Answering the Top 6 Questions About Currency Trading
Although forex is the largest financial market in the world, it is still relatively foreign to traders. Forex trading became popular on the internet a few years ago. Forex is the domain of large financial institutions, multinational companies and secret hedging funds. But time has changed, and individual forex investors are hungry for information about the market. Are you just a forex trading beginner or need a refresher course. To find out about the basics of currency trading, please read this article. This will answer some of the most frequently asked questions about the forex market.
What distinguishes the forex market from other markets?
Unlike stocks, futures or options, currency trading does not occur on a regulated exchange. This is not controlled by the central management body, there are no clearing houses to guarantee trade and there is no arbitration panel to adjudicate disputes. All members trade with each other based on a credit agreement. In essence, businesses in the world’s largest and most liquid markets depend on nothing more than a metaphorical handshake.
At first glance, this arrangement seems confusing to investors who are used to making structured exchanges such as the NYSE or CME. However, this arrangement works very well in practice. Because participants in forex must compete and work together, self regulation provides very effective control of the market. Furthermore, the leading retail forex dealers in the United States are members of the National Futures Association (NFA), and thus they agree to bind arbitration in the event of a dispute. Therefore, it is important for every retail customer who intends to trade currencies, doing so only through companies that are members of the NFA.
The forex market is different from other markets in several other main ways.
There is no uptick rule in forex as in stocks. There is also no limit to the size of your position (like in the future). So, in theory, you can sell a $ 100 billion currency if you have the capital to do it. For example, if you have friends from Japan, who also happen to be playing golf with the governor of the Bank of Japan telling you on the golf course that the BOJ plans to raise interest rates at the next meeting, you can go ahead and buy yen as much as you like. No one will try you for insider trading if your bets are paid. There is no such thing as insider trading in forex. In fact, European economic data, such as German employment figures,
Before we leave you with the impression that forex is a Wild West of finance, we must note that this is the most liquid and liquid market in the world. Forex is traded 24 hours a day, from Monday at 4am to Saturday at 4am and rarely has a price gap. The sheer size and coverage (from Asia to Europe to North America) makes the currency market the most accessible market in the world.
Where is the commission in forex trading?
Investors who trade stocks, futures or options usually use brokers, who act as agents in transactions. Brokers take orders to exchange and try to execute them according to customer instructions.
The forex market has no commission . Unlike exchange-based markets, forex is the main market. Forex companies are dealers, not brokers. This is an important difference that all investors must understand. Unlike brokers, dealers assume market risk by serving as a counterparty to investor trading. They do not charge a commission. Instead, they make money through spreads from the bid-ask price.
In forex, investors cannot try to buy bid prices or sell bid prices as in exchange-based markets. On the other hand, once the price clears the spread costs, there are no additional fees or commissions. Every single penny gained is purely an advantage for investors. However, the fact that traders must always deal with the spread of the bid / ask price makes scalping much harder in forex.
Is that a pip?
Pip is short of “percentage points” and is the smallest increase in forex trading. Pip is usually represented in 4 decimal places. For example if the price of a drug at a pharmacy is valued at $ 20, in the forex market, the same drug will be quoted at 1.2000. Changes at the fourth decimal point are called 1 pip, usually equal to 1/100 of 1%.
Among major currencies, the only exception to this rule is the Japanese yen. One Japanese yen is now worth around $ 0.01. So, in the USD / JPY pair, quotes are only taken for two decimal digits. That is at 1/100 yen, as opposed to 1/100 with the other major currencies.
What do you actually sell or buy on the currency market?
The short answer is “no”. The pure retail forex market is a speculative market. No physical currency exchange has ever occurred. All trades exist only as entries on the computer and are netted depending on market prices. For accounts denominated in dollars, all profits or losses are calculated in dollars and recorded as in the trader’s account.
The main reason for the FX market to exist is to facilitate the exchange of one currency to another for multinational companies that need to trade currencies continuously (for example for payroll, payment of fees for goods and services from foreign vendors, and merger and acquisition activities). However, daily corporate needs only range around 20% of market volume. Fully 80% of trading on the currency market is speculative, supported by large financial institutions. Multibillion-dollar hedge funds and even individuals who want to express their opinions about today’s economic and geopolitical events.
Which currency is traded on the forex market?
Although some retail dealers trade exotic currencies such as the Thai baht or Czech, the majority trade seven of the most liquid currency pairs in the world, which are the four “main” ones:
- EUR / USD
- USD / JPY
- GBP / USD
- USD / CHF
And three commodity pairs:
- AUD / USD
- USD / CAD
- NZD / USD
These currency pairs, together with various combinations (such as EUR / JPY, GBP / JPY and EUR / GBP), cover more than 95% of all speculative trading in forex. Given the large number of trading instruments, only 18 pairs are actively traded. The forex market is far more concentrated than the stock market.
What is currency carry trade?
Carry is the most popular trade in the currency market, practiced by the largest hedge funds and smallest retail speculators. Trade carry relies on the fact that every currency in the world has an interest rate attached to it. This short-term interest rate is set by the central banks of these countries: the Federal Reserve in the US, the Bank of Japan in Japan and the Bank of England in the United Kingdom.
The idea behind carry is quite easy.
Traders spend a long time with high interest rates and finances that make purchases with low interest rates. For example, in 2005, one of the best pairs was the NZD / JPY currency. The New Zealand economy, driven by huge commodity demand from China and the hot housing market, saw interest rates rise to 7.25% and stay there, while Japanese interest rates remained at 0%. An old trader at NZD / JPY can produce 725 basis points in results only. On the basis of leverage of 1:10, carry trade in NZD / JPY can produce an annual return of 72.5% of the difference in interest rates, without the contribution of an increase in capital. For that you will understand why carry trade is so famous.
But before you rush out and buy a currency pair, please pay attention to a few things. As when the carry trade is released, the decline can be fast and severe. This process is known as liquidation carry trade. This happens when the majority of speculators decide that carry trades may not have future potential. With each trader who wants to leave his position at once, the offer disappears and the profit from the interest rate difference is almost not enough to offset the capital loss. Anticipation is one of the keys to success, the best time to position in a carry is at the beginning of the tightening cycle, which allows traders to move up along with differences in interest rates.