Foreign Exchange or Forex is currently the largest financial market in the world. However, it remains an unfamiliar territory to retail currency traders. Large corporations and financial firms are the ones who rule this territory until Internet was born. When online trading was invented an individual can now have access to information that will help him invest in forex and earn. To help you out in learning about forex here are the most frequently asked questions?
What is the difference of the forex market from the rest of the markets?
Currency trading, unlike stocks, is not regulated. The stock market is controlled by a governing body that provides rules and arbiters to resolve disputes, forex does not have one. You can trade with other currency traders via credit agreements or is called a metaphorical handshake. This makes the forex market the most liquid market in existence.
A novice or someone used to structured exchanges will think that such an agreement is very risky and should be avoided. But in practice the arrangement works perfectly. This is because traders in forex must cooperate with each other even when they compete with each other. The result is self-regulation which helps make the trading more accurate and honest. This self-regulation tends to create a common ground for traders enabling them to form a group that share the same regulations like the National Futures Association in the U.S. The NFA made a very outstanding reputation in the forex trading making their members the most sought after traders.
What is the source for forex trading commissions?
Unlike stocks trading where traders have brokers, forex trading does not have one. Therefore forex trading does not have commissions. Forex trading have dealers and they only make money when there is a bid-ask spread, the amount in the ask price that exceeds the bid. The forex investor cannot buy on the bid or sell at the ask price. But once everything is finalized there is no additional cost for the investor such as fees and commissions.
In the Forex Market, what do you sell and buy?
The forex market is a currency market so it is expected that you sell and buy currencies. However, this is not what actually happens. Retail forex trading is speculative and no physical exchange of currencies takes place. All trades exist as electronic data. This means that in forex markets you sell and buy nothing at all.
You would ask now “what is forex trading when you sell and buy nothing?” The answer is that the forex market’s main purpose is to facilitate the currency exchange from one multinational corporation to another. It’s like helping a Japanese company buy goods or services from a European company. But is just about 1/5 of the entire market volume. The other 4/5 of the volume is from financial institutions and large hedge funds who want to profit from the currency exchange.
Another thing that you should know is that currencies are always trade in pairs. This means that you will always short one currency and long the other. To help you visualize what it means let’s say you have 100 units of USD and EURO. So when you trade dollars for euros you short your euros and long your dollars, or you lost some euros and gain some dollars. And all these are recorded on your account as a forex trader. You may not have the physical goods but the consequences of the trade are real nonetheless.
What are the currencies that are traded in the forex market?
The forex market virtually trades all known currencies. But the majority trades are with the seven most liquid currency pairs in the world. Most liquid here means the most used currency for trading in the global market.
• EUR/USD – euro/US dollar
• USD/JPY – US dollar/yen
• GBP/USD – pound/US Dollar
• USD/CHF – US dollar/Swiss franc
• AUD/USD – Australian dollar/US dollar
• USD/CAD – US dollar/Canadian dollar
• NZD/USD – New Zealand dollar/US dollar
The major currencies are the 1st four currencies above. Several other combinations from the seven are also traded (EUR/GBP, GBP/JYP and EUR/JYP). All of this account for the majority of all trading’s in the currency market.
What is a currency carry trade?
A carry trade is when an investor sells a certain currency with a low interest rate and use the profit to buy another currency with a higher interest rate. This trade relies on the interest rates of all currencies which are set by the central banks of countries where the currency originates. This makes carry trade the most popular type of trade in the forex market. You may be wondering why. In 2005, the best currency pairing was NZD/JPY. The economy of New Zealand was growing which raised the currency interest rates to 7.25%. Japan however had the yen at 0% interest rate. With a leverage basis of 10:1, a carry trade in NZD/JPY is expected to generate 72.5% in annual return from interest rate differentials. That is why carry trade is very popular among forex traders.