Forex Trading: The Best Starter Guide
Forex trading deals with the buying and selling of currencies. What is a Forex? Forex is the short form of foreign exchange. Forex involves exchanging currency used in one country for currency used in another country. There are so many reasons why one would want to do this. The two main reasons include tourism and for trading purposes. Since it is now possible to do business with anyone anywhere in the world, it becomes necessary to transact with the foreigner using their country’s currency.
The Bretton Woods Accord was put in place in 1971. Since then, money could be floated freely from one another. Since the value of each currency is different, there was a necessity for foreign exchange services. This service is mainly offered by commercial and investment banks. These services have brought about a speculative environment, where one currency can be exchanged for another one online.
Forex as a Hedge
The value of money is volatile. It goes up and down depending on the market. This means that the money market can be unpredictable when you are buying or selling goods to a foreign country. This poses a risk to traders. To minimize Forex trading risk, the Forex exchange sets a rate at which the deal will be completed in future.
This can be done when the seller buys or sells services in a swap or forward market. In this market, the financial institution will lock in a set rate, therefore making it possible for the trader to know exactly how much the exchange rate will be. You can protect yourself using the futures market, especially if you are planning to carry out a big trade. The futures market is centralized and is much more difficult to liquidate. The forwards market is easier to liquidate. It is decentralized and works with different bank systems all over the world.
Forex as Speculating
There are so many elements that affect Forex exchange. This includes such factors as how well the economy is doing, interest rates, tourism, trade and political instability. You can bet against all these factors when you are exchanging foreign currencies to see if you would make a financial profit. This is by betting that the currency you hold will be stronger than the currency you want to exchange it for.
Currency as an Asset Class
Money as an asset has two main elements:
- It is possible for you to earn an interest rate differential between two currencies
- You stand a chance of earning a profit based on the exchange rate
Why Can We Trade Currencies – Forex Trading Explained
For a long time, foreign exchange was an activity that was mainly carried out by banks. This led banks to have exclusive desks that focused on working on their own accounts. Other organizations that were given priority included multinational organizations, hedge funds, and wealthy persons. However, all this changed with the coming of the Internet. The Internet made it possible for Forex exchange to be focused on individuals. This made it easy for anyone who was interested in trading in the market to become a participant by online Forex trading through using brokers or through banks.
Forex Trading Risks
There is some level of misunderstanding when it comes to Forex trading about the risks that are involved in this activity. This is due to the many intricacies that are involved in this trade. There is a lot of speculation about the interbank system not being properly controlled, consequently exposing traders to some level of risk. This view is not 100% true. A good approach to this issue would be to understand the differences between a centralized market and a decentralized one and then come up with some regulations.
There is an interbank system where different banks from all over the world trade with each other. Due to the risk that the banks are taking upon themselves, there have been many checks and balances put in place to ensure their safety. This has resulted in many auditing processes put in place by banks. These safety checks have been put in place by the industry, to protect the interests of every bank.
Approximately $2 billion to $3 billion worth of foreign exchange is traded on the market on a regular basis. The exchange rate is normally dependent on the forces of supply and demand in the market. Given the magnitude of the trades that take place, it is quite difficult for an individual or a few traders to manipulate the market. It is also not possible for central banks to control and influence the exchange rates without the cooperation of other central banks.
To increase the level of transparency in the market, it has been proposed that an Electronic Communication Network (ECN) be formed. The aim of this network would be to centralize the operations of the market and buyers and sellers be brought together. This can be beneficial, as it will help to help get more reasonable pricing and centralized liquidity. Banks can remain decentralized since this is not one of their main concerns.
One of the main reasons why there is a call for the Forex money to be regulated is to protect retail traders, who have been led to believe that foreign exchange is a quick-fire way of getting rich fast. This is because retail traders mainly deal with Forex brokers, who are unregulated, instead of dealing with Forex banks. Some of these Forex brokers may even trade against their clients and re-quote prices.
If you are a savvy investor, then you are aware that you have an opportunity to open an account with any of the major banks and trade. You can even open an account with large and more liquid brokers. The caveat emptor concept applies in Forex exchange the same way it applies to with other financial investments. As a buyer, you should beware.
Forex Trading Pros and Cons
Dealing with foreign exchange comes with so many advantages and disadvantages. Here are some of them:
This market is quite liquid given the volume of trade that takes place on a regular basis. Therefore, you can enter and exit the market as you please.
Some banks or brokers offer leverage. This makes it possible for an individual trader or a small number of traders to control a significant part of the market, even if they do not have a lot of money. It is common to find leverages in the ratio of 100:1. Before using leverage, make sure that you have a good understanding of how it works. Failure to understand this can lead to your whole account getting wiped out. Therefore, be careful and cautious when using leverage.
You can trade in this market at any time of the day, any day of the week or month of the year. The markets are always open. The day normally starts in Australia and ends in New York. The main trading centers are Hong Kong, Sydney, Paris, Frankfurt, New York, London, and Tokyo.
You need to have a larger understanding of the economy to understand how the currencies work. You also need to understand how various countries are interconnected and the things that affect the value of currency. Understanding the economics of how countries work will come in handy as compared to learning about how companies are run and managed.
How to Trade Forex
Forex Trading Education
A lot of people who trade in the stock market need a paradigm shift for them to start engaging in the foreign market. This is a great way to diversify your investments.
This sort of trading has been promoted as something that needs someone who is active in the market. This means that this kind of trading is more suitable for brokers since they are on top of things in the market.
The leverage aspect of this trading has been promoted extensively. This means that it is easy for a trader to open an account and start trading even with an amount that is far much less than what is required in the stock market.
You can trade Forex as a way of earning a profit. You can also use it to hedge your portfolio. For instance, if someone invests in a foreign stock market where the stock prices could potentially increase in value but then there is the risk of the currency going down, the investor can buy the stock and then short the dollar against another currency, such as the Swiss Franc or the Euro. This means that even as the stock price increases, there will be a cushioning against the falling dollar. This is a good strategy if you live outside the U.S. and you aim to repatriate any profits that you make back into your home country currency. Most people open an account with such an aim in mind, whether they are day trading or swing trading.
Another way to approach Forex trading is by having a good understanding of the foundations and long-term benefits of this kind of trading. It is advantageous to a trader when a currency is moving towards a certain direction and providing a positive differential that gives a return on investment in addition to the value of the currency going up. This is what is known as a “carry trade.” For instance, when a trader purchases an Australian dollar against the Japanese yen, it means that he stands a chance of earning 4% interest if the yen offers an interest rate of 0.05% and the dollar provides an interest rate of 4.75%.
Can You Become Rich with Forex Trading?
For most people, the answer to this question is no. This is especially if you are a retail trader. You are more likely to have a rough and rocky ride and incur some losses on the way. However, if you operate a hedge fund and have lots of money at your disposal and you are an expert in Forex trading, then there are chances that you can get rich trading Forex.
It is best to look at the facts. According to Bloomberg magazine in a November 2014 article, most of their customers (from two of the largest publicly traded firms- Gain Capital Holdings Inc. and FXCM Inc.) that is 68% of them suffer losses when trading currency. This can be translated into saying that one in three traders do not lose money when trading Forex; however, they also do not get rich by trading Forex.
These figures were published two months before a major incident in the currency markets that highlighted the major risks that retail traders faced. On 15th January 2015, the Swiss National Bank gave up the 1.20 cap of the Swiss franc against the euro that had been constant for three years. This resulted in the Swiss franc going up by 41% against the euros 38% versus the US dollar on that day.
Consequently, there were huge losses witnessed by traders in the Forex market. This included retail traders, as well as banks. The money lost was so huge, that it completely wiped out money in the accounts of three stock brokerages, such that they became bankrupt. FXCM, which is the largest retail brokerage firm in the US, was almost driven to insolvency.
If you want to trade in the market, but you have limited funds, then the best option for you is to go for day trading or swing trading using a little amount of money. However, if you have a lot of funds to play around with, then the best option is to go for a carry trade.
Whichever option that you go for, you must ensure that you are skilled in trading. Some of the essentials that you should know include how to time the market right using charts since this is what forms the essence of good trading. It is also important that you understand your own personality as well. This will help you to rein in your negative habits that might affect how you trade in the market by learning good trading principles.