Sunday, January 30, 2011

Forex Trading Guide - FX Trading for Dummies


Forex Trading Overview

Forex trading, or the foreign exchange trading market (also commonly known as FX trading or simply, currency exchange, involves trading one currency for another. Forex is by far and away the largest financial market in the world. Trades are made between large banks, central banks, currency speculators, multinational corporations, governments, and even the other financial markets. According to The Bank for International Settlements (BIS), a world-wide central bank organization, the average daily trade in the global forex and related markets is currently over three trillion US dollars – A DAY. This is several times larger than all the U.S stock markets combined. The trading is done from all round the world, with little or no hard cash changing hands.
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Forex Trading vs Stock Market

Two of the main differences between (and some would say advantages over) the forex market compared to the stock market are:

1. Trading hours. The forex market is open 24 hours a day. Trading is done over three continents, allowing a trader to trade continuously and to react immediately to events and new developments. The market opens on Sunday evening and closes Friday night.

2. Commissions. Electronic trading and competition have brought about a sizeable reduction in the bid-offer spread (the equivalent of commissions). The spread covers the risk of the market maker. The spread for the majors remain very low, but can increase as the liquidity of a specific currency drops. Despite recent reductions of commissions through online stock brokers, the Forex market is considered, by some, to have the lowest commissions relative to trade size when compared to other financial markets. This is also in part due to the 100:1 leverage offered by most trading houses. A client with a $10,000 deposit can leverage this to $1,000,000. Some electronic communication network brokerages have introduced a per trade commision alongside a narrow pip spread.

Many retail trading houses would suggest that the large size of the market makes it impossible for a speculator to affect the market. This is not quite the truth - the stakes are higher, larger quantities of money are involved, and the bigger banks spend a lot of time and effort trying to manipulate the market. Governments have been known to step in and affect prices.
"Buy the rumor, sell the fact."

The price of a currency tends to anticipate the effect of a particular action before it occurs and, when the event comes to pass, react in the opposite direction. This is also referred to as a market being "oversold" or "overbought".

Unlike the stock market, where retail clients (individuals) have access to almost exactly the same prices as all other participants, the Forex market has several different levels of access and therefore commission costs or spreads. At the top are the largest investment banking firms such as Citi and Deutsche Bank, where the spreads or the difference between bid and ask prices are tiny. These spreads are a closely guarded secret, not normally known outside the inner circles of international finance.

Further down the trading chain, the spreads become wider. Basically, the larger the volume of trades, the narrower the spread. After the major top-tier banks come the smaller investment banks, large multi national corporations, pension funds, insurance companies and, more recently, some of the major retailers. Retail traders are a small fraction of the market and may only participate indirectly, through brokers or banks.

There are many influences on the value of currency when compared to other currencies, but the Forex market is almost a pure supply and demand market. Demand rises or supply falls, prices rise and vice versa. Electronic trading is slowly increasing in the Forex market with Algorithmic trading increasing also.

Spreads in Forex Trading

The BID price is the price at which a client can sell a unit of the base currency (in return for buying the secondary currency) and the ASK/OFFER price is the price at which a client can buy a unit of the base currency. For example, if the quote for the exchange rate of the Euro/U.S. Dollar in the market is 1.2583/1.2586, this means that the client can pay $1.2586 in order to buy one Euro (the base currency) and will receive $1.2583 if one Euro is sold. The BID price is lower than the ASK price and the difference or 'spread' between the two numbers is measured in 'pips' (3 pips here) and represents the profit of the dealing room or trading house.

Retail Forex Trading

Retail forex brokers or " market makers ," working on behalf of retail clients only handle a tiny fraction of the forex market. One retail broker estimates the total retail volume at $25–50 billion daily, which is approximately 2% of the whole market. Nonetheless, this is a substantial market for the individual trader and the ready availability of good quality trading platforms means this is an ever growing segment.

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