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The Forex Market

The Most Developed Market in the World.

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INTRODUCTION

Trading the foreign currency market, or the Forex Market, as it is commonly known, is the most developed financial market in the world. The Forex Market is not concentrated in any one exchange, rather the vast majority of forex trades are private deals between two parties in what is known as an ‘Over the Counter’ or OTC market. The currencies are traded and quoted in pairs such as Euro/U.S. Dollar or U.S. Dollar/Japanese Yen, where a deal is the combination of selling one currency while buying another currency at the same time.

THE RULE

The Rule says that the U.S. Dollar is the base currency against which all other currencies are quoted. In other words the exchange rate tells us how many units of the second currency are worth one dollar. For example, if the USDCHF (U.S. Dollar/Swiss Franc) exchange rate is quoted as 1.2515, each dollar is worth 1.2515 Swiss Francs. The exceptions to the rule where the Dollar becomes the secondary currency and its pair the base currency are: Euro (EUR), Pound Sterling (GBP), Australian Dollar (AUD) and New Zealand Dollar (NZD).

QUOTES

The BID price is the price at which a client can sell a unit of the base currency (in return for buying the secondary currency) and the ASK/OFFER price is the price at which a client can buy a unit of the base currency. For example, if the quote for the exchange rate of the Euro/U.S. Dollar in the market is 1.2581/1.2585, this means that the client can pay $1.2585 in order to buy one Euro (the base currency) and will receive $1.2581 if one Euro is sold. The BID price is lower than the ASK price and the difference or ‘spread’ between the two numbers is measured in ‘pips’ (4 pips in this case) and represents the profit of the dealing room.

TRADING HOURS

The major advantage of the Forex market, as opposed to the stock market or other financial markets stems from the fact that it is a continuous global market (trading 24 hours a day). Trading over three continents, Asia, Oceania, New Zealand, Europe, America, New York take it in turns to hold the baton, allows a trader to trade without being time-boutnd and to react immediately to events and new developments (the market opening on Sunday evening and the market closing Friday night).

Average daily trading volume in the Forex Market is estimated at 3 trillion dollars, several times larger than the combined voluem of all the U.S. stock markets. The vast majority of this volume is speculative, thanks to the huge liquidity available. Return to Top

LEVERAGE / MARGIN

The Forex Market, characterized by the high liquidity and continuous trading, allows for unlimited position sizes. This allows the suppliers of liquidity to provide clients with financial leverage. Leverage of 100:1 (ie. a deposit of $1,000 can be leveraged to a position of $100,000) is acceptable ratio in the market.

It is important to appreciate the fact that leveraging increases your risk, but while the stock market can have a daily volatility of 10% or more, the major currencies of the forex market have typically volatility of less than 1%. Therefore, leverage can enable you to make large gains very quickly with the help of relatively low volatility.

COSTS AND COMMISSIONS

Huge turnover in the Forex market, electronic trading and competition have brough a reduction in the bid-offer spread (the equivalent of commissions). The spread coverst the risk of the market maker. The spread for the majors remain very low, but can increase as the liquity of a specific curreny drops. The Forex Market is considered to have the lowest overall commissions relative to trade size compared with other financial markets.

CONTINUOUS FINANCIAL INFORMATION

Exchange rates are supplied real-time by a number of international institutions. As a result of this, news and economic announcements can be transmitted efficiently and immediately. This way trading conditions can be indentical for all traders with no consideration of their trade size.

GEOGRAPHIC LOCATION

In contrast with exchange traded securities dependant on the exchanges trading hours, currencies are OTC (Over the Counter) instruments traded electronically at all times and at several locations around the globe at the same time, 24 hours a day, 5 days a week. The main trade centers around the world are Tokyo, London and New York, with no exchange situated at any of these locations.

FACTORS AFFECTING THE FOREX MARKET

The massive size of the market means that it is nearly impossible for any one speculator to affect the market. Even central bank activity brings limited volatility and for short periods of time only.

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