Foreign exchange – often abbreviated to forex — trading involves the purchase of two currency pairs with the expectation that one of them will rise in value over the other so the pair may be sold to make a profit. What’s more unlike equities, bonds and commodities, which can all fall in price at the same time, this is not the case in the currency markets. By the nature of the market-place, currencies trade in pairs. If one currency is losing value then another, by definition, is rising in value.
“Quite simply, a lot of people in GCC region like to trade, and there’s an understanding of speculating and trading,” said Gary L. Tilkin, President and Chief Executive Officer of foreign exchange broker GFT. “Universally, understanding the trading is probably the biggest driver, and for geographic reasons people outside of the US are more used to exchanging currencies. In the US, unless people have travelled overseas they never really get into currency exchange.”
The high volume of the forex market (estimated at more than $ 3 trillion turnover around the world every trading day) offers one key benefit over other markets – high liquidity. That makes it very easy to buy or sell a currency pair at any time. The forex market never sleeps. Traders are active 24 hours a day, 5.5 days a week. The size of the market also means it is almost impossible for one entity to control, as many governments over the years have found to their cost. What that means for you is that you are not at the mercy of someone buying huge quantities of any given currency to influence market values. What determines the value of one currency to another is mostly a simple matter of supply and demand.
That said, if you are considering trading emerging countries’ currencies you will need to take account of increased risks – social, political and governmental risk – all of which may combine to create a serious liquidity risk in the market. Governments of emerging countries in particular may impose legislation that can impact on currency liquidity.
Why forex trading makes sense
The volatility of the forex market creates many opportunities to profit that just aren’t available in any other market-place; because forex trading always happens in pairs, it doesn’t matter which way the market is moving; you always have equal access to trade whether you’re buying or selling. This ability to buy or sell in a rising or falling market creates unlimited profit potential (and unlimited loss potential!).
Currency prices can and do change by the second, and movements in currencies can be seen thousands of times per day. Rates can fluctuate dramatically, particularly during times of major economic announcements. There is no way to avoid volatility risks in forex — the volatility is also what provides the trading opportunities — but you must learn to manage risk properly.
With forex trading you are not limited to market opening hours. The forex market is open 24 hours a day, from 5pm Sunday EST (2am Monday in the UAE) through to 5pm Friday EST (2am Saturday in the UAE). The trading day begins when the market opens in Sydney, Australia and continues around the world as business days begin in each financial centre. This means you have the ability to respond to currency fluctuations caused by economic, social and political events as they occur, rather than waiting for the market to open.
Forex also allows you to control a larger trade amount for a fraction of the value. This is important because forex is traded in small fractions (called pips). Using leverage lets you typically trade in ratios of 100:1 (sometimes up to 400:1). Typically, this means that for every $1 you use to trade, you can control $100 worth of currency, which gives you an opportunity to make (or lose) a more substantial amount – leverage can work against you as well as for you.
Using leverage (sometimes called margin) creates the potential for substantial profits by trading larger quantities for a fraction of the value, AND it creates the potential for substantial loss. Every forex investor should be aware that larger margins carry the potential for larger gains or losses.
Forex trading eliminates a long list of fees found in other markets: commission fees, clearing fees, exchange fees, government fees, and platform fees and charting fees. All a trader will pay to trade forex is the spread, which is built into the buy and sell prices, and will vary by dealer although you will find several that offer spreads as low as one pip.
Let's trade forex
You may already have bought and sold stocks and shares. If so you’ll be familiar with the basic concept of buying at a lower market price in the hope of selling at a higher price for profit (if that’s not been the underlying tenet of your investment strategy then you have serious problems!).
Buying currencies pairs is a similar exercise. The first currency quoted in the pair is the currency you are buying and the second is the currency you are selling. So, if you buy EUR/USD you are buying euros and at the same time selling US dollars. You would do this if you believed the euro was going to increase in value against the US dollar. Buying a pair like this is also known as ‘going long’. Let us assume the current quoted price for EUR/USD is 1.3429/1.3432 – the first of these two prices is the ‘bid price’ and the second is the ‘ask price’ (see Definitions on p.??)
Buy Example
You buy one lot (100,000 units) of EUR/USD at the quoted price of 1.3432.
EUR: +100,000 USD: -134,320 (100,000 x 1.3432)
Later that day, the EUR/USD is quoted at EUR/USD 1.3460/1.3463. You decide to sell and take a profit.
EUR: -100,000 USD: +134,600 (100,000 x 1.3460)
Your profit: 134,600 – 134,320 = $280
Taking a “short position” may be a new concept. This simply means you are selling a currency pair on the expectation that the value will fall and that you may, therefore, buy it back at a lower price to make a profit and thus complete the trade. What this actually means is you have a way to make money in a falling market as well as a rising market! Returning to the EUR/USD pair, if you sell this pair, you are selling euros and buying US dollars and you would do this if you believed the euro was going to fall in value against the US dollar.
Sell Example
You sell one lot (100,000 units) of EUR/USD at the quoted price of 1.3429.
EUR: -100,000 USD: +134,290 (100,000 x 1.3429)
Later that day, the EUR/USD is quoted at EUR/USD 1.3460/1.3463. You decide to buy to take your losses and close your position.
EUR: +100,000 USD: -134,630 (100,000 x 1.3463)
Your loss: 134,290 – 134,630 = -$340