You’re sitting at home watching television and your favorite advertisement comes on. It is the Aston Martin DB9. You melt at the sight of it, makes you want to cry and at that moment, no women would compare to that beauty! You see yourself in it, hearing the sound of a roaring V12 engine just begging you to nail it while the sleek and sexy curves of those bucket seats have you swallowed up with comfort. You say to yourself this is heaven and you know this is love.
Why trade forex?
In this day and age, traders are presented with a wide variety of markets in which they can participate, such as futures markets, options, the share market and forex. Each of the various markets exhibits particular advantages and disadvantage that must be carefully considered. A trader’s choice of market will be greatly influenced by his or her risk-tolerance which will shape a trader’s preference for either the buy-and-hold strategies ideal for stock markets or the shorter trading techniques employed in the options markets and forex.
Like a giant among humans, forex is distinguished from other markets thanks to its notable size. According to a study completed in 2004, forex’s trading volume reaches $1.9 trillion on any given day: twenty times greater than the combined trading value of the New York Stock Exchange and NASDAQ (DailyMarkets). Current levels of trading volume are considered to be more than $4 trillion a day, making forex the most celebrated market in existence.
Advantages of trading forex
The forex is well-known and celebrated for its great many advantages, these pros should be considered:
- No commission
Unlike the stock exchanges the forex market does not have noticeable transaction fees. It’s said that there are no brokerage fees but these fees are tied into the spread which are often only 1 pip. This makes forex market the cheapest markets to trade with the lowest barriers to entry.
- 24/5.5 market
One of the greatest advantages of the forex market is the fact that it can be traded on 24 hours, 5.5 days of the week. Currencies are traded all over the world and there is always some or other market that is open on week days, consequently, a person is enabled to trade on forex any time of the ‘week’ day – a great advantage for full-time employees.
By making use of leverage, a greater return can be achieved with a relatively small investment. The combination of the constant movement in prices and the leverage opportunity can be potentially dangerous. If high leverage is utilised, the constant movement of prices can result in the obliteration of the total invested amount if the trader does not have the proper risk management models in place.
As mentioned before, forex is the most liquid of markets, resulting in constant movement in market prices and transactions where the order price matches the execution price under normal conditions.
Much easier to place a short order:
The fact that one monetary unit is always traded for another. Thus, simply by selling and buying back at a later stage, a specific currency can be shorted. This technique is easily employed on the forex market, unlike other markets.
- One entity cannot move the market:
The immensity of forex also implies that the market is less sensitive to individual transactions or the opinions of famous analysts
- Low transaction cost:
The transaction costs are determined by the spread of a specific transaction (where the ‘spread’ refers to the difference between the buying and selling prices) and are awarded to the broker. However, due to high levels of competition in the forex market, the spread is usually minimal.
It follows then, that, if transactions on the forex market are appropriately and carefully approached, the advantages of this ‘giant trading arena’ far outweighs the negative aspects
Disadvantages of trading forex:
Forex prices are volatile and make big moves every day. This can lead to large profits and losses.
You need to be aware of when the market has periods of abnormally large volatility verses normal levels. For example: during very high periods of volatility it is better to wait for the market to return to a more stable level before taking a position.
Also most rookie traders make the mistake of placing stop orders too close to their entry point, they are taken out by high levels of volatility and this leads to a loss that could have been avoided.
These days you can leverage your investment with an online forex broker and possess tremendous profit potential. However, it is a fact that most traders actually over leverage. It goes without saying that you need to pay close attention to your money management models.
Forex vs. Other markets
This is where the advantages of forex trade triumph over other markets. Other markets such as stock markets already lose the battle when we consider time factor. Other markets have a daily opening and closing bell, which limits the freedom of their traders, while forex traders have a continuous trading time.
The other factor one might consider is costs attached to transactions. While the forex markets have little to no costs when trading, other markets expect a fee payable for every service attached to the trade.
The biggest difference between the forex market and other markets is that insider trading has no effect on the market. On the stock market traders get inside information to make trades play to their advantage. On forex there are no rules, it’s like a cage fight, may the best traders win.
Last but not least let us note that placing a short order on forex is much easier as there isn’t a complicated borrow / lend process that needs to take place between securities; as two different currencies are exchanged as a buy or sell.
Forex Market Structure
First thing we need to get clear is that the forex market is a decentralized market. Meaning that prices for currencies differ from dealer to dealer. This might seem like chaos but it is what makes forex trading so awesome. Perks for this decentralized system is that trading can take place anywhere at any time and allows for ample chance of profits being made.
Even though the forex market is decentralized it has some order to it. This is formally known as the hierarchy of the forex market, which includes all the participants in order of importance with regards to the forex market.
The forex market consists of various players: each having their own reasons and objectives for participating. Large banks, financial institutions and central banks trade with each other in the ‘interbank market’ where Electronic Broking Systems (EBSs) or Renters systems are used. These two systems are used to observe the exchange rates of the various banks with which a specific player is trading. It is important to note that, although the bid and ask prices are consolidated through the use of these systems, the forex market remains decentralised.
Smaller banks are then the link between the ‘interbank market’ and other participants, such as hedge funds, companies, retail brokers and Electronic Communication Networks (ECNs) which facilitates the transactions of everyday retail traders. It is thus clear that there is a definite hierarchy of participants in the forex market.
Take note though, that because ECNs makes use of various 2nd tier liquidity providers for the best possible rates, they, themselves, can be considered as a 2nd tier liquidity provider.
Thus, the forex market is a very competitive one where 3rd tier participants are competing to provide retail traders with the best possible rates.
The following are short descriptions concerning a few key market participants:
Governments and central banks are said to be the biggest players/ influencers within the market. They often work hand in hand to reach economic goals which include the purchasing or dumping of one currency for another.
Government participate in the forex market for operations, handling their forex exchange reserves and international trade payments.
One of the key roles of a central bank is to facilitate monetary policy which includes the issuing of money to reduce inflation or money in circulation.
- Banks and financial intermediaries
Theses institutes are seen as the second biggest market players and include all major banks and the smaller financial service providers. The following are a few of the transactions these giants take part in:
- Interbank market transaction: banks will lend huge volumes of money to another bank in order to help with cash flow or other problems.
- Market making: where a bank will help create liquidity for clients in addition to providing a bid and an offer.
- Hedging: reducing clients risk by utilising complicated hedging strategies.
- Commercial companies:
Many companies have a supplier overseas which requires the transaction of foreign currency for goods and services and/or services rendered. Example: the import and export of German engines to production plants in china which later sells cars in America.
These participants encompass the largest volume. Speculators are simply in it to win it, they come in different shapes and sizes with the goal to profit from market movements. Unlike the other markets Forex is well known for its speculative nature.
Forex trade has developed beyond being merely a tool for international business practices and trade. The high level of liquidity and the 24 hours of trading have opened the doors of this giant trading arena to aspiring traders. To summarise, at present, forex is a convenient way to become involved in the financial markets for speculative purposes.