FOREX

25/7/2007

What is FOREX?

What is FOREX?

FOREX (FOReign EXchange market) is an international foreign exchange market, where money is sold and bought freely. In its present condition FOREX was launched in the 1970s, when free exchange rates were introduced, and only the participants of the market determine the price of one currency against the other proceeding from supply and demand.

As far as the freedom from any external control and free competition are concerned, FOREX is a perfect market. It is also the biggest liquid financial market. According to various assessments, money masses in the market constitute from 1 to 1.5 trillion US dollars a day. (It is impossible to determine an absolutely exact number because trading is not centralized on an exchange.) Transactions are conducted all over the world via telecommunications 24 hours a day from 00:00 GMT on Monday to 10:00 pm GMT on Friday. Practically in every time zone (that is, in Frankfurt-on-Main, London, New York, Tokyo, Hong Kong, etc.) there are dealers who will quote currencies.

FOREX is a more objective market, because if some of its participants would like to change prices, for some manipulative purpose, they would have to operate with tens of billions dollars. That is why any influence by a single participants in the market is practically out of the question. The superior liquidity allows the traders to open and/or close positions within a few seconds. The time of keeping a position is arbitrary and has no limits: from several seconds to many years. It depends only on your trading strategies. Although the daily fluctuations of currencies are rather insignificant, you may use the credit lines, that are accessible even to currency speculators with small capitals ($ 1,000 - 5,000), where the profit may be impressive. (You can learn more about it in the section: The main principles of trading.)

The idea of marginal trading stems from the fact that in FOREX speculative interests can be satisfied without a real money supply. This decreases overhead expenses for transferring money and gives an opportunity to open positions with a small account in US dollars, buying and selling a lot of other currencies. That is, on can conduct transactions very quickly, getting a big profit, when the exchange rates go up or down. Many speculative transactions in the international financial markets are made on the principles of marginal trading.

Margin trading is trading with a borrowed capital. Marginal trading in an exchange market uses lots. 1 lot equals approximately $100,000, but to open it it is necessary to have only from 0.5% to 4% of the sum.

For example, you have analyzed the situation in the market and come to the conclusion that the pound will go up against the dollar. You open 1 lot for buying the pound (GBP) with the margin 1% (1:1000 leverage) at the price of 1.49889 and wait for the exchange rate to go up. Some time later your expectations become true. You close the position at 1.5050 and earn 61 pips (about $ 405). For the calculation of 1 pip click here.

Everyday fluctuations of currencies constitute about 100 to 150 pips, giving FX traders an opportunity to make money on these changes.

In FOREX, it's not obligatory to buy some currency first in order to sell it later. It's possible to open positions for buying and selling any currency without actually having it. Usually Internet-brokers establish the minimum deposit such as $ 2000, for working in the FOREX market, and grant a leverage of 1:100. That is, opening the position at $100,000, a trader invests $1,000 and receives $99.000 as a credit. The major currencies traded in FOREX, are Euro (EUR), Japanese yen (JPY), British Pound (GBP), and Swiss Franc (CHF). All of them are traded against the US dollar (USD).

In order to assess the situation in the market a trader has to be able to use fundamental and/or technical analysis, as well as to make decisions in the constantly changing current of information about political and economic character. Most small and medium players in financial markets use technical analysis. Technical analysis presupposes that all the information about the market and its further fluctuations is contained in the price chain. Any factor, that has some influence on the price, be it economic, political or psychological, has already been considered by the market and included in the price. The initial data for a technical analysis are prices: the highest and the lowest prices, the price of opening and closing within a certain period of time, and the volume of transactions.

A technical analysis is founded on three suppositions:
  • Movement of the market considers everything;
  • Movement of prices is purposeful;
  • History repeats itself.
That is, technical analysis is a statistical and mathematical analysis of previous quotes and a prognosis of coming prices.

A number of technical indicators have been installed into the PRO-CHARTS trading system. Analyzing the indicators one can come to the conclusion about further movements of the quoted currencies. For a more detailed de******ion of the indicators, analyzing price charts and volumes of trading, click here.

Fundamental analysis is an analysis of current situations in the country of the currency, such as its economy, political events, and rumors. The country's economy depends on the rate of inflation and unemployment, on the interest rate of its Central Bank, and on tax policy. Political stability also influences the exchange rate. Policy of the Central Bank has a special role, as concentrated interventions or refusal from them greatly influence the exchange rate.

At the same time one should not consider fundamental analysis just as an analysis of the economic situation in the country itself. A far bigger role in the FOREX market belongs to the expectations of the market participants and their assessment of these expectations. Various prognoses and bulletins, issued by the participants, have a strong influence on the expectations. Very often an effect of the so-called self-filfilling prophecy occurs when market players raise or lower the exchange rates according to the prognosis. But a deep and thorough fundamental analysis is available only for big banks with a staff of professional analysts and constant access to a wide field of information.

In spite of these different approaches, both forms of analyses complement one another. Traders who act on the basis of a fundamental analysis, have to consider some technical characteristics of the market (the main rates of support, such as resistance and resale), and supporters of the technical approach to the market must track the main news (interest rates, important political events).


The main merits of the FOREX market are:
  • The biggest number of participants and the largest volumes of transactions;
  • Superior liquidity and speed of the market: transactions are conducted within a few seconds according to online quotes;
  • The market works 24 hours a day, every working days;
  • A trader can open a position for any period of time he wants;
  • No fees, except for the difference between buying and selling prices;
  • An opportunity to get a bigger profit that the invested sum;
  • Qualified work in the FOREX market can become your main professional activity;
  • You can make deals any time you like.

25/7/2007

Part I: What is the Forex Market and How is it Different?

What is the Forex Market and How is it Different?







 

The foreign exchange market, often referred to as forex, is the market for the various currencies of the world. It is a market which, at its core, is rooted in global trade. Goods and services are exchanged 24 hours a day all over the world. Those transactions done across national borders require payments in non-domestic currencies.

For example, a US company purchases widgets from a Mexican company. To do the transaction, one of two things is going to happen. The US firm may, depending on the contract terms, make payment in Mexican Pesos. That would require a conversion of Dollars in to Pesos to make payment. Alternately, the payment could be made in Dollars, in which case the Mexican company would then exchange the Dollars for Pesos on their end. Either way, there is going to be some transaction which takes Dollars and swaps them for Pesos.

That is where the forex market comes in. Transactions like that take place all the time. The market maintains a rate of exchange between the US Dollar and the Mexican Peso (and between and amongst all other world currencies) to facilitate that activity. Consider the amount of global trade which takes place and you can see why the forex market is the biggest in the world, dwarfing all others. Literally trillions of dollars worth of forex transactions take place each and every day.

How is the Forex Market Different?

There are some significant differences between the forex market and others like the stock market. While it may be the feeling that a good trader should be able to handle any market, the fact of the matter is that some structural differences in forex can require a different trading approach.

Time
For most stock traders, the first difference they will notice between the forex market and equities is timeframe. Although the hours of stock trading have been expanding in recent years, the forex market is still the only one which can truly be viewed as 24-hour. There is ready forex trading activity in all time zones during the week, and sometimes even on the weekends as well. Other markets may in fact transact 24-hours, but the volume outside their primary trading day is thin and inconsistent.

No Exchanges
The lack of an exchange is probably the next big thing that sticks out as being different in forex. While it is true that there is exchange-based forex trading in the form of futures, the primary trading takes place over-the-counter via the spot market. There is no NYSE of forex.

On the largest scale, forex transactions are done in what is referred to as the inter-bank market. That literally means banks trading with each other on behalf of their customers. Larger speculators also operate in the inter-bank market where they can execute multi-million dollar trades with ease. Individual traders, who generally trade in much smaller sizes, primarily do so through brokers and dealers.

This is something which can trouble stock traders. There is no central location for price data, and no real volume information is attainable. Since volume is an often reported figure in the stock market, the lack of it in spot forex trading is something which takes a bit of getting used to for those making the switch.

Transaction Processing
Also, the lack of an exchange means a difference in how trading is actually done. In the stock market an order is submitted to a broker who facilitates the trade with another broker/dealer (over-the-counter) or through an exchange. In spot forex much of the trading done by individuals is actually executed directly with their broker/dealer. That means the broker takes the other side of the trade. This is not always the case, but is the most common approach.

Transaction Costs
The lack of an exchange and the direct trade with the broker creates another difference between stock and forex trading. In the stock market brokers will generally charge a commission for each buy and sell transaction you do. In forex, though, most brokers do not charge any commissions. Since they are taking the other side of all the customer trades, they profit by making the spread between the bid and offer prices.

Some traders do not like the structure of the spot forex market. They are not comfortable with their broker being on the other side of their trades as they feel it presents a type of conflict of interest. They also question the safety of their funds and the lack of overall regulation. There are some worthwhile concerns, certainly, but the fact of the matter is that the majority of forex brokers are very reliable and ethical. Those that are not don't stay in business very long.

Margin Trading
The forex market is a 100% margin-based market. This is a familiar thing for those used to trading futures.

In fact, spot forex trading is essentially trading a 2-day forward (futures) contract. You do not take actual possession of any currency, but rather have a theoretical agreement to do so in the future. That puts you in a position of benefiting from prices changes. For that your broker requires a deposit on your trades to provide surety against any losses you may incur. How much of a deposit can vary. Some brokers will asked for as little as 1/2%. That is fairly aggressive, though. Expect 1%-2% on the value of the position in most cases.

Now, unlike the stock market, margin trading does not mean margin loans. Your broker will not be lending you money to buy securities (at least not the way a stock broker does). As such, there is no margin interest charged. In fact, since you are the one putting money on deposit with your broker, you may earn interest in your margin funds.

Interest Rate Carry (Rollover)
When trading forex, one is essentially borrowing one currency, converting it in to another, and depositing it. This is all done on an overnight basis, so the trader is paying the overnight interest rate on the borrowed currency and at the same time earning the overnight rate on the currency being held. This means the trader is either paying out or receiving interest on their position, depending on whether the interest rate differential is for or against them.

This is commonly handled is what is referred to as a rollover. Spot forex trades are done on a trading day basis, and as such are technically closed out at the end of each day. If you are holding your position longer than that, your broker rolls you forward in to a new position for the next trading day. This is generally done transparently, but it does mean that at the end of each day you will either pay or receive the interest differential on your position.

The type of trader you are and the way your broker handles rollover will be the deciding factors in determining whether the interest rate differentials are an important concern for you. Some brokers will not apply the day's interest differential value on positions closed out during the trading day. By that I mean if you were to enter a position at 10am and exit at 2pm, no interest would come in to play. If you were to open a position on Monday and close it on Tuesday, though, you would have the interest for Monday applied (the full day regardless of when you entered the position), but nothing for Tuesday. (Note: There is at least one broker who calculates interest on a continuous basis, so you will always make or pay the interest differential on all positions, no matter when you put them on or took them off).

It should also be noted that although some folks will claim there is no rollover in forex futures, the interest rate spread is definitely factored in. You can see this when comparing the futures prices with the spot market rates. As the futures contracts approach their delivery date their prices will converge with the spot rate so that the holders will pay or receive the differential just as if they had been in a spot position.

Intervention
Fixed income traders know that central bankers, like the Federal Reserve, are active in the markets, buying and selling securities to influence prices, and thereby interest rates. This is not something which happens in stocks, but it does in the forex markets. This is known as intervention. It happens when a central bank or other national monetary authority buys or sells currency in the market with the objective of influencing exchange rates.

Intervention is most often seen at times when exchange rates get a bit out of hand, either falling or rising too rapidly. At those times, central banks may step in to try to nullify the trend. Sometimes it works. Sometimes not.

The US has traditionally taken a hands-off approach when it comes to the value of the Dollar, preferring to allow the markets to do their thing. Others are not quite so willing to let speculators determine their currency's value. The Bank of Japan has the most active track record in that regard.

25/7/2007

Advantages of Forex

Advantages of Forex

Trade on Your Schedule

The single biggest advantage the forex market has over other markets is its 24-hour nature. A trader can put on or take off positions literally any time of day or night, regardless of their base of operations. That opens the game up to a great many individuals who might not otherwise have the time available to trade.

Consider, for example, the working person with a 9 to 5 type of job. Most folks like that cannot be expected to operate effectively as day traders in a market such as stocks. They just can't spend the requisite time watching the market during trading hours. With forex, though, one could theoretically day trade in the evenings after work, or in the mornings beforehand. The forex market is never really closed (yes, in some cases you can even trade on the weekend!).

No (or low) Transaction Costs

For most traders, the forex market also offers the benefit of no transaction costs. For the most part, forex brokers do not charge commissions (if they do, they are relatively small). There is, of course, the bid/offer spread, which can be viewed as a transaction cost, but the reality of the situation is that most traders buy at the offer and sell at the bid in whatever other market they trade, so that's really no different. Actually, the forex spreads can be quite small in the major currency pairs.

Low (or no) Account Minimums

Forex trading is also open to a wider trading demographic in that there are many opportunities to open smaller accounts than is the case in other markets. In fact, there is at least one broker which has no minimum account size. What's more, they also have no minimum trade size. That sort of flexibility opens the door to essentially anyone who wants to explore forex trading. This isn't to say that all brokers are that flexible. There are, however, a great many which offer so-called mini-contracts.

Multiple Trading Vehicles

Additionally, forex trading can be done in a number of fashions. Many folks tend to think strictly of the spot market. While that is certainly the largest of the components, it is not the only one. The futures market has become a bit more attractive with the expansion of e-mini currency contracts. There are futures options as well. What's more, an array of other option trading alternatives have been popping up, providing traders even more ways to take positions in the forex market.

Always Moving

One of the biggest attractions to forex trading is that there's just about always something moving. There are a number of primary currencies involved, each of which is continuously interacting with all the others. Chances are, at any given time, there is movement in at least one of those exchange rates based simply on the sheer volume of trading and the number of global news events providing impetus to action.

Easily Trade Long or Short

In the stock market there are restrictions imposed on selling short. In forex there is nothing of the sort. It is just as easy to taking a short position as it is to take a long one.

Disadvantages of Forex

No Exchange

The disadvantage to forex, some would say, is in the lack of an exchange system in forex trading. Some traders find comfort in knowing that there is a regulated mechanism backing their market participation. What's more, the lack of a centralized data point means the spot forex market does not have all the great add-on information stock and futures are used to seeing (volume, for example).

Complex Nature

In terms of market analysis techniques, technical analysis is just as useful in forex trading as in any other market - some might say more so. The thing that gives some traders concern. however, is the complexity of the fundamental side of the forex market. Currency exchange rates are influenced by a wide variety of factors, which can fluctuate over time.

Two-Sides to Every Position

By it's very nature, there are always two sides to the forex market, because currencies are quoted in terms of their value against each other. That means for any given exchange rate there are two countries (or region's) to take in to consideration. Sometimes issues related to one of the countries will dominate, while sometimes the other will. It can be quite fluid in that regard, which can sometimes lead to quite confusing reactions to news and events.

While these issues may seem like significant barriers to trading forex for some, the fact of the matter is that for most folks they are easily overcome. Just like any market, forex requires some getting used to. Once you do, though, it provides a wide array of opportunity.

25/7/2007

Terminology and Market Conventions

Terminology and Market Conventions

If you are going to trade forex you need to understand the terms and quoting conventions used, especially in regards to the spot market.

Notational Conventions

The forex market uses 3-letter codes for all currencies. These are commonly known as SWIFT or ISO codes. For example, USD is the code for the US Dollar. Here are the codes for the other primary currencies:

AUD: Australian Dollar
CAD: Canadian Dollar
CHF: Swiss Franc
EUR: European Euro
GBP: British Pound
JPY: Japanese Yen

 

Expressing a relational value between two currencies is done by combining two currency abbreviations in the fashion of XXX/YYY. This indicates the amount of YYY currency (the "quote" currency) equivalent to one unit of XXX ("base" currency). For example if the exchange rate for USD/JPY - the US Dollar to Japanese Yen rate - was 100 it would mean that each USD is worth 100 JPY.

Using this convention, changes up or down in the quoted exchange rate indicate changes up or down in the value of the base currency. Using the USD/JPY example again, if the rate went from 100 to 101 it would mean a 1% increase in the value of the USD against the JPY. Similarly, a decline from 100 to 99 would represent a 1% fall in the USD value vs. the JPY.

In theory, one could quote the exchange rates either way around - meaning if USD/JPY is 100 it is the same as saying JPY/USD is 0.01 (one JPY is worth $0.01). In practice, however, the forex market has specific conventions for the traded pairs. In most cases, USD is the base currency, with the other currency in question being the quote currency. USD/JPY is an example.

There are a few exceptions, though. When it was introduced in 1999, the market authorities decided the Euro would always be the base currency in all traded pairs. Before that, the Pound (GBP) held that distinction. Thus, when traded against either of those, the USD is the quote currency (EUR/USD, GBP/USD). The same also holds for former British Commonwealth currencies the Australian Dollar (AUD/USD) and the New Zealand Dollar (NZD/USD).

It is worth noting that forex futures contracts involving currencies as quoted against the US Dollar do not hold to the spot market convention. Instead they all use the USD as the quote currency.

Majors and Crosses

In the forex you will here the terms "majors" and "crosses" when traders refer to different categories of currency pairs. In general terms, the "majors" are the pairs which include the USD quoted against the other primary industrialized currencies. Those include the ones listed above. So the majors are as follows:

AUD/USD
EUR/USD
GBP/USD
USD/CAD
USD/CHF
USD/JPY

While technically every currency pairing is a cross-rate, the term "cross" is most commonly used to refer to currency pairings which do not include the USD. For example, EUR/JPY is the Euro-Yen exchange rate. That would be considered a cross.

Forex Price Quotes

With an understanding of what we are looking at, now we can turn out focus to the actual price quotes. The graphic shows a sample table of quotes for an array of currency pairs - majors and crosses.

One thing you will notice in the table is that some pairs are quoted to four decimal places, while others only go out two places. In general terms, those pairs with values of about 10 or less will go out to four places, while those with higher values will be quoted only at two places.

Regardless of how many decimal places a currency pair is quote to, though, the term "pip" is used to define a single price movement value. So, for a two decimal place pair, a pip would be .01, while for a four decimal place pair a pip would be .0001.

We can see this in the quotes on the chart, especially when looking at the bid/offer spreads. AUD/JPY is quoted at 79.60-79.64, which is a 4 pip spread, while AUD/USD is quoted 0.7648-0.7650 for a 2 pip spread.

In recent times there has been introduced the "pipette", which is a fraction of a pip. In essence, some of the more popular pairs like EUR/USD are trading at five decimal places now, which is why you can see a spread of 1.5 listed on the chart (column to the right of the price quote itself). That means the bid-offer spread is 1 and 5/10 pips.

One will sometimes here the term "figure" in spot forex trading. That is used to refer to a price level which is a round 100 pip figure. In USD/JPY that would be a multiple of 1 full JPY (such as 104), while in GBP/USD the figure would be a $0.01 multiple (like 1.8800).

The term "yard" sometimes comes up as well. That is used to refer to a one billion base currency transaction. So a yard of USD/JPY would be $1 billion.

Getting in to the Trading

Opening an Account

It is quite easy to start trading forex. There are a great many forex brokers available and opening an account is pretty straightforward. Some things you should consider as you look to identify the one best suited to you are:

  • Account minimum deposit (if any)

  • Transaction size flexibility

  • Spreads

  • Execution

  • Commissions (if any)

  • Security of deposited funds

  • Allowable leverage

  • Currency pairs available for trading

  • Usability of the trading platform

The great thing is that nowadays the vast majority of brokers have available demo trading platforms you can use to *******uate their system. Be sure, though, to make note of any differences there are between the real platform and the demo one. Some brokers' platforms are both the same across the board, but some have noticeable differences in things like execution speeds. It wouldn't hurt to check around the discussion boards to see what others are saying.

Actually, if you are new to forex trading it is well worth it to spend a while trading via a demo platform first. It will help you develop and understanding of how it all works. That way, when you do go live, you will be more confident and ready for action.

Making Trades

Forex market trading is really little different from an execution perspective than most other markets. You can buy or sell. In most cases, the same types of orders (stops, limits, etc.) are available. The trading platforms are very modern and trades can be done very quickly. Anyone who has ever used an online trading platform for any other market will have no trouble making the move to forex and executing trades with ease. For that matter, even those new to trading will find entering and exiting forex positions a breeze.