in exchange rates, your investments may change in value, affecting your overall financial status. With this in mind, it should be no surprise that many investors have taken advantage of the fluctuation in Exchange Rates, using the volatility of the Foreign Exchange market as a way to increase their capital.
Traditionally, access to the Forex market has been made available only to banks and other large financial institutions. With advances in technology over the years, however, the Forex market is now available to everybody, from banks to money managers to individual traders trading retail accounts. The time to get involved in this exciting, global market has never been better than now. Open an account and become an active player in the largest market on the planet.
FOREX TRADING BASICS
Using fundamental and technical analyses, the individual trader attempts to determine trends in the price movements of currencies, and by buying or selling currency pairs, attempts to gain profits. The most often traded currencies, the major currencies, are those of countries with stable governments and respected central banks that target low inflation. Currencies that often trade along with the U.S. Dollar include the Japanese Yen, the British Pound, the Swiss Franc and now the new European currency - Euro are therefore the most liquid, unlike "exotic" currencies which are often tightly regulated and simply too illiquid. Countries suffering political instability or economic turmoil, and who use monetary expansion to fuel the economy or monetary devaluation to increase exports, usually have relatively higher inflation and weaker currencies.
Traders can generate profits (or losses) whether a currency is rising or falling by buying one currency, which is anticipated to gain value against another currency or selling one currency, which is anticipated to lose value against another currency. Taking a long position is one in which a trader buys a currency at one price and aims to sell it later at a higher price. Alternatively, a short position is one in which the trader sells a currency that he anticipates to depreciate and aims to buy the currency back later at a lower price. Buying or selling currencies in response to economic or political events which occur are reactive, whereas buying or selling currencies on anticipated events is speculative. The bulk of currency activity is generated by market participants anticipating the direction of currency prices. In general, the value of a currency versus other currencies is a reflection of the condition of that country's economy with respect to the other major economies.
Foreign exchange is a continuous global market, providing participants with 24-hour market access. The only breaks in trading occur during a brief period over the weekend. Although foreign exchange is the most liquid of all markets, the fact that it is an international market and trading 24-hours a day, the time of day can have a direct impact on the liquidity available for trading a particular currency. The major dealer centers and time zones are that of Sydney, Tokyo, London, and New York. Therefore, traders must consider which players are in the market, since in the modern interconnected financial world, events that occur at any hour, in any part of the globe, can affect some or all parts of the investment community. In addition, although trading in the "spot" market, the difference in time zones accounts for a two-day settlement period. The 24-hour nature of the foreign exchange market is a substantial attraction to many of its participants.
A proficient trader employs both technical and fundamental analyses prior to entering any trades. Fundamentals include watching the world news, and particularly studying variables that may cause the market price of a currency to fluctuate, including monetary and fiscal policy, political conditions, trade patterns, economic indicators (i.e. GDP, CPI, PPI), interest rates, inflation and unemployment numbers. Faith in a government's ability to stand behind its currency also impacts currency price. From time to time, central banks use intervention as an effective method of enforcing market adherence to their desired exchange rate comfort zones. Technical analysis, which has grown dramatically in popularity in the foreign exchange market since the 1980s, involves computer charting, using trend lines, support and resistance levels, reversals, and numerous patterns and analyses to study the behavior patterns of market crowds to track and identify buying and selling opportunities. Over long historical periods, currencies have displayed identifiable trends and patterns which provide investors with profitable opportunities.
It is the trader's option to take either a conservative or a more risk-taking approach. Employing a conservative approach, the trader establishes and liquidates positions quickly and efficiently to capitalize on even the slightest of price fluctuations, using limit and stop orders to manage risk. A limit order is placed to ensure a position is established once a price level in the market has been reached. A stop order is placed to automatically liquidate a position at a chosen price level in order to limit potential loss on a particular trade. By placing orders in relation to technical support and resistance levels, the trader may profit incrementally from the minor price fluctuations that occur each day.
There are two basic approaches to analyzing the currency market, fundamental analysis and technical analysis. The fundamental analyst concentrates on the underlying causes of price movements, while the technical analyst studies the price movements themselves.
Technical Analysis
Technical analysis focuses on the study of price movements. Historical currency data is used to forecast the direction of future prices. The premise of technical analysis is that all current market information is already reflected in the price of that currency; therefore, studying price action is all that is required to make informed trading decisions. The primary tools of the technical analyst are charts. Charts are used to identify trends and patterns in order to find profit opportunities. The most basic concept of technical analysis is that markets have a tendency to trend. Being able to identify trends in their earliest stage of development is the key to technical analysis.
Fundamental Analysis
Fundamental analysis focuses on the economic, social and political forces that drive supply and demand. Fundamental analysts look at various macroeconomic indicators such as economic growth rates, interest rates, inflation, and unemployment. However, there is no single set of beliefs that guide fundamental analysis. There are several theories as to how currencies should be valued.
Technical Analysis or Fundamental Analysis?
Most traders with FXCM abide by technical analysis because it does not require hours of study. Technical analysts can follow many currencies at one time. Fundamental analysts, however, tend to specialize due to the overwhelming amount of data in the market. Technical analysis works well because the currency market tends to develop strong trends. Once technical analysis is mastered, it can be applied with equal ease to any time frame or currency traded.
Market Hours
The spot FX market is unique to any other market in the world, as trading is available 24-hours a day. Somewhere around the world, a financial center is open for business, and banks and other institutions exchange currencies, every hour of the day and night with generally only minor gaps on the weekend. Essentially foreign exchange markets follow the sun around the world, giving traders the flexibility of determining their trading day.
| How Market Hours Work | ||
| Time Zone | New York | GMT |
| Tokyo Open | 7:00 PM | 0:00 |
| Tokyo Close | 4:00 AM | 9:00 |
| London Open | 3:00 AM | 8:00 |
| London Close | 12:00 PM | 17:00 |
| New York Open | 8:00 AM | 13:00 |
| New York Close | 5:00 PM | 22:00 |
How an FX Trade Works
In this market you may buy or sell currencies. The objective is to earn a profit from your position. Placing a trade in the foreign exchange market is simple: the mechanics of a trade are virtually identical to those found in other markets, so the transition for many traders is often seamless.
| Example of How FX Trade Works | ||
| Trader's Action | US Dollars | Euros |
| A trader purchases 10,000 euros when the EUR/USD rate was 1.1020 | -11,020 | +10,000 |
| The trader exchanges his 10,000 euro back into US dollar at the market rate of 1.2620 | +12,620 | -10,000 |
| In this example, the trader earned a gross profit of $1,600 | +1,600 | 0 |
Quoting Conventions
Currencies are quoted in pairs, such as EUR/USD or USD/JPY. The first listed currency is known as the base currency, while the second is called the counter or quote currency. The base currency is the "basis" for the buy or the sell. For example, if you BUY EUR/USD you have bought euros (simultaneously sold dollars). You would do so in expectation that the euro will appreciate (go up) relative to the US dollar.
| Currency Abbreviations | |||
| Definition | Symbol | Definition | Symbol |
| Euro | EUR | US Dollar | USD |
| Great British pound | GBP | Swiss franc | CHF |
| New Zealand dollar | NZD | Australian dollar | AUD |
| Canadian dollar | CAD | Japanese Yen | JPY |
In this example euro is the base currency and thus the "basis" for the buy/sell.
If you believe that the US economy will continue to weaken and this will hurt the US dollar, you would execute a BUY EUR/USD order. By doing so you have bought euros in the expectation that they will appreciate versus the US dollar. If you believe that the US economy is strong and the euro will weaken against the US dollar you would execute a SELL EUR/USD order. By doing so you have sold euros in the expectation that they will depreciate versus the US dollar.
USD/JPY
In this example the US dollar is the base currency and thus the "basis" for the buy/sell.
If you think that the Japanese government is going to weaken the yen in order to help its export industry, you would execute a BUY USD/JPY order. By doing so you have bought U.S dollars in the expectation that they will appreciate versus the Japanese yen. If you believe that Japanese investors are pulling money out of U.S. financial markets and repatriating funds back to Japan, and this will hurt the US dollar, you would execute a SELL USD/JPY order. By doing so you have sold U.S dollars in the expectation that they will depreciate against the Japanese yen.
GBP/USD
In this example the GBP is the base currency and thus the "basis" for the buy/sell.
If you think the British economy will continue to be the leading economy among the G7 nations in terms of growth, thus buying the pound, you would execute a BUY GBP/USD order. By doing so you have bought pounds in the expectation that they will appreciate versus the US dollar. If you believe the British are going to adopt the euro and this will weaken pounds as they devalue their currency in anticipation of the merge, you would execute a SELL GBP/USD order. By doing so you have sold pounds in the expectation that they will depreciate against the US dollar.
USD/CHF
In this example the USD is the base currency and thus the "basis" for the buy/sell.
If you think the US dollar is undervalued, you would execute a BUY USD/CHF order. By doing so you have bought US dollars in the expectation that they will appreciate versus the Swiss Franc. If you believe that due to instability in the Middle East and in U.S. financial markets the dollar will continue to weaken, you would execute a SELL USD/CHF order. By doing so you have sold US dollars in the expectation that they will depreciate against the Swiss franc.
Forex vs. Equities
24-Hour Market
The Forex market is a seamless 24-hour market. The Forex dealing desks are open from Sunday at 5:15PM EST until Friday at 4 PM EST (customer service is available 24/7). With the ability to trade during the U.S., Asian, and European market hours, traders have the advantage of customizing their own trading schedule.
Commission Free Trading
There is no commission or additional transactions fees to trade currencies online. Combined with the tight, consistent, and fully transparent spread, Forex trading costs are lower than those of any other market. The trader platform is compensated for its services through the bid-ask spread.
Rapid Execution of Market Orders
On the FX trading station, traders execute directly off real time streaming prices. There is no discrepancy between the displayed price shown on the platform and the execution price to enter your trade.
Short-Selling without an Uptick
Unlike the equity market, there is no restriction on short selling in the currency market. Trading opportunities exist in the currency market regardless of whether a trader is long or short, or which way the market is moving. Since currency trading always involves buying one currency and selling another, there is no structural bias to the market. Hence, a trader has an equal access to trade in a rising or falling market.
Equity Market: Making the Transition to Forex
Equity markets can be used as a key indicator for movement in the Forex market. As technology has enabled greater ease with respect to transportation of capital, investing in global equity markets has become far more feasible. Accordingly, a rallying equity market in any part of the world serves as an ideal opportunity for all, regardless of geographic location. The result of this has become a strong correlation between a country's equity markets and its currency: if the equity market is rising, investment dollars are coming in to seize the opportunity. Alternatively, falling equity markets will have domestic investors selling their shares of local publicly traded firms only to seize investment opportunities abroad.
| Forex vs. Equities Advantages | ||
| Advantage | FX Market | Stock Market |
| 24-Hour Trading | Yes | No |
| Commission Free Trading* | Yes | No |
| Rapid Execution of Market Orders | Yes | No |
| Short-Selling without an Uptick | Yes | No |