Monday, February 7, 2011
Introduction to Foreign Exchange Markets
The main enticements of currency dealing to private investors and attractions for short-term forex trading are:
* 24-hour trading, 5 days a week with access to global forex dealers
* An enormous liquid market making it easy to trade most currencies
* Volatile markets offering profit opportunities
* Standard instruments for controlling risk exposure
* The ability to profit in rising or falling markets
* Leveraged trading with low margin requirements
* Many options for zero commission trading
The investor's goal in forex trading is to profit from foreign currency movements. Forex trading is always done in currency pairs. When trading currencies, trade only when you expect the currency you are buying to increase in value relative to the currency you are selling. If the currency you are buying does increase in value, you must sell back the other currency in order to lock in a profit. An open trade (also called an open position) is a trade in which a trader has bought or sold a particular currency pair and has not yet sold or bought back the equivalent amount to close the position.
Private investors can trade in forex directly or indirectly through:
* The spot market
* Forwards and futures
* Contracts for difference
* Spread betting
It is estimated that anywhere from 70% to 90% of the forex market is speculative. In other words, the person or institution that bought or sold the currency has no plan to actually take delivery of the currency in the end; rather, they were solely speculating on the movement of that particular currency.
Currencies are traded in pairs and exchanged one against the other when traded, so the rate at which they are exchanged is called the exchange rate. The majority of the currencies are traded against the US dollar (USD). The four next-most traded currencies are the euro (EUR), the Japanese yen (JPY), the British pound sterling (GBP) and the Swiss franc (CHF). These five currencies make up the majority of the market and are called the major currencies or "the majors". Some sources also include the Australian dollar (AUD) within the group of major currencies.
Banks and/or online trading providers need collateral to ensure that the investor can pay in case of a loss. The collateral is called the margin and is also known as minimum security in forex markets. In practice, it is a deposit to the trader's account that is intended to cover any currency trading losses in the future. Margin enables private investors to trade in markets that have high minimum units of trading by allowing traders to hold a much larger position than their account value.
Leveraged financing is the use of credit, such as a trade purchased on a margin. It is very common in forex trading, and results in being able to control $100,000 for as little as $1,000.
Although Forex trading can lead to very profitable results, there are risks involved: exchange rate risks, interest rate risks, credit risks, and country risks. Approximately 80% of all currency transactions last a period of seven days or less, while more than 40% last fewer than two days. Given the extremely short lifespan of the typical trade, technical indicators heavily influence entry, exit and order placement decisions.
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