Forex

Foreign exchange or forex is the term used to describe the trading of the world's many currencies. With more than $1.5 trillion worth of trading every day, the forex market is the largest market in the world. The forex market is an unofficial decentralized market. Unlike common stocks or futures, there is no central exchange for forex trading.

The major currencies traded in the forex markets are the Euro, US dollar, Japanese yen, Swiss franc, Canadian dollar, Australian dollar and New Zealand dollar. Other currencies are available but as they are not traded often, the cost of trading them is much higher and so the forex traders generally focus on the more popular currencies.

Forex trading offers significant benefits to the small investor that may not be available in other markets, or other forms of investment. It has a high profitability potential. A forex trader can make a huge fortune even with a small investment. The trading is highly leveraged.

There is very little compliance requirements in forex trading and as such one can save a lot of money and time which would otherwise have been spent in complying with a range of government regulations, filling in returns and keeping up to date with various laws. There are no licenses and sales tax.

Forex market is a perfect market to invest in virtually free of any external controls, making it almost impossible for anyone to manipulate it. All forex trading is mostly tentative. Transactions are conducted between two counterparts over the telephone or via an electronic network.

Due to its huge size and turnover, the forex market is very liquid. One can enter or exit trading positions easily at the current market price whenever the market is open. There will always be a buyer or seller at the market price. The market is transparent and any information that affects the market price is available to all market participants. There is no discrimination between large and small traders. The huge size of the market makes it very difficult to be manipulated, especially in the medium or long term.

The forex markets reflect long term trends. Traders can take advantage of large long term movements to make significant profits. The capital requirements to begin trading are minor and one can start with less than $1000. Forex is often traded without commissions.

The trading is automated and can be one online 24 hours a day when the market is open. One of the major advantages of forex trading is the opportunity to trade 24 hours a day from Sunday evening (20:00 GMT) to Friday evening (22:00 GMT). There is no paperwork. There is no need for physical office and staff.

Forex market does away with the middlemen and allows traders to interact directly with the market-maker responsible for the pricing on a particular currency pair. Unlike the stock market which can be influenced by a particular investor buying or selling a particular stock, the forex market cannot be influenced. Experts and analysts can only analyze the forex market. They cannot drive the market. While there are over thousands of stocks listed on a stock exchange, in a forex market there are less than 10 major currencies and about 30 odd second tier currencies. There are no commissions, no clearing fees, no exchange fees, no government fees, and no brokerage fees.

The profit in a forex market is generated from the fluctuations or changes in the currency rates. The regular daily fluctuations are generally multiplied by 100. So 0.6% increases in the exchange rate of currency pair can result in a profit of 60% of the investment. This can happen in one business day, or in a few hours, even minutes.

Currency prices, though volatile, tend to create and follow trends, allowing an experienced forex trader to spot and take advantage of many entry and exit points.

Forex quotes always include a bid and an ask price. The price at which a market maker or a broker or a dealer is willing to buy the base currency in exchange for the counter currency is known as the bid while the price at which the market maker is willing to sell the base currency in exchange for the counter currency is known as the ask price. A market order is an order to buy or sell a currency pair at the market price the instant that the order is received and processed. An entry order is an order to buy or sell a currency pair when it reaches a certain price target. This can be any price in theory. One can set an entry order for the low price of a time period, or the high price of a time period.

Banks, Central banks, Hedge funds, Individual traders and brokers are the major players in the forex market. Banks dominate a major portion of the total turnover in the forex market. Banks buy and sell currencies needed by their customers and also to hedge or protect against market movements on behalf of their customers as well as for trading purposes.

With the internet expanding, individual traders are becoming more active in the forex market. Brokers provide access to the forex market to the individual traders. A broker will provide account keeping services, execute trades and usually provides some software to place orders and allow the trader to look at current prices and charts. Brokers earn their profit by charging a spread - a difference between the buying and selling price.

Central Banks are responsible for the country’s economy and use the forex market in an attempt to regulate or smooth exchange rates. Central banks are typically active in their own currency and make enormous trades that can quickly result in significant short term market movements. They are more active when there are sudden spikes or dips in their national currency.

Hedge funds manage funds on behalf of high net worth individuals and invest in various markets including forex in order to make speculative profits for their customers.

The forex market decentralized market which is conducted over the counter and is sometimes known as inter-bank market. Trading may be over the telephone or computer networks across the world. The forex market is a 24 hour market. The main trading centers are New York, London, Tokyo, Frankfurt and Sydney. The buyers and sellers set the prices by agreement. The difference in supply and demand with a forex market affect the prices – high demand for a currency with a low supply of that currency will increase the prices. The transactions are always between two national currencies known as currency pairs such as EUR/USD. When someone buys a EUR/USD pair, it means that they are buying Euros and selling US dollars. Basically forex trade is the simultaneous buying of one national currency and selling of another.

To make a profit, traders must sell a currency position for a price higher than they have bought it for. Sometimes a seller may sell a position and buy it back later. This is known as short selling or going short. As forex trading always involves buying one currency and selling another, so traders can easily trade in a rising or falling market. There are no restrictions on short selling. Short selling generally takes place when the market declines. A trader can also buy a position for sale later at a higher price. This is called going long. In a forex market one can make money as long as one can determine the direction the market will go in. The rise or fall in the market does not affect the chances of making money. For every dollar lost in the market, there is someone else who has made a dollar in profit. In short, the forex market does not create or destroy wealth it just moves them from one party to another.

A trader may find it very difficult to make a profit always. Often the market position will not be favorable despite best efforts. To make profits in the forex market, one must be willing to take losses.

In the forex market, the prices move constantly due to the different expectations of market participants, and the imbalance between buyers and sellers. The price moves up when there are more buyers than sellers and moves down when there are more sellers than buyers. Since there is no intrinsic value in currencies the market movements up or down can be very large. The value of a currency is determined purely by supply and demand. Prices represent the market consensus. The current market price reflects all the publicly available data such as key economic data of the country and the activities of the buyers and sellers. This theory is called the efficient market hypothesis. This hypothesis is contentious, because on the face of it implies that it is impossible to make excess profits without taking on more risk, since all information is reflected in prices. Professional forex traders are consistently able to make long term profits without taking on any more risk than other market participants as a result of better analysis of publicly available information and trading techniques, and because of better quantification and management of risk.

There is a high degree of risk in forex trading. Currency prices can fall rapidly resulting in substantial losses.

Forex is by nature speculative. The forex market is amongst the most volatile markets in the world. When traded on a margined basis they effectively become the most volatile in the world.  Traders with an appetite for high risks can make huge profits by indulging in day trading. Day trading is however not for everyone. It is essentially speculation.

The nature of forex trading does not lend itself as much to investment as it does to speculation. A long term investment in forex is possible but it requires a large account value and low leveraging.

A national currency is always exposed to the changes in the country’s political, economic and security situation all of which can substantially affect the price or availability of its currency. Volatile markets, political events and even the weather can cause unexpected rate changes.  Sudden changes in currency rates can cause substantial losses. Traders can overcome the risk of such unexpected rate changes by using stop loss orders which minimize loss by exiting a position if the currency price reaches a pre-set level. The trader decides the amount of loss that is acceptable for a given transaction, and puts the stop loss order in when entering that transaction.

Most forex trading is done on credit. There is the possibility that one party in a FOREX transaction may not honor their debt when the deal is closed.  A trader can lose his profit if the other party in the transaction declares bankruptcy.

There are factors beyond the control of the traders which add to the risks in forex trading. Variations in interest rates from one country to another can cause the profits of a forex transaction to be less than expected. Governments sometimes try to control the price of their currency by limiting the flow of currency. There is more country risk associated with exotic currencies than with major currencies that allow the free trading of their currency.

For even more information visit: http://en.wikipedia.org/wiki/Forex

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