What Exactly Is FOREX?
This question we get asked a lot. While most investors are familiar with stocks, bonds, mutual funds, ETFs, real estate (REITs), metal and gems, and a multitude of other investment vehicles, few investors are aware of and fully comprehend FOREX.
Intro:
FOREX, aka FX, FOREX Market, Foreign Exchange or Currencies, is the largest trading platform in the world with an excess trading volume of $5.3 trillion per day. To give you an idea of just how enormous that is, the daily trading volume of global equities equals to about $212 billion. That is 25 times less than the daily currency trading volume.
Trading or investing in Forex involves buying and selling of currencies from around the world. Currencies are always traded in pairs. That is because you can not buy or sell one currency without paying for it with another currency. You can’t buy Euro with Euros for example, because the value is the same thus eliminating the profit potential. However you can buy Euros with US Dollars, Canadian Dollars, Swiss Franc, Japanese Yen and Chinese Yuan; to name a few. The reverse is also true. You could buy US Dollars with Euros or Japanese Yen for example.
The difference in value between the two currencies that make up the pair at the time of purchase or sale could result in potential profit (or loss) for the individual buying or selling the currency pair. All Forex trades involve the simultaneous purchase of one currency and sale of another.
The most popular currency pairs in the world are:
- EUR/USD.(Euro/US Dollar)
- USD/JPY. (US Dollar/Japanese Yen)
- GBP/USD. (British Pound/US Dollar)
- AUD/USD. (Australian Dollar/US Dollar)
- USD/CHF. (US Dollar/ Swiss Franc)
- USD/CAD. (US Dollar/Canadian Dollar)
- EUR/JPY. (Euro/Japanese Yen)
- EUR/GBP. (Euro/British Pound)
These currency pairs are traded more than any other currency pair because of their liquidity. More about that later. However, with 196 existing countries in the world (including Taiwan), you could potentially buy/sell 196 different currency pairs. By the way, countries with the same currency denomination are traded separately since the value of these currencies vary by country.
Example:
One Mexican Peso equals 0.053 US dollar.
One Philippines Peso equals 0.08 US dollar.
One Argentine Peso equals 0.028 US dollar
One Uruguayan Peso equals 0.031 US dollar
- the values listed above where determined at the time this article was written and may have changed since.
The first currency in the pair (left side) is known as “the base currency” whilst the second currency in the pair (right side) is known as “the quote currency”.
The base currency determines the value for the quote currency.
Example:
EUR/USD = 1.2500 means that one euro is exchanged for 1.2500 U.S. dollars.
In other words, you would have to pay $1.2500 US dollars to buy 1 Euro. To buy 100 Euro you would have to pay 125 US dollars (1.2500 X 100).
Majors, Minors and Exotics:
There are three (3) types of currency pairs you can trade.
Majors:
The currencies that trade the most volume against the U.S. dollar are referred to as the major currencies. These include the EUR/USD, GBP/USD, USD/JPY, USD/CHF, AUD/USD and USD/CAD. These pairs are the most traded because they offer the greatest liquidity and have small spreads (more about that later).
Minors:
These are all currency pairs that are not associated with the US Dollar. Another word you might hear from time to time that refers to minor currencies as well is ‘crosses’.
Example: EUR/GBP, GBP/JPY and EUR/CHF.
Minor currencies or crosses have slightly wider spreads and are not as liquid as the major currencies.
Exotics:
Exotic currencies pairs include currencies of emerging markets*. These pairs are not as liquid, and the spreads are much wider than both the major and minor currencies.
Example: USD/SGD (U.S. dollar/Singapore dollar).
- An emerging market economy is a nation’s economy that is progressing toward becoming advanced, as shown by some liquidity in local debt and equity markets and the existence of some form of market exchange and regulatory body. However, emerging markets generally do not have the level of market efficiency and strict standards in accounting and securities regulation to be on par with advanced economies (such as the United States, Europe and Japan).
Hours, Liquidity, Spreads, and Leverage:
Hours:
Not all FX trading markets in the world open and close at the same time. Some markets actually overlap. But considering there are fifteen (15) independent exchanges worldwide, there is plenty of opportunity to trade currencies, no matter where you are in the world or what time of day or night it is.
Please note however that each exchange has unique trading hours, but from a trading perspective, the four most important exchanges have hours as follows (all times are Eastern Standard Time):
- London: 3 AM to 12 PM (noon)
- New York: 8 AM to 5 PM
- Singapore: 3 PM to 12 AM (midnight)
- Tokyo: 7 PM to 4 AM
When you look at the exchange hours listed above, it becomes clear that trading hours on major exchanges occur in two markets simultaneously from:
- 8 AM to 12 PM (noon) EST, with both New York and London exchanges open
- 3 PM to 5 PM EST, with both New York and Singapore exchanges open
- 7 PM to 12 AM (midnight) EST, with both Tokyo and Sydney exchanges open
- 3 AM to 4 AM EST, with both Tokyo and London exchanges open
The Best Forex Trading Hours
These four overlaps normally make the best times to trade. Of these, the most favorable trading time is the 8 AM to noon (EST) overlap when both New York and London exchanges are open. These two trading centers account for more than 50 percent of all trades on all 15 exchanges worldwide.
Liquidity:
Liquidity describes the degree to which an asset or security can be bought or sold quickly in the market without affecting the asset’s price. The faster an asset or security can be bought or sold the greater its liquidity.
The EUR/USD currency pair is the most liquid in the world and is traded 24 hours a day, five days a week (except holidays). The same trading time frame applies to all other currency pairs as well. However, the liquidity of some currency pairs greatly depends on the time of day these pairs are being traded.
Example: Trading the USD/SGD (US Dollar/Singapore Dollar) when the Singapore market is closed will not generate much trading volume in either the buy or sell direction.
Spreads:
Spread in Forex is defined as the difference in price between the bid (buy) and ask (sell) price of a given currency pair from a dealer’s perspective, not the trader’s. Known as the bid-ask spread, it varies from dealer to dealer and entirely depends on how much the dealer is willing to pay or “bid” for a currency he wants to buy or how much he is willing to get or “ask” for the currency he wants to sell.
The tighter the spread, the greater the potential for a trader to make more profit. The larger the spread, the less potential a trader has to earn a profit. That is because a trader will only begin to see a profit after he has successfully filled the dealer’s spread.
The spread is in simple terms nothing more than the commission a dealer (aka broker) wishes to earn when buying or selling currency pairs to traders. Commissions vary from broker to broker and could change daily.
Leverage:
Leverage involves borrowing a certain amount of the money needed to invest in something. In the case of Forex, that money is usually borrowed from a broker. Forex trading does offer high leverage in the sense that for an initial margin requirement, a trader can build up – and control – a huge amount of money, despite not having a large trading account.
Leverage is represented by two numbers. 1000:1 means that you have a trading leverage of 1000 for every dollar you trade. In other words, you could trade one thousand dollars worth of currency pairs yet you would only have to put up one dollar to do that. The dealer or broker would ‘loan’ you the balance ($999).
In the United States the maximum leverage allowed is 50:1 to avoid a trader from racking up a huge debt he cannot repay should the trade he placed go against him (become a loss).
The leverage offered by the broker determines the margin you need to place a trade.
For example:
A 50:1 leverage means you need a 2% margin (1/50). A 100:1 leverage means you need a 1% margin (1/100).
Example #1
Account balance: $100000
Leverage: 50:1
Margin required : 2% or $2000 ($100000 X 2%)
Units traded: 1
Reserve required: $2000 ($2000 X 1)
Meaning: you must keep a $2000 reserve in your account to meet the 50:1 leverage for every unit you trade.
Example #2
Account balance: $100000
Leverage: 100:1
Margin required : 1% or $1000 ($100000 X 1%) Meaning: you must keep a $1000 reserve in your account to meet the 100:1 leverage for every unit you trade.
Units traded: 5
Reserve required: $5000 ($1000 X 5)
Advantage of leverage:
The ability to earn significant profits by using leverage is substantial, especially since you get to keep the profits you earn on the money that you ‘borrowed’ from the broker. But that’s where the nicety of leverage ends.
Disadvantage of Leverage:
If the currency you are trading moves in the opposite direction of what you believed would happen, leverage will greatly amplify the potential losses. Indeed, many a trader completely wiped out their account balance when the trade went against them because they ‘over-leveraged’ themselves.
Worse still; you could potentially lose more money than what you have in your account. In that case you owe the broker and you are required to repay these ‘borrowed funds’ within 24 hours usually, to avoid further action against you.
How to make money trading Forex:
Contrary to the stock market a good Forex trader can make money regardless of market sentiment. Quite often, the stock markets can hit a snag, resulting in shrinking volumes and activity. As a result, it may be hard to open and close positions when you would like to. Furthermore, in a declining market it is only with extreme ingenuity and sometimes luck that an equities investor can make a profit. Add to that that in the U.S. stock market it can be difficult to short-sell because of strict rules and regulations.
On the other hand, Forex offers the opportunity to profit in both rising and declining markets easily because with every trade, you are buying and selling at the same time, and short-selling is, therefore, a part of every trade. In addition, since the Forex market is so liquid, traders are not required to wait for an uptick before they are allowed to enter into a short position, as is the rule in the stock market.
As such the potential to earn money trading Forex is much greater than with stocks or any other market.
Conclusion:
This is only a brief overview of Forex trading. There are many more factors to consider before placing a trade such as risk to reward ratio, market knowledge and understanding, and having a reliable trading strategy to augment profits and minimize losses.
As such it is a good idea to seek guidance from a professional trader instead of embarking on this venture yourself; especially when you lack the expertise and experience required to make Forex trading a profitable investment.
TMI specializes in Forex trading. That’s all we do and we do it very well. With over a decade of hands-on experience in this market, we managed to generate a ROI from 12.34% to 17.78% annual yields for our clients on a consistent basis.
While past performances are not indicative of future results, we believe that we can do the same for you.
For more information how you can become an investment partner with TMI click the link below: