What is Forex Trading?
Forex trading, or, the trade of Foreign Exchange (Forex) has only been commonly available to the retail traders in the last 3-5 years. For the common man, to have access to a forex brokerage house which can process your orders, at his/her convenience was literally impossible 10 years ago.
Today, thanks to the advent of the internet and internet based retail Forex brokerages, retail Forex traders are able to take advantage of this exciting and lucrative business.
Forex trading is basically trading of currencies (foreign exchange). The objective of this trading is to buy and sell currencies in expectance of the currency to rise or fall in value against one another.
The Foreign Exchange Market
The foreign exchange market is the largest and most liquid of all financial markets. Due to the diversity of the various players in the market, and the underlying nature of currencies to be involved in other assets, currency trading is without doubt the most liquid exchange. With central banks, large banks, currency speculators, corporations, hedge funds, governments and other financial institutions being active players in the market, it is easy to understand why.
In fact, daily exchange volume overall is expected to be in the range of $4 Trillion USD to $6 Trillion USD*1 . Foreign exchange volume has grown steadily over the last few years.
Growth in the market volume itself has been expected to be around 41% between 2007 and 2008. Whereas volume in Foreign exchange trading has increased by about 38% between 2005 and 2006.
This is mainly due to the growing importance of foreign exchange as an asset class and as a risk mitigation factor in fund management, assets management, hedge funds and particularly with offshore funds and of pension funds.
The Retail Foreign Exchange Market
With the growing volume of retail Foreign Exchange, there has been a constant influx of various brokers and dealers to facilitate these transactions. As foreign exchange is an OTC(over the counter) market, the brokers and dealers make deals directly with each other. This therefore allows a true global “marketplace” which can allow trading as long as the brokers/dealers are willing to trade.
This has given birth to the possibility of having a true 24 hours environment, which extends over 5 and ½ days.
Of these various exchange hours, the largest volume is determined to be during London trading hours, accounting to about 34% of overall volume in 2007.
It is therefore of little surprise that the Eur/Usd currency pair accounts for almost 27% of all transactions in the exchange market. Therefore, if there is a fundamental news shift or market focus on any event, Eur/Usd will be quite substantially affected as it accounts for more than 1 transaction out of every 4 transactions made.
Trading in the retail Forex Market has been made extremely accessible and affordable with the competitive environment that retail brokerage houses have built over the years. Today, one can start trading in the retail Forex Market using a “demo” or paper trading account with, literally, no money upfront.
This has also given rise to further proponents such as higher margin, lower or no commissions, swap rates on open positions to further aid the retail trader in having a chance at this market.
Further to that, the buying and selling of currency pairs offer trade opportunities in a bullish uptrend market as a bearish downtrend market.
As a summary, the benefits of trading in retail foreign exchange;
Largest Trading Volume
The FX market has a daily combined transactional volume of $3.98 Trillion USD. This is as of Dec 2007 and the volume is constantly increasing.
24 Hour market
Due to the geographical dispersion of the various markets throughout the world, the market is able to operate “continuously” for 24 hours on daily basis, except for Saturdays and Sundays.
High Leverage (Credit Terms)
This refers to the amount of Leverage or Margin offered by such brokers. For every trading dollar that you have invested, your broker may typically offer you 100 times leverage, or even more, which causes the cost of your contracts to be purchased to fall dramatically.
This therefore allows you to own large contracts even with limited capital, which will be otherwise impossible if you were to hold actual physical stocks of such instruments.
There are no commissions chargeable when you place or close your FX contract positions. There is a chargeable “fee” called spreads which can be as little as 2 units at 4 decimal places. When compared to stocks/options, it is normally at about 24 units at 2 decimal places. What a startling difference!
Bi-Directional (Recession Proof) Mkt
Unlike most conventional trading instruments such as stocks and commodities, you can sell (without owning the contract first) in the FX market. This can allow you to be profitable in both a bull (upwards) and bear (downwards) market.
*1 - Source from BIS - Bank of International Settlements.