The Curious case of the Forex market: An Insight into Forex Trading
The foreign exchange market, or forex in short is the global decentralized marketplace for currency trade. A recent study of the global markets put forex at the pinnacle of all trading markets with more than 5.1 trillion in daily trade volume. With advancements in trading practices and with trading software being squeezed down to smartphones and tablets, the lucrative market has now been open to more people than ever. Forex trading has now become a safer investment option to new traders looking to grow their money in the short term and in long term investments as well.
Forex 101: An Introduction
Forex is a fast paced and volatile monetary market where money can be made in the matter of seconds or minutes. Contrary to stock markets, which is a path much trodden by new investors, the foreign exchange market is an elusive market for many, due to the initial hiccups of misinformation and complications of international financial environment.
One salient characteristic of the forex market is the fact that there is no central marketplace like the stock exchanges of different countries like New York Stock Exchange (NYSE) for the US, Tokyo Stock Exchange (TYO) for Japan, or National Stock Exchange (NSE) for India.
Currency trading in the Forex market is orchestrated by electronic Over The Counter (OTC) process, where the exchange of currency is done by means of a broker-dealer network, rather than a centralized network. The forex trading marketplace is factually open throughout the day, and currencies are traded in major financial centers of the world, for five days a week and half day on the weekend. As the time zone changes from different financial centers like London, New York, Tokyo etc, the forex market is open throughout the day, as when one market, say London closes, another one in a different time zone is open. This provides a unique advantage for the trader, because the forex market can be active throughout the day and the exchange rates would be ever changing depending on the market conditions.
Learn the ropes of the Forex market
The forex market is the holy grail of financial markets. Even though it has been around for a long time, it was not an investment tool for the masses due to the lack and complications of getting oneself into a trader with the forex marketplace. But with the advancements in electronic trading, and the streamlining of the cumbersome registration and enlisting process by incorporating mass market support apparatus by means of easily accessible tools and software, users can now simply download an app on their iPhone or android device and start navigating the waters of the Foreign Exchange Market.
Forex market, like other financial markets works by speculating the value of one currency over another. The word ‘speculation’ is synonymous with operation of any financial market. But in forex, profit could be made by the dynamic analysis of marketplace behaviour which is being affected by many different key factors- predictions, international diplomacy, and domestic market behaviours of individual countries. The different entities that drive the exchange prices can intimidate new investors, but if you get the basics right, it is easier to understand the baseline of how forex works by studying the value change of currency with the major events of the day.
For example, when the OPEC (Organization of the Petroleum Exporting Countries) meets for taking a call on oil prices, the currency value of the participating countries like Saudi Arabia or Qatar fluctuates. If the overall estimate of world demand is positive, the Saudi Rial and the other OPEC currencies would be getting a bump on exchange prices. Or, if the US imposes a new trade law over outsourcing technology infrastructure development, the Indian Currency, Rupee, would have a downturn in the forex marketplace, which would trigger more volatility in the forex market.
Speculating on the Forex market is about making informed bets on the market trajectory in hope of making healthy returns. Speculating should not be confused with Gambling. In Gambling, a trader makes a financial decision even though the risks involved is high and the chances of a profit grim. In any healthy financial decision, a trader should make an informed decision on his investment and the end goals should be foreseen by minimizing risk and maximizing return opportunity.
The salient advantage of Forex Trading is that the market is open six days of the week, which gives the traders freedom of accessing the market anytime.
The largest volume of forex trade, by volume is the US Dollar against the Eurozone Currencies, Japan, Great Britain and Switzerland. In the Asian Zone the major forex pairs are the Indian Rupee and the Japanese Yen. These two countries, characterized by their stable economies and high growth rate sees a high-volume action in the Asian Forex markets. There are up to 20 different major currency pairs depending on the brokerage you are affiliated with.
The foreign exchange market is structured in such a way that different types of investors have different levels where they operate and trade in. Interbank foreign exchange market is the topmost level for forex trading. This level is composed of commercial multinational banks and securities dealers like J.P Morgan & Co., Goldman Sachs and Morgan Stanley. In this level, the major movements in the forex market is predicted with a large army of analysts and AI (Artificial Intelligence) driven investment architecture, and the information is largely secretive as this tier sees the largest gross turnover by volume. As they operate with high volumes, these types of investors can ask for competitive bids among each other, as each trading entity entitles itself for their ask and bid prices by ensuring a large number of transactions in large amounts. The Interbank Foreign Exchange accounts for 51% of all the proceedings. Pension funds, smaller banks, mutual funds, insurance companies, Hedge funds and large multinational corporations like Aramco of Saudi Arabia, or Reliance Investment Group in India.
Individual investors in the forex market gets their investment actions done via brokers or banks. Some of the major retail forex brokers are Forex.com, Finam, eToro etc. In India some major players are FXTM, HotForex and HXCM.
Among individual traders, forex trading is done through the internet, by affiliate brokerage applications. Online forex trading is usually done on margin basis. This gives retail and individual investors the advantage of just pledging a nominal amount as a deposit and trade in larger amounts. The margin trading ratio can be very high and differs depending on the type of brokerage package you are negotiating with the brokerage. As the sign-up procedure for forex trading is increasingly made online, newbie traders can choose between different subscriptions and choose form the margin trading ratio which can go up to 200:1, which means an investment of $100 as margin can give the investment capability of $20,000.
Trading on margin is a double-edged sword as it augments profit and loss equally. Risk management is a very important factor when you trade on margin on forex market. For a successful foray into Forex Trading a brooding investor must evaluates the risks involved. The golden rule would be to make an investment minimizing financial investment and risk by not investing too much, i.e., never invest money you can’t afford to lose. Making healthy bids and betting on a particular currency based on the analysis of the different market parameters like stock market performance of the country’s indices, GDP estimates, Political landscape etc would ensure that your investment is safe.
Baby steps: Forex Trading
Forex trading is identical to the stock market trading in many ways. With the wider outreach of IT and internet services its easier for modern prospectors to foray into the bountiful waters of forex trading. The first step of becoming a forex trader is to choose a forex broker for yourself. Do note, before you make this decision many details can be missed, which would hamper your forex activities in the future.
The first point to consider before choosing a forex broker is to look for a Low Spread. In simple terms, spread is nothing but the difference in amount that you can achieve. For example, if the exchange rate for $1 is INR 68, the spread means the lowest iteration of value change the broker can offer, i.e., broker #1 might give you a spread of .001 or another one would give you just an increment or decrement of .01. This means that when you make a bid, you can make a bid for 68.001 with broker #1 and 68.01 with broker #2. In this case broker #1 gives you a larger flexibility for the bids you make and the ask you quote when you sell. Having a lower spread would help you trade in finer margins and increase your ability to make bids closer to the market value of the currency.
In technical terms, Spread is calculated in pip, which is short for “percentage in point”. Most currencies are matched and priced with four decimal points. A pip is equal to 1% of value. The value of pip can be calculated by dividing 1/10,0000 of the exchange rate. Even though most currency pairs are quoted to 4 decimal points, the Japanese Yen (JPY) forex currency pairs are quoted with just two decimal points.
The next important to consider before you choose a forex broker is to choose a qualified and valued institution. Contrary to equity brokers, most forex brokers are affiliated to large banks or money-lending financial entities. This is because of the nature of the business they are involved and large sums of capital is required as most retail investors trade on margins. While reviewing the brokers credentials, make sure they are registered with FCM (Futures Commission Merchant). The FCM is a technical entity in the forex trading ecosystem which pools the orders by individual brokers and they are the facilitators of the transaction by collecting margin form customers and delivering trade orders. The FCMs are regulated by CFTC (Commodity Futures Trading Commission) in the US. In India SEBI (Securities and Exchange Board of India) regulates the forex trade brokers.
You can find the financial performance and turnover volumes of different brokers on their websites or the regulatory commission of the individual country the forex broker is registered in.
Another thing to consider before choosing a forex broker for your foray into trading in the foreign exchange market is to compare the tools and research provided by the broker. Forex brokers would be operating in different trading platforms and these platforms would have different features providing analysis tools and graphic diagrams and charts to visualize market conditions to compile all the information and the market changes helping you to make an easier decision on how to make a bid or sell currency by quoting an ask.
Lastly, leverage options or margin ratios should be taken into account before you choose a forex broker. The margin ratio determines the amount you need to pledge to the broker. IN return the broker would be providing an amount for you for trading. The margin ratio of 100:1 gives you a leverage of $100 to be invested in the forex market for a margin deposit of $1. But you need to understand that with a larger margin ratio, the risk factor would increase. A higher margin ratio is a good option when trading with a less volatile currency pair and a lower one for a volatile pair, thus decreasing risk and increasing profitability by reducing exposure to risk.
Analysing Market behaviour and making profitable investment
Successful forex investment can be made by tweaking your investment strategy, taking advantage of the different deciding factors of currency rates. The factors can be political or economic.
The economic policies of the countries and recent decisions made about the fiscal and monetary policies play a major role in the currency rate of a particular country. Short term investment decisions can be made taking into account the performance of different industries of a country or the performance of the agricultural or manufacturing sectors of the country or the major GDP driver sector of a particular country. The country’s balance sheet and the budget deficit play an important role in the long-term investment prospects of a currency. Economic growth GDP estimates, Trade balances can all indicate how the currency might perform.
Also, the political conditions play a vital role in making the forex trading prices fluctuate, Domestic political conditions like a political struggle against the government or war or international sanctions can have an effect in a country’s performance in the financial perspective and that would reflect in the forex markets. All the forex exchange rates are highly affected by political instability and the expectations and policy for cat for an incoming government. Making a note on the major events in a country can give you great insights on how the currency would perform in the forex market.
The forex market gives you an advantage of day trading 6 days of the week by analysing the market trends. Or you can choose to make use of the analytical tools provided by the broker to follow daily or weekly trends to make intelligent bids and sell at the right time. For long term investments, carry trading can be done, where you can buy and hold on to currency that pays high interest rates by choosing a forex pair, one with high interest rate and the other with low interest rate. This has the advantage of a rollover being paid for the difference in the interest rates of the two currencies. With a bit of effort in analysing the global trends in markets and being aware of the political and economic ins and outs of your target currencies, forex trading provides a great money-making platform for the tech savvy millennial.
-Written by Guest Blogger,Muhammed Suhail
Check https://www.shearsspot.com for my articles.