Forex is the foreign exchange
market (also known as the currency exchange market or just FX). If you have ever
visited a foreign country and needed to trade some of your currency for their
currency – you have already participated in a Forex transaction. Traders do not actually “handle” the foreign
currencies that they buy/sell, but are speculating on the currency exchange
rates between two countries. Since exchange
rates change constantly, there is
always an opportunity to profit from these exchanges. Forex markets trade about $5 trillion (USD)
per day, making Forex the largest and most liquid financial market in the world. By comparison, all the world’s stock exchange
markets combined turn over around $50 billion USD per day; in other words, the
Forex market trades about 98 times more volume than the stock exchanges daily!
When and where do you trade Forex?
This international market has no
(physical) central marketplace for foreign exchange. Trades are made almost instantaneously online
from just the push of a button. You can
basically trade from anywhere. On
vacation in Hawaii? No problem! As long as you have an internet connection,
you can trade from your laptop, tablet, or even smart phone.
The trading day has three main sessions: Asia,
London, and New York. These run in a
continuous loop, with some overlap – because of the different time zones around
the world, there are always markets available to trade via the internet 24
hours a day, Monday through Friday. So,
you really can set your own schedule (though there are certain times that most
traders feel are most important to pay attention to, such as NY close).
Who can Trade Forex?
Although the major players are
large financial institutions and corporations, since the advent of the internet
– literally anyone can learn to trade
Forex and participate in the electronic OTC (over-the-counter) market via a
Forex broker. It doesn’t matter where
you’re from, what language you speak, whether you hold any degrees, have
internship experience, or special training – no one is checking on your
credentials in this field. The only
thing that matters is results. Since it’s your money you’re risking, you
answer to yourself. Individuals, who
trade for themselves and not for an employer, are called “retail traders”. Retail traders make up about 5% of the entire
Forex market.
Four Markets to Trade Forex
The largest market by far is the
“spot market”, and when people refer to Forex trading, they are usually
referring to the spot market. The spot
market is where currencies are bought and sold for the current price (“on the
spot”). This market has the greatest
liquidity (meaning a readily available supply of buyers and sellers), which is
important because the greater the liquidity the more easily the market can move
(and we need that volatility in order to make money in the market).
The “futures market” (sometimes
called “forwards”) is where currencies are not actually traded, but instead
they deal in contracts to buy or sell at a specific price on a specific future
date. Futures markets’ contracts can
offer protection against risk when trading currencies. Typically, corporations use these markets to
hedge against future exchange rate fluctuations, but there are some speculators
that take part in these markets as well.
These markets take place in well-regulated and monitored exchanges, so
they are relatively safe – but cannot be traded 24-hours a day.
The “options market” deals with
financial instruments called “options” that allow a trader to have the option to buy or sell an asset at a
specific price on the expiration date of the option. Options are traded through a central exchange
just like futures, so they cannot be traded 24-hours per day. One downside to Forex options trading is that
it has less liquidity than the futures or spot markets.
The last market is the
“Exchange-Traded Funds market” (or ETFs).
ETFs allow traders to diversify with different assets, so they could
have a combination of currencies and stocks in one ETF. ETFs are created by financial institutions,
and since they contain stocks, they are subject to commissions and transaction
costs. ETFs are traded through exchanges
and are not open for trading 24-hours a day.
Advantages of Forex Trading
We’ve already mentioned the fact
that the Forex market is open 24-hours a
day, Monday through Friday – this is a huge advantage because there are
just far more opportunities to trade than a market which is open only during
normal business hours. We also discussed
the high liquidity of the Forex
market, which means that there is constant change in the price of
currencies. As we pointed out – we need
this movement in price in order to create opportunities for us traders to
profit.
Another advantage is that unlike
most markets, it’s fairly easy to get started in Forex trading. You don’t have to go to a special school to
learn to be a trader or work for a big bank, and you don’t need much money to
get started. There are even free demo
accounts offered by brokers, so you can learn how to use the trading platform
and get the hang of things before risking your cash. The internet is flooded with information and videos
on “how to trade Forex”, and there are many online communities that a new
trader can participate in to learn the ropes as well.
Forex brokers offer low
transaction costs when compared to other exchange markets (in the form of the
bid/ask spread). There are also no fixed
lot sizes in the forex market, so you can determine the amount of risk you are
willing to take on your trades. Also,
because brokers offer leverage (a.k.a. gearing), a small deposit can still give
the trader the ability to make nice profits and at the same time keep your risk
to a minimum (leverage does increase risk however, more on that later).
In my opinion, the best advantage
of all is that you can work from home, while on the road, on vacation,
wherever! Successful retail Forex
traders work for themselves, and don’t have a boss to answer to, can wear
whatever they want, look however they want, etc. Forex trading doesn’t have to take up all of
your time either; you can spend as little as 30 minutes a day analyzing the
charts and managing your trades. For
many people, Forex is the dream job, that could provide the dream lifestyle and
the time to enjoy it.
Risks of Forex Trading
Like any form of trading, Forex is
not without risk. Forex trading actually
carries more risk due to the trader’s ability to leverage capital; leverage
magnifies profits, but it also magnifies losses. For example, let’s say you had a 50:1
leverage ratio, this means that it is possible to enter into a trade for up to
50 dollars for every dollar in your account.
So, while risking $1000, you could potentially earn $50,000. However, you also run the risk of losing
funds based on a $50,000 trade, so if you aren’t careful, you can quickly wipe
out your account causing a margin closeout. Lastly, make sure that you are
dealing only with a reputable broker who is in good standing with the
recognized regulators for their country.
Fraud used to be a serious problem in Forex trading, but most countries
now have regulators that supervise the trading market and brokers; just
remember that not all countries’ governments and regulators are free of
corruption themselves, so brokers from these areas are riskier.
The fact is that majority of
traders lose money in the Forex market because they rush in and begin trade
before they really understand the markets.
Some traders fail because they approach trading like gambling. The
thrill of Forex can be addictive, and certain traders seem to be unable to stop
themselves from overtrading and over extending their risk. Also, be cautious of paying for things like “magical
indicators”, “signal services”, and expensive “guaranteed to win” trading
systems; there are many scams and worthless “helpers” available on the
internet.
Conclusion
Like any skill, it takes time to
learn what works with Forex. It’s not a
get-rich-quick scheme. Successful
trading requires to you to not only “figure it out”, but also to have mental
discipline, a strong psychological fortitude, and proper money management with
a positive risk/reward system in place.