Forex is the largest marketplace in the world with more than 5 trillion dollars changing hands daily and so making it one of the most attractive and lucrative markets. Traders can make speculative transactions on the exchange rate between two currencies. These rates may be influenced by world economic and political events, currency rate differentials, as well as many other factors including extreme weather conditions (hurricanes), acts of terror etc.

 

1.Forex history

In order to gain a complete understanding of what forex is, it is useful to examine the reasons that lead to its existence in the first place. Exhaustively detailing the historical events that shaped the foreign exchange market into what it is today is of no great importance to the Fx trader and therefore we will happily omit explanations of historical events such as the Bretton Woods accord in favor of a more specific insight into the reasoning behind foreign exchange as a medium of exchange of goods and services.

Originally our ancestors conducted trading of goods against other goods this system of bartering was of course quite inefficient and required lengthy negotiation and searching to be able to strike a deal. Eventually forms of metal like bronze, silver and gold came to be used in standardized sizes and later grades (purity) to facilitate the exchange of merchandise. The basis for these mediums of exchange was acceptance by the general public and practical variables like durability and storage. Eventually during the late middle ages, a variety of paper IOU started gaining popularity as an exchange medium. 

 

2.How does the foreign exchange market work?

The forex market allows you to buy and sell currencies against each other and speculate on the differences in exchange rates. 

Making a transaction on the forex market is simple: the procedures are identical to that of any other market so switching to trading currencies is straightforward for most traders.

 

3.Forex market participants

In the last years, the foreign exchange market has expanded from one where banks would execute transactions between themselves to one in which many other kinds of financial institutions like brokers and market-makers participate including non-financial corporations, investment firms, pension funds and hedge funds. 

Its' focus has broadened from servicing importers and exporters to handling the vast amounts of overseas investment and other capital flows that currently take place. Lately foreign exchange day trading has become increasingly popular and various firms offer trading facilities to the small investor.  

 

Foreign exchange is an 'over the counter' (OTC) market, that means that there is no central exchange and clearing house where orders are matched. Geographic trading 'centers' exist around the world however and are: (in order of importance) London, New York, Tokyo, Singapore, Frankfurt, Geneva & Zurich, Paris and Hong Kong. Essentially foreign exchange deals are made between participants on the basis of trust and reputation to deliver on an agreement. In the case of banks trading with one another, they do so solely on that basis. In the retail market, customers demand a written legally accepted contract between themselves and their broker in exchange of a deposit of funds on which basis the customer may trade.  

Some market participants may be involved in the 'goods' market, conducting international transactions for the purchase or sale of merchandise. Some may be engaged in 'direct investment' in plant and equipment, or may be in the 'money market', trading short-term debt instruments internationally. The various investors, hedgers, and speculators may be focused on any time period, from a few minutes to several years. But, whether official or private, and whether their motive be investing, hedging, speculating, arbitraging, paying for imports, or seeking to influence the rate, they are all part of the aggregate demand for and supply of the currencies involved, and they all play a role in determining the exchange rate at that moment.

 

4.Forex Pricing

Every currency pair consists of a base currency and a term/quoted currency.

The first currency in the pair is the base currency, the second is the quote or term currency.

As an example with the EURUSD currency pair:
EUR = Base currency

USD = Term currency

 

5.Spreads

The spread of a currency pair is the difference between the bid and the ask rate.

 

6.Forex trading margins

A margin deposit is not, as many traditional traders suggest, the payment in cash for purchasing market shares. A margin is in fact a guarantee or a trust deposit, providing protection from losses during a deal? It allows traders to open positions on amounts that greatly exceed their account limits and so increase their buying power.

If the funds in the account, in the course of trading, fall below the prescribed margin, your positions will be closed automatically without prior notice. Using this system, the client's account cannot go overdrawn even under volatile, fast-changing market conditions. 

 

7.Common Order Type

Buy Stop:buy order above the current market price

Sell Limited:sell order above the current market price

Market Execution:buy or sell order at the current market price

Buy Limited:buy order below the current market price

Sell Stop:sell order below the current market price

 

Stop orders are commonly used for breakout and momentum style strategies. They buy in a rise market and sell and a falling market. Traders will often place these orders above resistance or below support, trading a break of these levels.

Limit orders are used by range and countertrend traders. Limit orders sell into a rising market and buy into a falling market. Because of this they are preferred by more experienced traders who are able to place these order types at key resistance and support levels, picking market swing points.


Market orders are orders to buy at the current ask (offer) rate or sell at the current bid rate.

Advantages of Forex

Some of the advantages of forex trading are listed below, find out why forex is fastest growing market in the world. 

 

1. 24 Hour Market

The forex market is open 24 hours 5 days a week. Trading starts when major global financial centres around the world open. The market opens in New Zealand on Sunday evening and ending after the market closes in New York on Friday. The greatest liquidity occurs when multiple time zones overlap.

 

2. Liquidity

One of the main benefits of the forex market is its superior liquidity. The foreign exchange market is the most liquid market in the world, this is one of the main differentiating factors between the forex market and other financial markets. The foreign exchange market turns over 4 trillion dollars each day, liquidity means that your assets can be quickly converted to cash without and price discount, this makes it easy to convert a large sum of money into a foreign currency with little impact on the price.

3. Accessibility

Generally the amount required to trade forex is lower than what would be required to enter into other financial markets.

 

4. Leverage

Forex is typically traded on leverage. Leverage allows means that a lower initial outlay is required to control a larger position. For example if a trader had $1,000 in your trading account and had leverage of 100:1 the trader would be able to open a position with a value of $100,000. It is however important to note that although leverage gives traders the ability to open larger positions to maximum potential profits, the potential for loss is equally as large.

5. Trade both Rising and Falling Markets

Unlike equity markets where short selling restrictions apply there are not restrictions in the forex market as to which direction you can trade. This means that if you believe that a currency pair is going to increase in value you can buy it or ‘go long’. Similarly, if you believed that the pair was going to decrease in value you could sell it, or ‘go short’.

 

6. Low Cost of Trading

The cost per transaction in forex is less than a tenth of the cost of your average stock trade, this represents a huge saving.

7.Transparency
In some exchange based markets, larger players have been known to move stock or commodity in order to gain an advantage. Given the deep liquidity in the foreign exchange market is it almost impossible to interfere with general market forces.

8. Volatility

Due to the huge daily volumes of the Forex market there is always volatility. Increased volatility means more access to trading opportunities. You have the ability to pick currency pairs that suit your trading style. For example the AUD/NZD is a great currency to begin trading as a beginner due to its lower daily range and low spread, where as the EUR/USD would be better suited for an advanced trader due to its large daily range and the speed with which it moves.

9. Non standardised contract sizes

Forex is an over the counter market unlike the futures markets. which means that the contract sizes can be determined by the broker rather than an exchange. This means Forex traders have no fixed lot size and can trade any amount between 0.01 lots (1 micro lot) and 1,000 lots. This gives trades a greater ability to manage their risk.

10. Disadvantages

You should often consider your risk appetite and investment strategy prior to trading leveraged products. Leverage can work for you as well as against you and can magnify profits as well as losses. In the event of a significant move against you, you may loose more than your initial deposit. Further information regarding the benefits and risks can be found in our Product Disclosure Statement.

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