Why Trade Forex?

Forex Market vs. The Stock Market

There are well over 2,000 stocks listed on the New York Stock Exchange and over 3,000 stocks listed on the NASDAQ.

In regards to stock trading: How do you decide which one(s) will you trade? Do you even have the time to stay on top of so many companies?

With Forex trading, there are only a few dozen currencies traded, and the majority of market players trade the four major pairs.

In my opinion, only needing to trade four pairs is so much easier to keep up with than trading thousands of stocks.

 

24Hr Market 5 ½ Days per Week of Trading!!

The Forex market is a continuous 24-hour market. Most brokers are open from Sunday at 4:00 pm EST in the US until Friday at 4:00 pm EST in the US.  A good broker will have customer service available 24/7.

Traders are able to trade during the U.S., Asian, European, and Sydney market hours.

This means you can trade whenever it is convenient for you!

 

Low or No Commissions

Most Forex brokers charge no or very low commission or other fees (ie swap) to trade currencies online.

Forex trading also have tight, consistent, and fully transparent spreads.

Forex trading costs are lower than those of any other market.

Most brokers are paid for their services by way of the bid/ask spread.

 

Market Orders Executed Instantaneously

Trades are instantaneously executed when market conditions are operating normally. During these conditions, usually the price shown when you execute the market order is the price you enter the trade at.

Understand that this means you are able to execute a buying and selling of a pair directly off real-time prices and not off of hyped up off market prices.

Brokers typically will only guarantee stop, limit, and entry orders under normal market trading conditions.

Fills of orders are instant, most of the time, but under highly volatile market conditions order execution can and usually will experience delays.

 

Taking a Short Can Be Just as Profitable as Taking a Long

Unlike the equity market, there is no restriction on short selling in the currency market. Trading opportunities can be taken advantage of regardless of whether a trader is long or short.

Because Forex trading always involves buying one currency and selling another, there is no predisposition to the market. You always have equal access to trade in a rising or falling market.

 

Direct Access To Price Quotes

There is no doubt that centralized exchanges provide many advantages to the trader. However, one problem with any centralized exchange that there is a need for a middleman.

And as you probably know if you have someone or something in between the trader and the buyer or seller of any type of financial instrument that will cost money. The cost will either be either in time or in fees.

Forex trading, is decentralized, which means quotes can vary from different currency dealers.  And competition between them is so aggressive that you are almost always assured that you get the best prices. Forex traders are exposed to quicker access and cheaper costs.

 

Buyers/Sellers do not capitalize the market.

The advantage of trading in a massive market such as one the size of the Forex market, makes the likelihood of any one fund or bank being able to control a particular currency very small.

Banks, hedge funds, governments, retail currency conversion houses, and people with deep pockets are just some of the participants in the spot currency markets where the liquidity is unmatched.

 

Analysts and brokerage firms are less likely to influence the market

If you have listened to any financial news recently you’ve probably heard about a certain stock or crypto currency (or whatever) and an analyst of a well-known brokerage firm sticking to its recommendations, such as buy a recommendation to buy the asset when the stock was on a steady decline.

This is typically how stock analyst works. And no matter what the government does to step in and discourage this type of activity, it's not effective.  We have not heard the last of it guaranteed.  IPOs and now ICO's are big business for both the companies going public and the brokerage firms.

Relationships are mutually beneficial and analysts work for the brokerage houses that need the companies as clients. That dynamic will never disappear.

The Foreign exchange market generates billions in revenue for the world’s banks and is a necessity of the global markets. Analysts in foreign exchange have very little effect on exchange rates; they’re job is to simply analyze whats happening in Forex market and not make "recommendations".

 

Forex vs. Futures

It’s not just the stock market that we can compare Forex with, the Forex market garner many advantages over the futures market as well.

 

Liquidity

In the Forex market, $5.3 trillion is traded daily, in other words this is the largest and most liquid market in the world.

The futures market trades about $30 billion per day.

The futures markets can’t compete with the Forex market because has fairly limited liquidity.

The Forex market is always liquid, meaning positions can be liquidated and stop orders executed with little or no slippage, there is a caveat to this statement.   Slippage can occur in extremely volatile market conditions.

 

24-Hour Market

  • At 5:00 pm EST Sunday, trading begins as markets open in Sydney.
  • At 7:00 pm EST the Tokyo market opens,
  • At 3:00 am EST the London market opens,
  • And finally, at 8:00 am EST the New York opens.

 

 

And before the New York trading session closes, the Sydney market is back open – so see it’s a 24-hour continuous market.

What does this mean for you are a trader?  Well this allows you to react to favorable or unfavorable news by being able to execute or exit a trade immediately. Not having to wait until the market reopens is truly an advantage.

If important news happens in the United Kingdom or Japan while the U.S. futures market is closed, the next day’s opening could be a voliate ride.

 

Low or no commissions

With Electronic Communications Brokers (ECN) becoming more popular and dominant over the past couple of years, there is the chance that a broker may require you to pay commissions.

But really, the commission fees are very low compared to what you pay in the futures market.

The competition among spot Forex brokers is so fierce that you will most likely get the best quotes and very low transaction costs.

 

Price Certainty

When trading Forex, you get rapid trade execution and price certainty under normal market conditions, of course. As compared to the futures and equities markets, which do not offer price certainty or instant trade execution.

Even with the initiation of electronic trading and limited guarantees of execution speed, the prices for fills for futures and equities on market orders are most definitely anything but certain.

The prices quoted by brokers often represent the last trading price and not necessarily the price for which the contract will be filled.

 

Guaranteed Limited Risk

Traders must have position limits to implore proper risk management. This is a direct result of the amount of money in a trader’s account.

Risk is minimized in the Forex market because the online capabilities of the trading platform will automatically implement a margin call if the required margin amount exceeds the available trading capital in your account.  When this happens during normal market conditions, all open positions will be closed immediately (during fast market conditions, your position could be closed beyond your stop loss level.  It is because of this reason I always advocate for traders to actively trade the market).

In the futures market, your position may be liquidated at a loss bigger than what you had in your account, and you will be liable for any resulting deficit in the account. That can be disastrous.

 

Forex Participants: Who participates in the Forex market?

 

Forex Market Structure

To make this as simple as possible, let us first examine a market that most traders are usually very familiar with the stock market.

By the nature of the stock market it tends to be monopolistic. There is only one entity that controls prices.

All trades must go through this entity. Because of this, prices can easily be altered to benefit the entity and not traders.

So how does this happen?

In the stock market, the entity is forced to fulfill the trader’s order.

For example, if the number of sellers suddenly exceed the number of buyers, the entity is obligated to fulfill the order of its clients, the sellers in this instance, is left with a bunch of stock that he or she cannot sell-off to the buyer.

To prevent this from happening, the entity can merely widen the spread or increase the transaction cost to prevent sellers from entering the market.

In other words, the entity can manipulate the quotes it is offering to accommodate its needs.

 

Trading Spot Forex is Decentralized

To trade stocks or futures you have to go through a centralized entity, with Forex trading you don’t need to go through a centralized exchange like the New York Stock Exchange.

In the Forex market, there isn’t a single price for a given currency at any time, which means quotes from different currency brokers may vary.

The Forex market is so huge and the competition between dealers is so aggressive that you almost always get the best deal for every trade every single time.

The very best thing about Forex trading is that you can do it anywhere!!! That’s right ANYWHERE!! The key to Forex trading is to find the best deal out there.

 

The Forex Ladder  

Even though the Forex market is decentralized, it isn’t chaotic!

The participants in the Forex market can be explained in a hierarchy. To better understand this consider the following:

At the very top of this hierarchy is the interbank market. The interbank is made up of the largest banks in the world and some smaller banks, the participants of this market trade directly with each other or electronically through the Electronic Brokering Services (EBS)  or the Reuters Dealing 3000-Spot Matching..

They are in constant battle for clients and continually try to one-up each other for market share. While both companies offer most currency pairs, some currency pairs are more liquid on one than the other.

For the EBS platform, EUR/USD, USD/JPY, EUR/JPY, EUR/CHF, and USD/CHF are more liquid.  For the Reuters platform, GBP/USD, EUR/GBP, USD/CAD, AUD/USD, and NZD/USD are the most liquid.

All the banks that are part of the interbank market can see the rates that each bank is offering, but that don’t mean anyone can make deals at those prices.

Similar to real life, the rates will largely be dependent on the established credit relationship between the trading parties. For instance, there’s a rate that can be considered the “VIP rate,” a rate that can be considered the typical “consumer rate,” and the rate that’s highly marked up for profits.  Think of it in regard to going to the bank and requesting a loan. The better your credit standing and relationship is with them, the better the interest rates and the larger loan you are offered.

Next on the hierarchy are the hedge funds, corporations, retail market and retail ECNs. These institutions do not have as close of a  credit relationships with the interbank market, so they have to do their transactions through commercial banks. This means that their rates are more expensive than those who are part of the interbank market.

At the very bottom of the hierarchy are the retail traders--us. It used to be very hard for retail traders to engage in the Forex market but, thanks to the power of the internet, electronic trading, and retail brokers, the barriers that stood in the way allows us entry in Forex trading more accessibly.  And of course we don't get as great of a rate as the interbank or the hedge funds etc. but the rates are still cheaper than trading stocks and or futures.

 

Forex Market Participants

It is important for you that you understand the nature of the spot Forex market and who the main Forex market players are.

Up until recently, only those included in the highest hierarchy category could participate in the Forex market. The initial requirement was that you could trade only if you had about ten of millions of dollars to start with.

Forex was originally intended to be used by bankers and large institutions.

However, because of the rise of the internet, online Forex brokers are now able to offer trading accounts to us retail traders.

 

1. The Super Banks

Since the Forex spot market is decentralized, it is the largest banks in the world that determine the exchange rates.

Based on the supply and demand for currencies, they are generally the ones that determines the bid/ask spread.

These large banks are collectively known as the interbank market, take the majority of the Forex transactions each day for both their customers and themselves.

Some of these super banks include Citi, JPMorgan, Barclays, and Deutsche Bank.

 

2. Large Commercial Companies

Companies take part in the foreign exchange market frankly because they have to do business.

Let’s take a well-known example Apple.  Apple must first exchange its U.S. dollars for the Japanese Yen when purchasing electronic parts from Japan to manufacture their products.

Since the volume they trade is much smaller than those in the interbank market, these types of market participants typically deals with commercial banks for their transactions.

And like the stock market, mergers and acquisitions between large companies can also create currency exchange rate fluctuations.

 

3. Governments and Central Banks

Governments and central banks, like the European Central Bank, the Bank of England, and the Federal Reserve, are regularly involved in the Forex market as well.

Just like companies, national governments participate in the Forex market for their operations, international trade payments, and handling of their foreign exchange reserves.

Central banks affect the Forex market when they adjust interest rates to control inflation.

When this happens currency valuation is affected.

Central banks can also intervene, either directly or verbally, in the Forex market when they want to readjust exchange rates.

If central banks think that their currency is priced too high or too low, they can massively sell/buy currencies to alter exchange rates.

 

4. The Speculators

Covering close to 90% of all trading volume, speculators in the Forex market come in all shapes and sizes.

Some of the speculators have lots of money, some not so much, but all of them engage in the Forex with one goal in mind to make a ton of money.

 

 

A Little Forex History!

The Bretton Woods System, the agreement set the exchange rate of the US dollar against gold. Which allowed all other currencies to be pegged against US dollar.

The Bretton Woods System was created at end of the World War II.  The world was in so much chaos that the major Western governments felt they needed to create a system to stabilize the global economy.

The agreement stabilized exchange rates for a while, but as the major economies of the world started to change and grow at different rates, the rules of the system soon became obsolete and limiting.

This lead to the Bretton Woods Agreement being abolished in 1971 and replaced by a different currency valuation system.

With the United States in the at the forefront, the currency market evolved to a free moving market, where exchange rates were determined by supply and demand.

At first, it was difficult to determine fair exchange rates, but with the advances in technology and communication it became easier to determine.

In the 1990s, thanks to computer programmers and the booming growth of the internet banks began creating their own trading platforms.

These platforms were designed to stream live quotes to their clients so that they could instantly execute trades themselves.

All the while, smart business-minded marketing machines exposed internet-based trading platforms for individual traders.

Known as “retail Forex brokers”, these entities made it easy for individuals to trade by allowing smaller trade sizes.

Unlike in the interbank market where the standard trade size is one million units, retail brokers allowed individuals to trade much smaller units.

 

Retail Forex Brokers

In the past, only the big speculators and highly capitalized investment funds could trade currencies, but thanks to retail Forex brokers and the Internet, we all can participate in the Forex trading market.

Anyone can just contact a broker, open up an account, deposit some money, and trade Forex from the comfort of your own home.

Brokers come in two forms:

  1. Market makers, as their name suggests, “make” or set their own bid and ask prices themselves and
  2. Electronic Communications Networks (ECN), who use the best bid and ask prices available to them from different institutions on the interbank market.

 

Market Makers

When you decide to take a trip to another country, say you’re going to France. In order for you to transact in this country, you need exchange your local currency to euros first.  This is achieved by going to a bank or your local foreign currency exchange office. They will take the opposite side of your transaction, so you have to agree to exchange your home currency for euros at the price they set.

Just like any business transactions, there is a catch. In this case, the catch is presented as the bid/ask spread.

So, if the bank’s buying price or the bid for EUR/USD is 1.4000, and their selling price or ask is 1.4007, then the bid/ask spread is 0.0007.

Although this price difference appears to be small, when you consider millions of these transactions through the Forex market every day, it add up to create a substantial profit for the market makers!

Retail market makers basically provide liquidity by allowing large contract sizes from wholesalers to be redistributed into smaller contracts. Without them, it will be very hard for those of us without millions of dollars to trade Forex.

 

Electronic Communications Network

Electronic Communication Network is the name given for trading platforms that automatically match customer’s buy and sell orders at the quoted prices.

These quoted prices are all gathered from different market makers, banks, and even other traders who use the ECN.  Whenever a certain sell or buy order is made, it is matched up to the best bid/ask price out there. Due to the ability of traders to set their own prices, ECN brokers typically charge a small commission for the trades you take.

The combination of tight spreads and small commissions usually make transaction costs cheaper on ECN brokers.

 

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