What is Forex ? FOREX - the foreign exchange market is the largest market in the world (see next question). The purpose of the foreign exchange market 'Forex' is to assist international trade and investment. The foreign exchange market allows businesses to convert one currency to another foreign currency. For example, it permits a U.S. business to import European goods and pay Euros, even though the business's income is in U.S. dollars. Some experts, however, believe that the unchecked speculative movement of currencies by large financial institutions such as hedge funds impedes the markets from correcting global current account imbalances. This carry trade may also lead to loss of competitiveness in some countries. The foreign exchange market is unique because of: • trading volume results in market liquidity • geographical dispersion • continuous operation: 24 hours a day except weekends, i.e. trading from 20:15 UTC on Sunday until 22:00 UTC Friday • the variety of factors that affect exchange rates • the low margins of relative profit compared with other markets of fixed income • the use of leverage to enhance profit margins with respect to account size In the foreign exchange market there is little or no 'inside information'. Exchange rate fluctuations are usually caused by actual monetary flows as well as anticipations on global macroeconomic conditions. Significant news is released publicly so, at least in theory, everyone in the world receives the same news at the same time. As such, it has been referred to as the market closest to the ideal perfect competition, notwithstanding market manipulation by central banks. back to top What is the Market Size and Liquidity ? As have been stated in the prolog, the Forex market is the largest and most liquid financial market in the world. Traders include large banks, central banks, currency speculators, corporations, governments, and other financial institutions. The average daily volume in the global foreign exchange and related markets is continuously growing. Daily turnover was reported to be over US$3.2 trillion in April 2007 by the Bank for International Settlements. Since then, the market has continued to grow. According to Euromoney's annual FX Poll, volumes grew a further 41% between 2007 and 2008. Of the $3.98 trillion daily global turnover, trading in London accounted for around $1.36 trillion, or 34.1% of the total, making London by far the global center for foreign exchange. In second and third places respectively, trading in New York accounted for 16.6%, and Tokyo accounted for 6.0%.In addition to "traditional" turnover, $2.1 trillion was traded in derivatives. Exchange-traded FX futures contracts were introduced in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other futures contracts. Several other developed countries also permit the trading of FX derivative products (like currency futures and options on currency futures) on their exchanges. All these developed countries already have fully convertible capital accounts. Most emerging countries do not permit FX derivative products on their exchanges in view of prevalent controls on the capital accounts. However, a few select emerging countries (e.g., Korea, South Africa and India) have already successfully experimented with the currency futures exchanges, despite having some controls on the capital account. FX futures volume has grown rapidly in recent years, and accounts for about 7% of the total foreign exchange market volume, according to The Wall Street Journal Europe (5/5/06, p. 20). Foreign exchange trading increased by 38% between April 2005 and April 2006 and has more than doubled since 2001. This is largely due to the growing importance of foreign exchange as an asset class and an increase in fund management assets, particularly of hedge funds and pension funds. The diverse selection of execution venues have made it easier for retail traders to trade in the foreign exchange market. In 2006, retail traders constituted over 2% of the whole FX market volumes with an average daily trade volume of over US$50-60 billion (see retail trading platforms). Because foreign exchange is an OTC market where brokers/dealers negotiate directly with one another, there is no central exchange or clearing house. The biggest geographic trading centre is the UK, primarily London, which according to IFSL estimates has increased its share of global turnover in traditional transactions from 31.3% in April 2004 to 34.1% in April 2007. The ten most active traders account for almost 80% of trading volume, according to the 2008 Euromoney FX survey. These large international banks continually provide the market with both bid (buy) and ask (sell) prices. The bid/ask spread is the difference between the price at which a bank or market maker will sell ("ask", or "offer") and the price at which a market taker will buy ("bid") from a wholesale or retail customer. The customer will buy from the market-maker at the higher "ask" price, and will sell at the lower "bid" price, thus giving up the "spread" as the cost of completing the trade. This spread is minimal for actively traded pairs of currencies, usually 0–3 pips. For example, the bid/ask quote of EURUSD might be 1.2200/1.2203 on a retail broker. Minimum trading size for most deals is usually 100,000 units of base currency, which is a standard "lot". These spreads might not apply to retail customers at banks, which will routinely mark up the difference to say 1.2100/1.2300 for transfers, or say 1.2000/1.2400 for banknotes or travelers' checks. Spot prices at market makers vary, but on EURUSD are usually no more than 3 pips wide (i.e., 0.0003). Competition is greatly increased with larger transactions, and pip spreads shrink on the major pairs to as little as 1 to 2 pips. back to top What are the Trading characteristics ? Being the world's largest financial market, the forex market offers unmatched benefits and advantages to the prospective investor. With superior liquidity and leverage compared to stocks and futures markets, the forex market is arguably the best financial investment you can find. What makes the forex market an excellent financial market? The characteristics that make the forex market a good one are lower trading costs, excellent transparency, superior liquidity and very strong market trends. EXCELLENT TRANSPARENCY Transparency means the free access to trading information. Forex trading is a transparent process because the trader has full access to market data and information that are necessary to perform successful transactions. The excellent transparency of the forex market means that forex traders have more control over their investments and can decide what to do based on the information available. LOWER TRADING COSTS The lower trading costs in the forex market has made it possible for even small, individual investors to make decent profits from forex trading. With lower costs, the possible losses are also much lower. You will discover that forex trading usually has no commission fees unlike in other investments. The costs of forex trading are limited to the spread or the difference between the selling and buying prices for a particular currency pair. SUPERIOR LIQUIDITY In a forex market, traders are free to buy and sell currencies of their own choosing. The superior liquidity of the forex market enables traders to easily exchange currencies without affecting the prices of the currencies being traded. So whether you trade a few thousand dollars or several millions, you can be assured of the same currency prices during the time an order was placed and then executed. The forex market's superior liquidity allows you to get the profits you expect at the time you made the trade. STRONG MARKET TRENDS Forex traders make money by getting accurate market data and then analyzing the direction the market takes. To do this, forex traders rely heavily on trends and trending in an attempt to predict the direction of the forex market. Most traders use technical analysis to analyze past and present forex market data and then search for trends. Other financial markets use trends and trending but this characteristic is much stronger in the forex market. Due to strong trending, forex markets are much easier to analyze and identify possible entry and exit positions during trading. back to top What are the main currency pairs? Currencies are traded against one another. Each currency pair thus constitutes an individual trading product and is traditionally noted XXXYYY or XXX/YYY, where XXX and YYY are the ISO 4217 international three-letter code of the currencies involved. The first currency (XXX) is the base currency that is quoted relative to the second currency (YYY), called the counter currency (or quote currency). For instance, the quotation EURUSD (EUR/USD) 1.3465 is the price of the euro expressed in US dollars, meaning 1 euro = 1.3465 dollars. Historically, the base currency was the stronger currency at the creation of the pair. However, when the euro was created, the European Central Bank mandated that it always be the base currency in any pairing. The factors affecting XXX will affect both XXXYYY and XXXZZZ. This causes positive currency correlation between XXXYYY and XXXZZZ. On the spot market, according to the BIS study, the most heavily traded products were: • EURUSD: 27% • USDJPY: 13% • GBPUSD (also called cable): 12% and the US currency was involved in 86.3% of transactions, followed by the euro (37.0%), the yen (17.0%), and sterling (15.0%) . Volume percentages for all individual currencies should add up to 200%, as each transaction involves two currencies. back to top What are the Determinants of FX Rates ? The basic theories underlying the exchange rates : 1. Law of One Price: In competitive markets free of transportation costs barriers to trade, identical products sold in different countries must sell at the same price when the prices are expressed in terms of their same currency. Purchasing power parity: As inflation forces prices higher in one country but not another country, the exchange rate will change to reflect the change in relative purchasing power of the two currencies. 2. Interest rate effects: If capital is allowed to flow freely, the exchange rates stabilize at a point where equality of interest is established. The dual forces of demand and supply determine exchange rates. Various factors affect these, which in turn affect the exchange rates: The business environment: Positive indications (in terms of government policy, competitive advantages, market size etc) increase the demand of the currency, as more and more entities want to invest there. This investment is for two basic motives –purely business motive, and for risk diversification purposes. Foreign direct investment is for taking advantage of the comparative advantages and the economies of scale. Portfolio investment is mainly done for risk diversification purposes. Stock market: The major stock indices also have a correlation with the currency rates. The Dow is the most influential index on the dollar. Since the mid-1990s, the index has shown a strong positive correlation with the dollar as foreign investors purchased US equities. Three major forces affect the indices: 1) Corporate earnings, forecast and actual; 2) Interest rate expectations and 3) Global considerations. Consequently, these factors channel their way through the local currency. Political Factors: All exchange rates are susceptible to political instability and anticipations about the new ruling party. A threat to coalition governments in France, India, Germany or Italy will certainly affect the exchange rate. For example, political or financial instability in Russia is also a red flag for EUR/USD, because of the substantial amount of Germany investment directed to Russia. Economic Data: Economic data items like labor report (payrolls, unemployment rate and average hourly earnings), CPI, PPI, GDP, international trade, productivity, industrial production, consumer confidence etc. also affect the exchange rate fluctuations. Confidence in a currency is the greatest determinant of the exchange rates. Decisions are made keeping in mind the future developments that may affect the currency. And any adverse sentiments have a contagion effect. The observers have generally concluded that devaluations should be avoided at all costs, since the panics have almost all followed currency devaluations. Some are of the view that is it not the devaluation, but rather the defense of the exchange rate preceding the crisis that opens the door to financial panic. The devaluation, which follows the depletion of reserves usually, alerts the market to the exhaustion of reserves, a state of affairs, which is not fully apparent to many market participants before the devaluation takes place. Holders begin to convert their money into foreign exchange in expectation of devaluation, and suppose that the central bank defends the exchange rate, by buying high-powered money and selling dollars. Thus, a panic can unfold simply by the belief of creditors that it will indeed occur. In the past four years, mainly three types of events have triggered such panics: 1) The sudden discovery that reserves is less than previously believed 2) Unexpected devaluation (often in part for its role in signaling the depletion of reserves); and, 3) Contagion from neighboring countries, in a situation of perceived vulnerability (low reserves, high short-term debt, overvalued currency). Government influence: A country's government may reduce the growth in the money supply, raising interest rates, and encouraging demand for its currency. Or a government may simply buy or sell forex to maintain stability or to support either exporters or importers. Productivity of an economy: An increase in productivity of an economy tends to impact exchange rates. It affects are more prominent if the increase is in the traded sector. A recent study by the federal reserve bank of New York shows that over a 30 yrs. Period [1970-1999] productivity changes and the dollar /euro real exchange rates have moved in tandem. Algorithmic Trading / Forex –Robots (press tab: Forextra – Service) Electronic trading is rowing in the FX market, and algorithmic trading is becoming much more common. According to financial consultancy Celent estimates, by 2008 up to 25% of all trades by volume will be executed using algorithm, up from about 18% in 2005. Now you already know the characteristics that make the Forex market a sound, financially-stable and profitable investment area, maybe it's time to put your money into a reliable Forex trading system and earn handsome profits. You can just take advantage of the Forex market's positive assets and make your money work for you by using the “Forextra –Robot“ (press tab: Services) • Main source of info : Wikipedia back to top |
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