The foreign exchange market directly impacts every bond, equity, private property, manufacturing asset and any investments accessible to foreign investors. Foreign exchange rates play a major role in financing government deficits, equity ownership in companies and real-estate holdings. Foreign exchange trading helps determine who hires and fires employees, and who owns the banks at which you maintain your corporate and personal accounts. The currency in your pocket is literally stock in your country, and like a share, its value fluctuates on the international market providing knowledgeable traders with substantial opportunities for profit or loss.
Foreign Exchange a brief history
The Breton Woods Agreement was initiated in 1944 in an effort to keep cash from draining out of war-ravaged Europe. Currency values were pegged to the U.S. Dollar, which was then pegged to the price of gold. The modern era of foreign exchange first emerged in 1971 with the collapse of the Bretton Woods Agreement. The U.S. Dollar was no longer convertible into gold, signaling an increase in currency market volatility and trading opportunities.
The collapse in 1973 of the subsequent Smithsonian and European Joint Float agreements signaled the true beginning of the free-floating currency exchange system that drives the markets today. Starting in the 1980s, computer technology extended the reach of the exchange marketplace. Today, the values of the major world currencies are independent of each other, with intervention available to the states only through the central banking system.
Foreign Exchange Markets size and scope
The foreign exchange market dwarfs the combined operations of the New York, London, and Tokyo futures and stock exchanges. Daily turnover on the spot market is approximately US$1.5 trillion per day.
Spot transactions and forward outright FX trading takes place in the inter-bank market. 51% of the market is in spot FX transactions, followed by 32% in currency swap transactions. Forward outright FX transactions represent another 5% of this daily turnover. Options on inter-bank FX transactions making up another 8%. Therefore the inter-bank market accounts for 96% of the global foreign exchange market, with the remaining 4% being divided among all the global futures exchanges.
The role of Forex in the Global Economy
Over time, the foreign exchange market has been an invisible hand that guides the sale of goods, services and raw materials on every corner of the globe. The forex market was created by necessity. Traders, bankers, investors, importers and exporters recognized the benefits of hedging risk, or speculating for profit. The fascination with this market comes from its sheer size, complexity and almost limitless reach of influence.
The market has its own momentum, follows its own imperatives, and arrives at its own conclusions. These conclusions impact the value of all assets -it is crucial for every individual or institutional investor to have an understanding of the foreign exchange markets and the forces behind this ultimate free-market system.
Inter-bank currency contracts and options, unlike futures contracts, are not traded on exchanges and are not standardized. Banks and dealers act as principles in these markets, negotiating each transaction on an individual basis. Forward "cash" or "spot" trading in currencies is substantially unregulated - there are no limitations on daily price movements or speculative positions.
Why Trade Forex
Forex Provides More Leverage
You control the degree of leverage you wish to employ in trading. Forex Capital Management automatically sets your leverage level at the most lenient requirement, based on the size of your account. As an example, a US$30,000 account has a margin requirement of US$1,000 for every position held that is approximately equal to US$100,000 worth of currencies. At this account level, 1% of the total value of the currency traded is required to be maintained on margin a leverage ratio of 100 to 1.
Forex is Maximum Liquidity
The forex market is the largest and most liquid in the world, with the spot foreign exchange market accounting for on average US$1.5 trillion in transactions every day. The foreign exchange market can absorb transaction sizes and trading volumes that dwarf the capacity of other markets. Stop-orders and liquidation of positions are executed without slippage.
Forex Trades 24-Hours a Day
Forex trading is your window to the world economy. Trading starts on Sunday at 5:00 PM Eastern Time with the opening of the markets in Singapore and Sidney. A couple of hours later, the Tokyo market is open. Next is London, which opens at 2:00 AM Eastern Time on Monday. By the time the day catches up to New York, the world currency markets have been at work for fifteen hours. You determine the timing of your trades, reacting instantly to any news or market pressures.
Forex is Firm Prices and Instantaneous Execution
Forex Capital Management enables price certainty and instant execution on orders up to US$1 million. Your trading is based on real time streaming currency prices so there is no discrepancy between the offered price and the execution price. This remains true even during volatile, fast moving trading sessions. Streaming prices ensure that your orders, stops, and limits are executed without partial fills or slippage.
Forex Enables Automatic Rollovers
With Forex Capital Management, open positions are automatically rolled over every two days. At 5:00 PM Eastern Time, your account automatically rolls over any open positions, swapping the trade forward to a settlement date two business days in the future. Rolling over a position does include some carrying costs, which is true with futures as well.
Rolling over a Forex position can sometimes make you money, since carrying cost is determined by the difference between interest rates for the two currencies. If you are long in the currency with the higher interest rate, you can gain on the spot rollover from the premium relationship of the long currency relative to the short currency. Gain is determined by the differential between the interest rates of the two currencies, and fluctuates with the movement of rates.
Forex Brings Profit in Bear and Bull Markets
In the foreign exchange market, there is no short selling restriction. There is potential for profit in currencies regardless of which way the market moves. Forex always involves selling one currency to buy another, so there is no structural bias to the market. Depending on short and long positions, a trader always has an opportunity to profit in a fluctuating market.
Forex Makes Money on Interest News
Any significant news regarding interest rates directly impacts the international financial markets. In the past, when a country has raised its interest rate, its currency strengthens relative to other currencies as investors shift assets to gain better returns. The influence of stock markets has changed this equation since increasing interest rates are typically bad news for the stock markets. Investors transfer money out of the stock market when interest rates rise, which can cause the currency of the country to weaken on the broader markets.
Determining which effect will dominate can be difficult, but there is typically a consensus in the marketplace as to what a rate change will do. Rate changes are typically anticipated since they usually take place after regularly scheduled meetings of central banks. Indicators that typically have the biggest impact on interest rates are PPI, CPI, and GDP.
Forex Offers Broad Diversity
The balance of trade between nations is one determinant to the relative value of these currencies. A nation that imports more than it exports has a deficit trade balance, which is considered unfavorable to the value of that currency. Prudent investors know that they should diversify the U.S. Dollar balance in their assets through holding a range of currencies. This is challenging since most U.S. banks do not offer foreign currency accounts.
Perfect for Technical Traders
Currencies rarely spend time in tight trading ranges, and there is a tendency for strong trends to develop. Over 80% of trading volume is speculative in nature, so the market frequently overshoots before correcting itself. A technically trained trader can identify these breakouts, providing a range of opportunities for entering and exiting positions.
Analyze a Nation like a Corporation
Currencies are always traded in pairs one currency is purchased with holdings in another. As with stocks, better FX returns are provided by the currency of a country that demonstrates faster growth and is in a better economic condition that others.
Currency pricing reflects the amount of available supply and demand. Interest rates and the relative strength of the economy are the two primary factors that determine the availability of a currency. Leading economic indicators reflect the economic health of a nation, and are in large part responsible for shifts. An overwhelming amount of data is available at regular intervals the challenge is to determine what factors are more influential than others. Interest rates and international trade ratios are typically the most important.
