What Is Forex and Foreign Currency Trading?
Can You Make Money Trading Foreign Currencies
- What Is Forex Foreign Currency Trading?
- Where are the Forex Foreign Currency Markets?
- Who Trades in the Forex Foreign Currency Market?
- How Did Forex Foreign Currency Trading Get Started?
- When Are the Forex Currency Trading Markets Open?
- How Can I Trade Forex Foreign Currencies?
- How Do Forex Foreign Currencies Trade?
- What Foreign Currencies Are Traded?
- How Leverage Increases Forex Profits, Losses and Risk
- Why Does the Price of a Foreign Currency Change?
- Role of Governments in Forex Foreign Exchange Trading
- Market Psychology in Forex Foreign Exchange Trading
What Is Forex Foreign Currency Trading?
What is Forex? Forex is shorthand for the foreign exchange market
. Forex is the worldwide market for trading the currencies of the world. Dollars are traded for pounds, pounds for yen, yens for euros, euros for Hong Kong dollars, and so on. Forex is the new gold rush
of the Internet age. Foreign exchange trading has increased because of the importance of foreign currency as an investment asset class and because hedge funds and pension funds are active in Forex. The development of Internet trading platforms also makes it easier for retail traders to trade in the foreign exchange market.
Where are the Forex Foreign Currency Markets?
There is no single clearing house for foreign exchange
, and no single price for a currency. The money market is an over-the-counter market. The foreign exchange market exists wherever one currency is traded for another. It is by far the largest financial market in the world, and includes trading between large banks, national central banks, currency speculators, multinational corporations, governments, and other financial markets and institutions.
Who Trades in the Forex Foreign Currency Market?
Many institutions must trade in the Forex foreign exchange market
. Worldwide corporations need to hedge risk and pay employees in different countries. A U.S. company that sells goods in Japan for yen, wants to trade its yen for dollars in the money markets to repatriate its profits. Large hedge funds, pension funds, insurance companies and mutual funds also use the Forex market. The central bank of each country also trades in the forex market to support the price of the national currency and to fund government operations. Also trading in the Forex foreign currency markets are the private financiers like George Soros who, it is said, made $3 billion in 3 days by speculating in currencies.
Almost ¾ of all Forex foreign currency trading
is done by ten large banks and brokers, who set and publish the prices. They are Deutsche Bank, UBS AG, Citigroup, Barclays Capital, Royal Bank of Scotland, Goldman Sachs, HSBC, Bank of America, JPMorgan Chase and Merrill Lynch. On an average day, in US dollars, $3 trillion worth of currency trades takes place around the globe. In the inter-bank currency market, there is no central exchange or clearing house. Brokers, bankers and dealers used to negotiate directly with one another by voice, but now most use dealing platforms like EBS, Reuters, Fxall and Currenex.
There is no unified or central clearing market
for the majority of Forex currency trades, and there is very little cross-border regulation. Instead, there are a number of interconnected marketplaces, where different currency instruments are traded. Thus there could be several different prices for a product at the same time. In practice, the prices are usually very close. If prices became different in two marketplaces, arbitrageurs immediately would step in to take advantage of the price difference, buying in the cheaper market and selling at the higher price.
How Did Forex Foreign Currency Trading Get Started?
Forex foreign currency exchange trading started after 1970
. Before 1970, the exchange rate for all world currencies was fixed. During the 1970s countries gradually switched to floating exchange rates for their currencies from the previous fixed exchange rates. Floating exchange rates made possible the modern foreign exchange markets.
A joint venture of the Chicago Mercantile Exchange and Reuters
, called FXMarketSpace, opened. It is expected to become a central market clearing mechanism.
When Are the Forex Currency Trading Markets Open?
The Forex markets to trade foreign currencies
are open 24 hours a day somewhere in the world, Monday through Friday. Each day, Forex trading begins in Wellington New Zealand, followed by Sydney Australia, Tokyo, HongKong, Singapore, then Bahrain and the rest of the Middle East, London with the rest of Europe and, finally, New York and the rest of the USA. The U.S. and U.K. trading sessions account for more than 50% of the Forex market transactions. London, New York and Tokyo are the largest markets. Nearly two-thirds of the U.S. activity occurs in the morning hours while the European markets are open. Forex trading activity is the heaviest when the major markets overlap. Traders prefer to trade during these times.
How Can I Trade Forex Foreign Currencies?
Individuals who trade in the Forex foreign currency markets
are called retail traders. They are a small fraction of the Forex market and may only participate indirectly through brokers or banks. Retail forex brokers or market makers handle a minute fraction of the total volume of the foreign exchange market, say $25 to $50 billion a day, which is about 2% of the whole Forex market.
In the United States, Forex foreign currency trading
is regulated by the National Futures Association, which is under the Commodity Futures Trading Commission. All Forex dealers and market makers must be registered with the NFA, but account managers and reps are not regulated.
How Do Forex Foreign Currencies Trade?
For each currency pair, large international banks continually provide the market with both bid and ask prices, that is, the price they at which they will buy and the price at which they will sell. The difference between the bid and the ask price is called the spread.
The price of a foreign currency is quoted
in another currency such as EUR/USD bid 1.4173, ask 1.4176. This quote means that the market maker will buy euros at 1.4173 dollars, and sell euros for 1.4176 dollars. Each trade involves two currencies, the one you are buying and the one you are selling, or paying with. Currencies are traded against one another. Each pair of currencies thus constitutes an individual product. If the quote moves from EUR/USD 1.2500 to EUR/USD 1.2510, the euro is getting stronger and the dollar weaker. On the other hand if the EUR/USD quote moves from 1.2500 to 1.2490, the euro is getting weaker while the dollar is getting stronger.
A pip is the smallest number
in a quotation of a currency. A pip is determined by the last decimal place in the price. If the Japanese yen climbs from 105.05 to 105.08 against the U.S. dollar, it has gained three pips. If the euro jumps from 1.0032 to 1.0072, it has gained 40 pips. If you buy EUR/USD at 1.4173 and sell at 1.4176, you have made 3 pips. The spread runs about 1-3 pips for actively traded pairs.
What Foreign Currencies Are Traded?
Forex foreign currency trading uses a pair of two currencies for each trade
. The most liquid and widely traded currency pairs are called the Majors. Trades involving majors make up about 90% of total Forex trading. The currency codes are : EUR euro; GBP Great Britain pound; JPY Japan yen; CHF Swiss franc; AUD Australian dollar; CAD Canadian dollar, NZD New Zealand dollar.
The Major trading pairs are: EUR/USD, GBP/USD, USD/JPY, USD/CHF, AUD/USD and USD/CAD. The GBP/USD is known as "Cable", from the days when a undersea cable linked London and New York traders in the GBP/USD.
Other currency pairs have nicknames
|Forex Foreign Currency Trading Pairs|
|AUD/USD the Aussie||EUR/USD the Euro|
|GBP/JPY the Geppy||GBP/USD the Cable|
|NZD/USD the Kiwi||USD/CAD the Loonie|
|USD/CHF the Swissy||USD/JPY the Gopher|
How Leverage Increases Forex Profits, Losses and Risk
For the small investor who trades foreign currencies in the Forex market
, leverage is an essential part of the trade. It enables him/her to make more than a few pips on a trade. You can buy currencies on margin, using borrowed money for your trade. Minimum trading size for most deals is usually $100,000. You can trade a $101,000 lot with just $1,000 of your own money and $100,000 of borrowed funds. This is leverage of 100:1. If you sell out for $116,000, you can repay the $100,000 and keep the $15,000 gain for yourself, minus interest charges. This is a return of 1500% on your investment of $1,000.
Give me a place to stand and with a lever I will move the whole world. – Archimedes
The leverage of borrowed money
works in your favor, when your trade makes money. Leverage works to your disadvantage when your trade loses money. You could lose $14,000, and owe $13,000 to the broker. In reality, it is unlikely that you will lose this much. If the value of your position falls below the amount in your account, the position will be closed out for you and your account closed.
Why Does the Price of a Foreign Currency Change?
There are many factors that determine the prices when you trade Forex foreign currencies
. Money has no intrinsic value. Its value is determined by the willingness of people to accept it as a mediium of barter. The value of a currency fluctuates as a result of supply and demand. It reflects events going on in the world. The factors that move currency prices are economic factors, political conditions and market psychology, both the actual current conditions, their trends and the expectation of future events.
The price of a Forex foreign currency is affected by economic factors such as
government actions, the balance of trade in a country, inflation, and a country’s prosperity. An increase in the government budget deficit has a negative affect on its currency. Trade deficits, when a country imports more than it exports, affect its currency. The monetary policy of a government and the level of interest rates affect a country’s currency. Economic reports of the gross domestic product, employment level, retail sales and capacity utilization are also significant. Large international mergers and acquisitions are another factor. When a country is productive and stable, the demand for its currency increases and likewise its price.
Role of Governments in Forex Foreign Exchange Trading
National central banks, with their substantial currency reserves, play an important role in the Forex foreign currency market
. Sometimes national central banks try to support currency prices by intervening in the markets. Nevertheless, the global currency markets cannot be controlled by any one country.
The Forex foreign currency exchange market is also affected by war, revolutions, political upheaval
and natural disasters. Any element of uncertainty or surprise can change the price of a currency in the foreign exchange markets. If governments need more money, or if they run deficits and ruin their credit, they can always make more money, or else raise taxes. There is an economic relationship between an increase in the money supply and an increase in prices of goods and services, which we know as inflation. Interest rate changes are important for the price of a country’s currency. Money markets around the world keep a check on government powers.
Market Psychology in Forex Foreign Exchange Trading
The psychology of the Forex foreign currency market
and the perceptions of traders influence foreign currency prices. In period of uncertainty and upheaval, markets turn to stronger currencies as a safe haven. Traders often move as a herd in anticipation of future events, rightly or wrongly, which can lead to a market that is overbought or oversold. Traders often fixate on a certain economic figure as the talisman of trading strategy and get trigger-happy when any change is announced. They can grow preoccupied with money supply or inflation and over-weigh its significance.
There is little or no inside information in the Forex foreign currency markets
. Major news is released publicly, often on scheduled dates, so most people have access to the same news at the same time. However, the large banks still have an important advantage in the foreign exchange market because they can see their customers' order flow.
Whether you are active in the Forex foreign currency trading markets
, or you decide to sit this game out on the sidelines, in coming years you’ll hear more about Forex and foreign currency trading as an important, growing financial arena.
I hope life brings you much success.
I wish you a very happy day.
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