8000 stocks vs. 4 major currency pairs
There are approximately 4,500 stocks listed on the New York Stock exchange. Another 3,500 are listed on the NASDAQ. Which one will you trade? Got the software? Got the time? Concentrate on the majors; find your trade. You have approximately 34 second-tier currencies to look at in your spare time (if you are so inclined).
No Middlemen
The stock markets are comprised up of a number of centralized exchanges. One of the problems with any centralized exchange is the involvement of middlemen. Any party located in between the trader and the buyer or seller of the security or instrument traded presents additional costs. The cost can be either in time or in fees. Spot currency trading does away with the middlemen and allows clients to interact directly with the market maker. Forex traders get quicker access and cheaper transaction costs.
* FX Solutions is compensated through a portion of the bid / ask spread.
Trade Countries Like You Do Companies
Equity traders rely on key fundamental and technical data when making assessments of a particular company’s future growth and performance. Just the same, similar factors are considered when gauging the overall health of a country’s economy and currency. Currency valuation is a function of supply and demand. Namely, factors such as interest rate movements, economic indicators such as GDP, foreign investment, and the trade balance all provide an indication of the general health of an economy and underlying shifts in the supply and demand for that currency. As a basic example, consider an interest rate decision by a country’s central bank. If a rate is hiked, it is expected that capital flows into that country may increase, as investors may seek to realize a greater return on their investment in that country vis-à-vis others. As more capital flows into the country, the demand for its currency increases - which generally causes an appreciation of that currency.
24-Hour Trading Liquidity
Since the Forex market, in a sense, follows the sun around the globe, it rarely experiences periods of illiquidity. When trading Forex, clients can place trades continously from Sunday 5 PM EST to Friday 4:30 PM EST. You no longer have to wait for the market to open when news has already hit the streets or have to stop trading because the CME, CBOT or other American futures pits have closed for the day. This gives the Forex trader added flexibility and continuous market opportunities that just aren't available in Futures.
There are three main economic zones that are linked throughout the world. For instance, when the Pacific Rim markets such as Japan and Singapore begin to slow, the European markets of England, Switzerland and Germany begin. These Forex markets are followed by the North American markets of the United States, Canada and Mexico. As the North American markets begin to slow down for the evening, the Pacific Rim starts their trading day again. This example shows that you are no longer limited to trading using a comparatively short, trading day offered by U.S. markets only.
* FX Solutions dealing desk is closed from Friday 4:30 PM EST until Sunday 5 PM EST. No trades may be opened or closed during this period.
Execution Speed and Quality
As a result of the unsurpassed liquidity in the spot FX market, the execution speed and quality is far superior to that of the Futures markets, and other markets as well. Every Futures trader has experienced periods of inconsistent execution and price uncertainty – for example when even a market order was subject to a 30-minute fill delay. Despite electronic platforms and limited guarantees on execution in the Futures market, execution price and time is far from certain. In contrast, when trading on the GTS Platform, the price you see is a real-time streaming executable rate.
Highly Trending markets
The Forex market offers some of the smoothest trends available in any market. No other market can come close to the amount of monetary volume and participation as the Forex market. In turn, this creates a haven for traders not having to deal with gaps and price movements, erratic spikes and other choppy market conditions more commonly experienced in the lower volume markets, like Futures or Options.
Commission-Free Trading
Though some speculators are unaware, all financial markets have a spread (the difference between the bid and ask price). In the Futures market you are not only paying the spread, but you are also paying commission charges, clearing and exchange fees on top of the spread. Ticker prices in the Futures market typically signify the last traded price, not the spread. FX Solutions offers you commission-free trading on tradable prices. This allows you to make quick decisions on your Forex trades without having to account for fees that may affect your profit/loss or slippage between the price you have just seen on the ticker and the price upon which the order will be filled.
* FX Solutions is compensated through a portion of the bid / ask spread.
Better Leverage
One of the main advantages for traders trading Spot currencies is the leverage capability afforded to them. With margin policies as lenient as .25%, a trader is able to leverage up to 400:1. That is, a trader can control a $100,000 position for only $25. Keep in mind however, leverage is a double-edged sword and you should try to avoid overleveraging, as it magnifies both profits and losses.
* FX Solutions asks that you consider the risks associated with increasing your leverage. A relatively small market movement will have a proportionately larger impact on the funds you have deposited or will have to deposit, this may work against you as well as for you. You may sustain a total loss of initial margin and you may be required to deposit additional funds to cover a short margin position. FLEXI Leverage is available for self-traded accounts only (does not apply to managed accounts).
Sunday, February 3, 2008
The Basics of Currency Trading
Quoting Conventions
In the Foreign Exchange market, currencies are traded in pairs. For instance, a speculator may trade the Euro versus the US Dollar, EUR/USD, or the US Dollar versus the Japanese Yen, USD/JPY. The base currency is the term for the first currency in the pair. The counter currency is the term for the second currency in the pair. The exchange rate represents the number of units of the counter currency that one unit of the base currency can purchase.
Traders in the Foreign Exchange market are speculating on the exchange rate between two currencies. Exchange rates measure the relative strength of one currency to another. Speculators make buy and sell decisions on currency pairs based on fundamental and technical analysis, with the intention of the exchange rate moving in their favor.
EUR/USD
In this example euro is the base currency and thus the “basis” for the buy/sell.
If you believe that the US economy will continue to weaken and this will hurt the US dollar, you would execute a BUY EUR/USD order. By doing so you have bought euros in the expectation that they will appreciate versus the US dollar. If you believe that the US economy is strong and the euro will weaken against the US dollar you would execute a SELL EUR/USD order. By doing so you have sold euros in the expectation that they will depreciate versus the US dollar.
USD/JPY
In this example the US dollar is the base currency and thus the “basis” for the buy/sell.
If you think that the Japanese government is going to weaken the yen in order to help its export industry, you would execute a BUY USD/JPY order. By doing so you have bought U.S dollars in the expectation that they will appreciate versus the Japanese yen. If you believe that Japanese investors are pulling money out of U.S. financial markets and repatriating funds back to Japan, and this will hurt the US dollar, you would execute a SELL USD/JPY order. By doing so you have sold U.S dollars in the expectation that they will depreciate against the Japanese yen.
GBP/USD
In this example the GBP is the base currency and thus the “basis” for the buy/sell.
If you think the British economy will continue to be the leading economy among the G7 nations in terms of growth, thus buying the pound, you would execute a BUY GBP/USD order. By doing so you have bought pounds in the expectation that they will appreciate versus the US dollar. If you believe the British are going to adopt the euro and this will weaken pounds as they devalue their currency in anticipation of the merge, you would execute a SELL GBP/USD order. By doing so you have sold pounds in the expectation that they will depreciate against the US dollar.
USD/CHF
In this example the USD is the base currency and thus the “basis” for the buy/sell.
If you think the Swiss franc is overvalued, you would execute a BUY USD/CHF order. By doing so you have bought US dollars in the expectation that they will appreciate versus the Swiss Franc. If you believe that due to instability in the Middle East and in U.S. financial markets the dollar will continue to weaken, you would execute a SELL USD/CHF order. By doing so you have sold US dollars in the expectation that they will depreciate against the Swiss franc.
Sample Trade
A trader wishes to speculate on EUR/USD. Believing that the EUR will rise against the USD, or that the exchange rate will move upwards, the trader places an order to buy EUR/USD at a market rate of 1.3050. Let us also assume that the trader is speculating on 100,000 units of the base currency, which is the standard lot size, or trading increment, used in the Foreign Exchange market. Since the base currency is the first currency in the pair, the trader is speculating on the value of 100,000 Euros with respect to the US Dollar.
In this example, the trader is buying Euros, since he believes the Euro will rise in value with respect to the US Dollar. Accordingly, he finances the transaction of buying 100,000 Euros by borrowing an equivalent amount of US Dollars.
For the trader, the value of the amount borrowed is a function of the exchange rate. Since the exchange rate at the time of the transaction was 1.3050, the market cost for 1 Euro was 1.3050 US Dollars. Hence, 100,000 Euros cost $130,500 (1.3050 * 100,000). This borrowed amount of 130,500 USD must be paid back when the transaction is closed.
Let’s assume that the trader is correct in assuming that the Euro would rise in value with respect to the USD, and that the exchange rate moved to 1.3150, 100 pips above the rate at which the trader entered. If the trader were to close his position now, the 100,000 Euros he purchased at the onset of the transaction would be sold, and his debt of 130,500 US Dollars would be paid off.
At an exchange rate of 1.3150, the trader’s 100,000 Euros are now worth 131,500 US Dollars (100,000 * 1.3150). After repaying the borrowed amount of 130,500, this leaves him with a profit of $1,000.
Traders have equal opportunities to profit regardless of whether the exchange rate is rising or falling.
Spreads & Bid/Ask
When viewing quotes, you will notice that there are two prices for each currency pair. Similar to all financial products, FX quotes include a "bid' and "ask". The bid is the price at which a dealer is willing to buy and clients can sell the base currency in exchange for the counter currency. The ask is the price at which a dealer is willing to sell and a client can buy.
Bid = The Price at which the Trader (You) Can Sell
Ask = The Price at which the Trader (You) Can Buy
For example, say the EUR/USD is trading at 1.3050 x 1.3053. In this case, the bid is 1.3050 and the ask is 1.3053. The difference between the bid and ask constitutes the spread. In the above example, the spread is 3 pips, or points. This differential reflects the cost of the trade. Essentially, the market would have to move 3 pips in your favor for you to break even, and 4 pips for you to be in your profit zone.
Structure of the Market
The FX market is an over-the-counter market with no centralized exchange. Traders have a choice between firms that offer trade-clearing services.
Unlike many major equities and futures markets, the structure of the FX market is highly decentralized. In other words, there is no central location where trades occur. The New York Stock Exchange, for example, is a totally centralized exchange. All orders pertaining to the purchase or sale of a stock listed on the NYSE are routed to the same dealer and pass through the hands of a single clearing firm. This structure requires buyers and sellers to meet at the NYSE in order to trade a stock that is listed on this exchange. It is for this reason that there is one universally quoted price for a stock at any given time.
In the FX market there are multiple dealers whose business is to unite buyers and sellers. Each dealer has the ability and the authority to execute trades independently of each other. This structure is inherently competitive as traders are faced with a choice between a variety of firms with an equal ability to execute their trades. The firm that offers the best services and execution will capitalize on this market efficiency by attracting the most traders. In the equities markets, the execution of trades is monopolized and there is no incentive for a clearing firm to offer competitive prices, to innovate, or to improve the quality of their service.
Margin
In standard cash stock accounts, money should be deposited for the full amount of the position you are trading, or if you have a margin account, for at least half of the position. This is in contrast to the FX market, where only a small percentage of the actual position value needs to be deposited prior to taking on the trade. This small deposit, known as the margin, is not a down payment, but rather a performance bond or good faith deposit to ensure against trading losses. The margin requirement allows traders to hold positions much larger than their account value (up to 200x the size).
Margin requirements are as low as .5% meaning for every standard lot size of 100,000 units, you must commit $500. However, if you wanted to control a $100,000 in the stock market, you would have to deposit at the very least, $50,000. Even in the futures market you would have to deposit at least $5,000 to control a $100,000 position.
Bank of England Collapse
The above illustration shows a classic example of a 5000-pip collapse of the GBP/DEM in 1992 from 2.9000 to 2.4000 in a matter of weeks. George Soros, in fact made $1 billion overnight buying GBP to convert them into DEM.
Currency Abbreviations
Below is a list of the abbreviations for various currencies that are commonly traded in the FX market:
EUR = Euro
GBP = British Pound (Sterling, Cable)
JPY = Japanese Yen
CHF = Swiss Franc (Swissie)
USD = United States Dollar
NZD = New Zealand Dollar (Kiwi)
AUD = Australian Dollar (Aussie)
CAD = Canadian Dollar
In the Foreign Exchange market, currencies are traded in pairs. For instance, a speculator may trade the Euro versus the US Dollar, EUR/USD, or the US Dollar versus the Japanese Yen, USD/JPY. The base currency is the term for the first currency in the pair. The counter currency is the term for the second currency in the pair. The exchange rate represents the number of units of the counter currency that one unit of the base currency can purchase.
Traders in the Foreign Exchange market are speculating on the exchange rate between two currencies. Exchange rates measure the relative strength of one currency to another. Speculators make buy and sell decisions on currency pairs based on fundamental and technical analysis, with the intention of the exchange rate moving in their favor.
EUR/USD
In this example euro is the base currency and thus the “basis” for the buy/sell.
If you believe that the US economy will continue to weaken and this will hurt the US dollar, you would execute a BUY EUR/USD order. By doing so you have bought euros in the expectation that they will appreciate versus the US dollar. If you believe that the US economy is strong and the euro will weaken against the US dollar you would execute a SELL EUR/USD order. By doing so you have sold euros in the expectation that they will depreciate versus the US dollar.
USD/JPY
In this example the US dollar is the base currency and thus the “basis” for the buy/sell.
If you think that the Japanese government is going to weaken the yen in order to help its export industry, you would execute a BUY USD/JPY order. By doing so you have bought U.S dollars in the expectation that they will appreciate versus the Japanese yen. If you believe that Japanese investors are pulling money out of U.S. financial markets and repatriating funds back to Japan, and this will hurt the US dollar, you would execute a SELL USD/JPY order. By doing so you have sold U.S dollars in the expectation that they will depreciate against the Japanese yen.
GBP/USD
In this example the GBP is the base currency and thus the “basis” for the buy/sell.
If you think the British economy will continue to be the leading economy among the G7 nations in terms of growth, thus buying the pound, you would execute a BUY GBP/USD order. By doing so you have bought pounds in the expectation that they will appreciate versus the US dollar. If you believe the British are going to adopt the euro and this will weaken pounds as they devalue their currency in anticipation of the merge, you would execute a SELL GBP/USD order. By doing so you have sold pounds in the expectation that they will depreciate against the US dollar.
USD/CHF
In this example the USD is the base currency and thus the “basis” for the buy/sell.
If you think the Swiss franc is overvalued, you would execute a BUY USD/CHF order. By doing so you have bought US dollars in the expectation that they will appreciate versus the Swiss Franc. If you believe that due to instability in the Middle East and in U.S. financial markets the dollar will continue to weaken, you would execute a SELL USD/CHF order. By doing so you have sold US dollars in the expectation that they will depreciate against the Swiss franc.
Sample Trade
A trader wishes to speculate on EUR/USD. Believing that the EUR will rise against the USD, or that the exchange rate will move upwards, the trader places an order to buy EUR/USD at a market rate of 1.3050. Let us also assume that the trader is speculating on 100,000 units of the base currency, which is the standard lot size, or trading increment, used in the Foreign Exchange market. Since the base currency is the first currency in the pair, the trader is speculating on the value of 100,000 Euros with respect to the US Dollar.
In this example, the trader is buying Euros, since he believes the Euro will rise in value with respect to the US Dollar. Accordingly, he finances the transaction of buying 100,000 Euros by borrowing an equivalent amount of US Dollars.
For the trader, the value of the amount borrowed is a function of the exchange rate. Since the exchange rate at the time of the transaction was 1.3050, the market cost for 1 Euro was 1.3050 US Dollars. Hence, 100,000 Euros cost $130,500 (1.3050 * 100,000). This borrowed amount of 130,500 USD must be paid back when the transaction is closed.
Let’s assume that the trader is correct in assuming that the Euro would rise in value with respect to the USD, and that the exchange rate moved to 1.3150, 100 pips above the rate at which the trader entered. If the trader were to close his position now, the 100,000 Euros he purchased at the onset of the transaction would be sold, and his debt of 130,500 US Dollars would be paid off.
At an exchange rate of 1.3150, the trader’s 100,000 Euros are now worth 131,500 US Dollars (100,000 * 1.3150). After repaying the borrowed amount of 130,500, this leaves him with a profit of $1,000.
Traders have equal opportunities to profit regardless of whether the exchange rate is rising or falling.
Spreads & Bid/Ask
When viewing quotes, you will notice that there are two prices for each currency pair. Similar to all financial products, FX quotes include a "bid' and "ask". The bid is the price at which a dealer is willing to buy and clients can sell the base currency in exchange for the counter currency. The ask is the price at which a dealer is willing to sell and a client can buy.
Bid = The Price at which the Trader (You) Can Sell
Ask = The Price at which the Trader (You) Can Buy
For example, say the EUR/USD is trading at 1.3050 x 1.3053. In this case, the bid is 1.3050 and the ask is 1.3053. The difference between the bid and ask constitutes the spread. In the above example, the spread is 3 pips, or points. This differential reflects the cost of the trade. Essentially, the market would have to move 3 pips in your favor for you to break even, and 4 pips for you to be in your profit zone.
Structure of the Market
The FX market is an over-the-counter market with no centralized exchange. Traders have a choice between firms that offer trade-clearing services.
Unlike many major equities and futures markets, the structure of the FX market is highly decentralized. In other words, there is no central location where trades occur. The New York Stock Exchange, for example, is a totally centralized exchange. All orders pertaining to the purchase or sale of a stock listed on the NYSE are routed to the same dealer and pass through the hands of a single clearing firm. This structure requires buyers and sellers to meet at the NYSE in order to trade a stock that is listed on this exchange. It is for this reason that there is one universally quoted price for a stock at any given time.
In the FX market there are multiple dealers whose business is to unite buyers and sellers. Each dealer has the ability and the authority to execute trades independently of each other. This structure is inherently competitive as traders are faced with a choice between a variety of firms with an equal ability to execute their trades. The firm that offers the best services and execution will capitalize on this market efficiency by attracting the most traders. In the equities markets, the execution of trades is monopolized and there is no incentive for a clearing firm to offer competitive prices, to innovate, or to improve the quality of their service.
Margin
In standard cash stock accounts, money should be deposited for the full amount of the position you are trading, or if you have a margin account, for at least half of the position. This is in contrast to the FX market, where only a small percentage of the actual position value needs to be deposited prior to taking on the trade. This small deposit, known as the margin, is not a down payment, but rather a performance bond or good faith deposit to ensure against trading losses. The margin requirement allows traders to hold positions much larger than their account value (up to 200x the size).
Margin requirements are as low as .5% meaning for every standard lot size of 100,000 units, you must commit $500. However, if you wanted to control a $100,000 in the stock market, you would have to deposit at the very least, $50,000. Even in the futures market you would have to deposit at least $5,000 to control a $100,000 position.
Bank of England Collapse
The above illustration shows a classic example of a 5000-pip collapse of the GBP/DEM in 1992 from 2.9000 to 2.4000 in a matter of weeks. George Soros, in fact made $1 billion overnight buying GBP to convert them into DEM.
Currency Abbreviations
Below is a list of the abbreviations for various currencies that are commonly traded in the FX market:
EUR = Euro
GBP = British Pound (Sterling, Cable)
JPY = Japanese Yen
CHF = Swiss Franc (Swissie)
USD = United States Dollar
NZD = New Zealand Dollar (Kiwi)
AUD = Australian Dollar (Aussie)
CAD = Canadian Dollar
History of Foreign Exchange
Money has been around in one form or another since the time of Pharaohs. Middle Eastern moneychangers were the first currency traders who exchanged coins from one culture to another. However, during the middle ages, the need for another form of currency besides coins emerged as the method of choice. The Babylonians are credited with the first use of paper bills and receipts. These paper bills represented transferable third-party payments of funds, making foreign currency exchange trading (also referred to as Forex or FX) much easier for merchants and traders.
From the infantile stages of foreign currency exchange during the Middle Ages to WWI, the Forex markets were relatively stable and without much speculative activity. After WWI, the Forex markets became very volatile and speculative activity increased tenfold.
A Transitional Era
The Bretton Woods Accord
The first major transformation, the Bretton Woods Accord, took place toward the end of World War II. The United States, Great Britain and France met at the United Nations Monetary and Financial Conference in Bretton Woods, New Hampshire to design a new global economic order. The location was chosen because, at the time, the U.S. was the only country unscathed by war; most of the major European countries were in shambles.
The Bretton Woods Accord was established to create a stable environment by which global economies could restore themselves. The Bretton Woods Accord established the pegging of currencies and the International Monetary Fund (IMF) in hopes of stabilizing the global economic situation.
Up until WWII, Great Britain 's currency, the Great British Pound, was the major currency by which most currencies were compared. This changed when the Nazi campaign against Britain included a major counterfeiting effort against its currency. In fact, WWII vaulted the U.S. dollar from a failed currency after the stock market crash of 1929 to a benchmark currency by which most other international currencies were compared.
Now, major currencies were pegged to the U.S. dollar. These currencies were allowed to fluctuate by one percent on either side of the set standard. When a currency's exchange rate would approach the limit on either side of this standard, the respective central bank would intervene to bring the exchange rate back into the accepted range. At the same time, the US dollar was pegged to gold at a price of $35 per ounce further bringing stability to other currencies and the world Forex situation.
The Bretton Woods Accord lasted until 1971. Ultimately, it failed, but did accomplish what its charter set out to do, which was to re-establish economic stability in Europe and Japan.
The Beginning of the Free-Floating System
After the Bretton Woods Accord came the Smithsonian Agreement in December of 1971. This agreement was similar to the Bretton Woods Accord, but allowed for a greater fluctuation band for the currencies.
In 1972, the European community tried to move away from its dependency on the dollar. The European Joint Float was established by West Germany, France, Italy, the Netherlands, Belgium and Luxemburg. The agreement was similar to the Bretton Woods Accord, but allowed a greater range of fluctuation in the currency values.
Both agreements made mistakes similar to the Bretton Woods Accord and in 1973 collapsed. The collapse of the Smithsonian agreement and the European Joint Float in 1973 signified the official switch to the free-floating system. This occurred by default, as there were no new agreements to take their place. Governments were now free to peg their currencies, semi-peg or allow them to freely float. In 1978, the free-floating system was officially mandated.
In a final effort to gain independence from the dollar, Europe created the European Monetary System in July of 1978. Like all of the previous agreements, it failed in 1993.
The Foreign Exchange Market Today
The major currencies today move independently from other currencies. The currencies are traded by anyone who wishes. This has caused a recent influx of speculation by banks, hedge funds, brokerage houses and individuals. Central banks intervene on occasion to move or attempt to move currencies to their desired levels. The underlying factor that drives today's Forex markets, however, is supply and demand. The free-floating system is ideal for today's Forex markets.
From 1931 until 1973, the Forex market went through a series of changes – many of which have paved the way for the road ahead. The Forex market, as we know it today, originated in 1973.
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