Forex Market | by ForexCycle.com | Wednesday, 24 December 2008 15:49 UTC
Trading on the foreign exchange (FOREX) market has many advantages. In this article, we will describe these principal advantages to help you better understand the workings of one of the world's largest markets.
FOREX is the world's most liquid financial market. When we say that something has high liquidity, we mean that it can readily be converted to cash. Now, if we have a market in which we are trading in money, its liquidity is simply unsurpassable. Investors are drawn by this fact because it allows them to open and close positions regardless of the volume. The trading volume in the FOREX market on average totals to one and a half trillion dollars per day. This is why we say that its liquidity is matched by no other market. The trader can thus freely enter or exit the market with no limit on the amount of trade that can be done in a single day and minimal execution barriers. This holds true under any market conditions.
FOREX is also an extremely efficient market. This is due to the fact that it is a market that never closes. A trader can literally be active twenty-four hours per day. Other markets, such as the stock market, do not allow for this possibility. As important news reaches you, as an investor you have the possibility of reacting immediately since you can always find working sellers and buyers in some corner of the globe. You also do not need to worry about conference calls of analysts or earnings reports that are done after hours as these cannot influence your portfolio in the FOREX market. Albeit with a few limitations, trading after hours is now possible for stocks in the United States of America through Electronic Communication Networks (ECNs). ECNs were designed to connect sellers and buyers outside of stock exchanges, but they cannot ensure that each trade is successfully carried out and cannot vouch that it will take place at fair market value. With a view to obtaining a tighter spread, traders often have to await the opening of markets on the next day. There is no need for this in currency markets as traders can reap the benefits of all advantageous conditions whenever they occur.
Another advantage of the FOREX market is low expenditure. In fact, the only charges consist of the spread, i.e. the market difference that naturally occurs between supply and demand prices. There are no commission fees. When operating under standard market conditions, the wholesale transaction cost (bid/offer spread) is usually below 0.1% or 10 pips. The spread can be significantly lower in bigger transactions (under 5 pips) and in very dynamic markets it can broaden substantially.
Furthermore, there is no ambiguity of quotations. Since FOREX is a market with high liquidity, you can sell or purchase virtually unrestricted amounts on a standard market price. Hence, while futures and stock markets, for example, carry a lot of instability and allow you to trade only a restricted amount at a given time and at a set price, this is not the case with currency markets.
Let us now talk about margin. In the FOREX market, the margin amount is agreed upon by the client and the broker or bank. This amount is normally in the 1:33, 1:50 or 1:100 ratio to the sum that is invested. Let's take the latter as an example. This means that when a client's account has $1,000, he or she can carry out $100,000 transactions. The currency market is both very profitable and very risky because such a high leverage is used in combination with the great variability of currency quotations. The difference in leverage ratios is very large between the equity market with a ratio of 2, for example, and the FOREX market whose ratio can be up to 400. Although this can be advantageous in that the potential for profit is very appealing, buying and selling in the foreign exchange market also carries a much greater risk of loss.
Another great thing about the FOREX market is that the prices are always rising or are expected to rise. This is what is meant by the term "bull market". The logic is very simple. Since trading in the foreign exchange market implies weighing out the perspective of one currency relative to another, there will always be a currency which presents a positive outlook. Whatever happens with a given currency, we can always trade it for another which is expected to do well and hence has a bull market.
The foreign exchange market is also an inter-bank market. Behind this market lies a web of traders, which mostly consist of business banks. Using telecommunications and electronic networks, these banks maintain contact and buy and sell to and from each other and their customers. Unlike stock exchange markets, no centralized exchanges exist to manage transactions in the currency market.
The FOREX market cannot be controlled for a long period of time simply because it is so diverse and so many actors are involved in the process. Market prices are hard to manipulate by even the most powerful central banks, which have over the past years refrained more and more from attempting to control them.
It is also an unregulated market, even though there are laws which direct the operations of the principal traders like business banks. Brokers, however, are not controlled by any regulations or laws that are specially apply to the foreign exchange market because these do not exist. Moreover, a large number of brokerage firms in America do not even declare to the IRS. The currency options and futures that are bought and sold on financial exchanges are controlled in the same manner as other derivatives that are traded on exchanges.
Another important difference between the FOREX market and the equity market is that in the former there is equality of information access. Expert equity markets traders benefit from their knowledge of inside information, i.e. information which they find out before the rest of the population. This gives them great power over others, because they know what to buy and what to sell at the right time. Contrary to this, the foreign exchange market allows everyone to have the same amount of information at the same time. It suffices to watch the news, read newspapers or browse the internet to obtain up-to-date information.
In the FOREX market, profit can be made in markets which are rising, as well as in markets which are falling. Since currency transactions are symmetrical, a trader is always long in one currency and short in another at the same time. When an investor expects a currency to depreciate and sells it, this is called a short position. Hence, traders have the possibility of making money in both rising FOREX markets and falling FOREX markets. This is greatly facilitated by the fact that you have no limitations when selling currencies, which is something that the equity market does not provide. When trading in US equity, it is very hard to create a short position due to the fact that the uptick rule regulates short selling. This means that a security has to be sold short for a price which is the same or higher than the price at which the last prior trade was carried out.
An added benefit of FOREX trading is that efficient software for executing trade is available to the majority of brokers. Few brokerages own execution software with OCO, or order cancels order. FOREX brokerages give great value to functionality, since that which is easier to do can be done with higher frequency.
Last but not least, it should be noted that currencies have a disposition to trend. This is due to the fact that macro factors, central banks and the financial policies of states still hold sway over currencies. That is why, when compared to other markets, they have a greater habitual inclination to trend.
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