Forex trading popularity is soaring through the roof top! Many investors and curious bystanders are now turning to currency exchange. What is so attractive about forex? Why is it a comfortable way of investment? Why is forex the talk of the day?
Forex market is the largest and most liquid market in the world. Lots of big corporations are taking part – banks, currency speculators, government, and financial institutions. Along with big fish, there are traders like you and I, who slowly but surely take part in the $3 trillion daily turnover.
How do currency markets work?
Unlike shares or commodities, forex trading does not take place on exchanges but directly between two parties, in an over-the-counter (OTC) market. The forex market is run by a global network of banks, spread across four major forex trading centres in different time zones: London, New York, Sydney and Tokyo. Because there is no central location, you can trade forex 24 hours a day.
There are three different types of forex market:
- Spot forex market: the physical exchange of a currency pair, which takes place at the exact point the trade is settled – ie ‘on the spot’ – or within a short period of time
- Forward forex market: a contract is agreed to buy or sell a set amount of a currency at a specified price, to be settled at a set date in the future or within a range of future dates
- Future forex market: a contract is agreed to buy or sell a set amount of a given currency at a set price and date in the future. Unlike forwards, a futures contract is legally binding
Most traders speculating on forex prices will not plan to take delivery of the currency itself; instead they make exchange rate predictions to take advantage of price movements in the market.
- The foreign exchange (also known as FX or forex) market is a global marketplace for exchanging national currencies.
- Because of the worldwide reach of trade, commerce, and finance, forex markets tend to be the largest and most liquid asset markets in the world.
- Currencies trade against each other as exchange rate pairs. For example, EUR/USD is a currency pair for trading euro against the US dollar.
- Forex markets exist as spot (cash) markets as well as derivatives markets offering forwards, futures, options, and currency swaps.
- Market participants use forex to hedge against international currency and interest rate risk, to speculate on geopolitical events, and to diversify portfolios, among several other reasons.
What’s a Pip Worth in Real Money?
Trading one standard lot (100,000 units of the base currency), one pip equals 10 “dollars” worth of the quote currency (the second currency in a currency pair). For example, if you’re trading one standard lot of Gbp/Usd, then one pip = $10 US.
Trading one mini lot (10,000 units of the base currency), one pip equals one “dollar” of the quote currency.
Trading one micro lot (1,000 units of the base currency), one pip equals 1/10th of a dollar of the quote currency (for example, if the quote currency is Usd, then a pip equals 10 cents).
What is so attractive about forex anyway? What made you enter the market arena?
1. Trade Any Time, Any Day!
In the beginning, several years ago, before turning forex to a full-time career, I traded part-time. The greatest thing about this investment is that you can turn it to fit your needs. The fact that forex market is up and running for 24 hours, it is continuous and volatile, makes it possible to enter trades when It best suits you and still make generous chunks of money without the need to search the market for opportunities 24/7.
2. Control Large Sums of Money
A very important feature in trading is leverage. All forex brokers allow traders to use leverage, which is basically a loan that allows you to trade much more money than you actually have in the trading account. For example, if the leverage is 100: 1, you can trade $100 for every $1 in your account. This also means, you can trade $100,000 having just $1,000 of your own capital.
3. Even Small Movements Means Profit
Forex is all about liquidity. Large sums of money are getting in and out of the market even with minimal price movements. Besides, you can choose the direction of your trading decisions. If you believe that the currency pair is going up – buy it! If you think that the currency pair is likely to fall in price, sell it!
4. Relatively Low Fees
We all know that brokers get their commissions via spreads. So since there is no transaction fee, there are fewer expenses for an average trader. There might be some extra fees here and there, but it is generally quite low compared to other commodities and stock market fees.
5. Practice Makes Perfect
My favorite feature in online currency trading is the ability to practice. All forex brokers offer free demo accounts to all traders. On top of that, many have courses and webinars for free or for rather small fee. Mini accounts with very small minimum deposit requirements are also great for practicing. You can get the feel of the market without potentially devastating losses.
6. Money and Risk Management
In forex, like in any other kind of investment, there is a chance of loss. I wouldn’t even use the word “chance”, because loss is the required part of the game! The good thing is that you can control your money and risk with stop/loss to limit losses based on irrational decisions.
7. Trading Platforms and Tools
Today brokers constantly compete for reputation and customers. Every broker differ in one way or another – trading platforms are all different (whether in configuration, download or online, tools included, or user-friendly interface etc.), deposit requirements, features and available tools are unlike, services and support is definitely unique. This colorful variety allows you to find what suits you best.
Advantages of Forex Trading
Here’s a rundown of the main advantages offered by forex trading:
- It requires only a small amount of capital to get started. The forex market is very appealing to small investors because you can begin trading with as little as a few hundred dollars.
- It offers a high degree of leverage. Because of the leverage forex trading offers, one can make sizeable returns on investment with just a small amount of trading capital.
- Selling short is just as easy as buying long. This means that you can just as easily make money in a currency pair that is trending down as in one that is trending up.
- Low transaction costs. The transaction costs for forex trading are relatively low compared to trading other assets. With most brokers, the transaction costs are simply factored into the bid/ask spread.
What moves the forex market?
The forex market is made up of currencies from all over the world, which can make exchange rate predictions difficult as there are many factors that could contribute to price movements. However, like most financial markets, forex is primarily driven by the forces of supply and demand, and it is important to gain an understanding of the influences that drives price fluctuations here.
Supply is controlled by central banks, who can announce measures that will have a significant effect on their currency’s price. Quantitative easing, for instance, involves injecting more money into an economy, and can cause its currency’s price to drop.
Commercial banks and other investors tend to want to put their capital into economies that have a strong outlook. So, if a positive piece of news hits the markets about a certain region, it will encourage investment and increase demand for that region’s currency.
Unless there is a parallel increase in supply for the currency, the disparity between supply and demand will cause its price to increase. Similarly, a piece of negative news can cause investment to decrease and lower a currency’s price. This is why currencies tend to reflect the reported economic health of the region they represent.
Market sentiment, which is often in reaction to the news, can also play a major role in driving currency prices. If traders believe that a currency is headed in a certain direction, they will trade accordingly and may convince others to follow suit, increasing or decreasing demand.
Economic data is integral to the price movements of currencies for two reasons – it gives an indication of how an economy is performing, and it offers insight into what its central bank might do next.
Say, for example, that inflation in the eurozone has risen above the 2% level that the European Central Bank (ECB) aims to maintain. The ECB’s main policy tool to combat rising inflation is increasing European interest rates – so traders might start buying the euro in anticipation of rates going up. With more traders wanting euros, EUR/USD could see a rise in price.
Investors will try to maximise the return they can get from a market, while minimising their risk. So alongside interest rates and economic data, they might also look at credit ratings when deciding where to invest.
A country’s credit rating is an independent assessment of its likelihood of repaying its debts. A country with a high credit rating is seen as a safer area for investment than one with a low credit rating. This often comes into particular focus when credit ratings are upgraded and downgraded. A country with an upgraded credit rating can see its currency increase in price, and vice versa.
Forex Trading Disadvantages
Here are some of the potential disadvantages of forex trading:
- Managing trading with high leverage. Trading with a high degree of leverage amplifies both profits and losses. Traders who fail to realize the importance of careful risk management when using leveraged investments often end up losing money.
- The difficulty of finding a good broker. There are hundreds of forex brokerages to choose from — that alone can make finding a good broker a daunting task. This task is made more challenging by virtue of the unfortunate fact that many forex brokers are simply not reputable firms.
- Risks associated with volatility. Like trading with high leverage, volatility is a double-edged sword. The bid/ask price of a currency pair can move up or down 50, or even 100, pips in the space of just a few moments. Unexpected price surges or collapses can happen at any moment.
How to Identify and Avoid Forex Scams
Some of the most common forex scams to watch for include:
- Spoofing, also called ghosting. When a trader manipulates the market by placing a large order the trader doesn't plan to execute in order to create the impression of interest in the position.
- Front-running. When a broker, knowing a client is going to be placing a big order, places an order for the broker's own account ahead of the client's.
- Signal sellers. Firms or traders who promise to identify buy or sell signals that indicate it's a favorable time to make a trade in exchange for a fee.
- Robot scams. The promise to make automated forex trades using a trading program, often called a "robot."
To trade currency safely, Lies suggests finding a registered broker and understanding how he or she gets paid; the way that brokers profit says a lot about what their incentive structure is. Lies, who is a registered investment adviser, says it would be hard to justify currency trading to his clients because of the volatility in the markets.