This short introduction explains the basics of trading Forex online, a brief explanation of the markets and the major benefits of trading Forex online. There are also two scenarios describing the implications of trading in a bear as well as bull market to better acquaint you with some of the risks and opportunities in the largest and most liquid market in the world.
Foreign exchange , forex or just Forex are all terms used to describe the trading of the world’s many currencies. The Forex market is the largest market in the world, with trades amounting to more than $1.5 trillion every day. This is more than one hundred times the daily trading on the NYSE (New York Stock Exchange) . Most Forex trading is speculative , with only a few percent of market activity representing governments’ and companies’ fundamental currency conversion needs.
Unlike trading on the stock market, the forex market is not carried out by a central exchange, but on the “interbank” market , which is thought of as an OTC (over the counter ) market. Forex Trading takes place directly between the two counterparts necessary to make a trade, whether over the telephone or on electronic networks all over the world. The main centers for trading are Sydney, Tokyo, London, Frankfurt and New York. This worldwide distribution of trading centers means that the Forex market is a 24-hour market.
A currency trade is the simultaneous buying of one currency and selling of another one. The currency combination used in the trade is called a cross (for example, the Euro/US Dollar, or the GB Pound/Japanese Yen.). The most commonly traded currencies are the so-called “majors” – EURUSD, USDJPY, USDCHF and GBPUSD.
The most important Forex Trading market is the spot market as it has the largest volume. The market is called the spot market because trades are settled “immediately” or on the spot. In practice this means within two banking days.
For forward outrights, settlement on the value date selected in the trade means that even though the trade itself is carried out immediately, there is a small interest rate calculation left. This is because if you trade e.g. NOKJPY, you get almost 7% (annual) interest in Norway and close to 0% in Japan. So, if you borrow money in Japan, to finance the trade as you must have one currency with which to buy or another, and place it in Norway you have a positive interest rate differential. This differential has to be calculated and added to your account.
You can have both a positive and a negative interest rate differential, so it may work for or against you when you make a trade. The interest rate differential doesn’t usually affect trade considerations unless you plan on holding a position with a large differential for a long period of time. The interest rate differential varies according to the cross you are trading. On the USDCHF, for example, the interest rate differential is quite small, whereas the differential on NOKJPY is large.
Trading on Margin
Trading on margin means that you can buy and sell assets that represent more value than the capital in your account. Forex trading is usually done with relatively little margin since currency exchange rate fluctuations tend to be less than one or two percent on any given day.
To take an example, a margin of 2.0% means you can trade up to $500,000 even though you only have $10,000 in your account. In terms of leverage this corresponds to 50:1, because 50 times $10,000 is $500,000, or put another way, $10,000 is 2.0% of $500.000. Using this much leverage gives you the possibility to make profits very quickly, but there is also a greater risk of incurring large losses and even being completely wiped out.
Why trading Forex?
24 hour trading
One of the major advantages of trading Forex is the opportunity to trade 24 hours a day from Sunday evening (20:00 GMT) to Friday evening (22:00 GMT). This gives you a unique opportunity to react instantly to breaking news that is affecting the markets.
The Forex market is so liquid that there are always buyers and sellers to trade with. The liquidity of this market, especially that of the major currencies, helps ensure price stability and low spreads . The liquidity comes mainly from large and smaller banks that provide liquidity to investors, companies, institutions and other currency market players.
The fact that trading Forex is often without commissions makes it very attractive as an investment opportunity for investors who want to deal on a frequent basis. Trading the “majors” is also cheaper than trading other cross because of the high level of liquidity.