Whenever I mention Forex trading to someone, the first question I’m usually asked is, “What the heck is Forex trading?” Well, I’m prepared to answer that question right from the beginning: Forex trading–also known as the foreign exchange market or FX–involves the buying of one nation’s currency and the selling of another nation’s currency. These units of currency are always expressed in pairs, such as EUR/USD for the Euro and the US Dollar. The currency being purchased will be listed first, while the currency being sold is listed second.
Forex trading usually revolves around the world’s major currencies, with more than 80 percent of the market devoted to the Australian Dollar (AUD), British Pound (GBP), Canadian Dollar (CAD), Euro (EUR), Japanese Yen (JPY), Swiss Franc (CHF) and the US Dollar (USD). Trading takes place 24 hours a day, as one session begins when another one ends. Major trading centers are located in London (the largest), Tokyo, New York, Singapore and Hong Kong, although others do exist. Trading is closed on the weekends.
While the average person can participate in Forex trading, the majority of the moves are made by major players such as governments, corporations, and investment banking institutions. Leading currency traders include: Deutsche Bank, Barclays Capital, UBS AG, Royal Bank of Scotland, Citi, Morgan Stanley, Goldman Sachs, HSBC, and Lehman Brothers. There’s a lot of money to be made, and the daily turnover is over $3 trillion (with a 41% increase between 2007 and 2008, alone).
Many savvy investors find Forex trading preferable to that of the traditional stock market. The usual reasons given are twofold:
- Simplicity – Okay, Forex trading isn’t exactly simple, but there are a lot fewer commodities to keep track of. If you combine the New York Stock Exchange and the NASDAQ, there are over 8,000 stocks to monitor and analyze. With the foreign exchange market, there are only four major currencies and thirty-four second tier currencies. 38 is a lot more manageable of a number than 8,000.
- Stability – As you probably know, the traditional stock markets are prone to wild swings due to fluctuating interest rates and the general Bear/Bull mentality; this isn’t the case with Forex trading. If one currency isn’t performing up to expectations, the trader can always look to make a profit with another one.
Forex Trading Terms
- Bid Price – The price at which a buyer is willing to purchase a currency. Always expressed as a 5 digit number.
- Ask Price – The price at which a seller is willing to sell a currency. Always expressed as a 5 digit number.
- Spread – The difference between the bid price and ask price.
- Margin – Collateral for a position. This comes into play when the market moves in a downward direction and the forex trader requires additional funds. This is done by requesting a “margin call.”
- Long Position – The trader buys a currency at a certain price, expecting to sell it later at a higher price.
- Short Position – The trader sells a currency with the expectation of buying it back later at a lower price.
- Spot – A two-day delivery transaction which indicates a direct exchange of currencies.
- Forward – In this style of exchange, money does not change hands until an agreed-upon date in the future.
- Future – Currency which matures at a future date and usually carries a three-month contract.
- Swap – The swap is the most common type of forward transaction. In these cases, two parties agree to swap currencies and then swap them again at a future date.
Forex Trading Participants
There are a wide range of Forex trading participants, meaning those who actively buy and sell currency on the foreign exchange market. Keep in mind that the Forex is divided into multiple levels of access, with the top level only being accessible by the inter-bank market and its collection of the world‘s largest investment banking firms (which accounts for 53% of all transactions). Forex participants include:
- Hedge Funds – These investors speculate on the movement of a currency. A very powerful investment group which controls billions of dollars in equity (with access to billions more).
- Banks – Each day, large banks may trade billions of dollars of currency. Some of this is done on behalf of the bank, while the rest may be done on behalf of customers.
- Central Banks – These are the banks which trade on behalf of their own nation. They often have target rates for their own currency and seek to control factors such as interest rates, money supply and inflation.
- Commercial Companies – These are often companies seeking foreign currency in order to pay for goods or services.
- Non-Bank Foreign Exchange Companies – Offer international payments and the exchange of currency to private companies and individuals.
- Investment Management Firms – These are firms which manage accounts such as endowments or pension funds for their customers.
- Money Transfer Companies – These are companies such as Western Union which assist economic immigrants in transferring money back to their native countries.
- Retail Foreign Exchange Brokers – These individuals or firms make Forex investments on behalf of their customers. In the past, it wasn’t uncommon for brokers to trade against their clients, but this is quickly becoming less common thanks to policies such as NDD (No Dealing Desk) and STP (Straight Through Processing).
So what determines Forex rates? Well, there are actually three major factors in the movement of Forex rates. These include:
- Political conditions
- Markey psychology
- Economic factors (such as a government budget deficit)
Online Forex Trading
Before you begin your online Forex trading career, here are a few things you might want to consider:
- Know Your Diagrams – Diagrams and currency charts are used by investors to analyze market conditions, recognize behavior patterns and create forecasts. Numerous types of charts exist, and it’s important to at least understand how one of these works before you begin your online Forex trading. This will allow you to analyze trades and market movement over the course of seconds, minutes, hours, days, weeks or months.
- Get A Broker – You’ll need to obtain the services of a broker in order to take advantage of online Forex trading. Every broker is different, and it’s important to find one you feel comfortable with. Always examine their record before beginning a relationship, as this will allow you to see how they’ve done on the Forex market over the years. If their performance has traditionally been poor, it might be advisable to seek the services of another Forex broker.
- Mock Accounts – Once upon a time, it was sink or swim when it came to online Forex trading. Now, potential traders can access mock accounts which allow them to trade for free and learn how the system works. This is an excellent way to test out what you know–and what you think you know–without losing a bundle of real money. When you feel comfortable, then you can jump in with the big boys.
- Live Trading – Success isn’t guaranteed when it comes to live online Forex trading. If you make a profit right out of the gate, try not to get too cocky; you’ll probably be brought back to Earth soon enough. If, however, you’re experiencing losses from the beginning, try not to lose your patience. Examine your Forex losses and try to determine if you made a mistake or the market simply made a move beyond your ability to predict. Remember: you’re in this for the long haul, so don’t get easily discouraged.
- Automatic Trading – You can also purchase automatic trading software which will make trades on your behalf. You input certain parameters, and the software does the rest. You can set it in the morning before you go to work, and then check back when you get home to see how much money you’ve made (or lost).
- Remember The Advantages – Online Forex trading can seem complicated to the beginner, but keep the following encouraging news in mind: Forex offers quick trade executions and low commissions, plus the addition of margin loans allow Forex traders to operate at far more than the limiting 2:1 margin of the traditional stock market.
I hope this article on Forex trading has been of some assistance. Forex trading is an exciting way to make money, and it’s a shame that most people aren’t even aware that it exists. Here at AskDeb.com, we’ve got a whole section devoted to Forex trading, so feel free to look around and read our other articles. For that matter, you might also want to look at some of our helpful advice and answers on life, love, and health.