Businesses operating in foreign countries face risks caused by fluctuations in the value of currency when they need to buy or sell to another country. Foreign exchange markets offer a way to hedge this risk by coming up with a fixed rate for the transaction at a set time in the future. A trader accomplishes this by buying or selling currencies in the forward or swap markets.
Usually at this time; banks lock in a rate for the business owner to know the exact exchange rate, helping them mitigate their company’s risk. The futures market, to some extent, can provide a method for hedging currency risk, based on the actual currency and size of the trade involved. Currency values are constantly fluctuating due to changing demand and supply factors.
Therefore, there is a chance to bet against the changing values by either buying or selling a currency against another hoping that the one you buy becomes stronger or the one you sell weakens against its counterpart. There exist two different characteristics to currency as an asset class:
- Earning the interest rate differential
- Gaining value in the exchange rate
Over time, banks came up with proprietary desks to help them trade and were soon followed by international corporations, wealthy people, and hedge funds. The Internet led to the creation of a retail market for individual traders to access Forex markets either via banks or brokers. The interbank market is a compilation of several banks that trade with each other globally. Since the banks themselves accept credit risks and sovereign risk, they have numerous internal auditing processes for their safety.
The pricing mechanism is determined by supply and demand so a rogue trader cannot control the price of any currency. Attempts are underway to have an Electronic Communication Network (ECN) that will bring traders into a centralized exchange for more transparent pricing.
Banks can still remain decentralized. Traders who have direct access to Forex banks are, obviously, not as exposed as retail traders dealing with unregulated Forex brokers. The foreign exchange market is the largest in the world and therefore the most liquid, hence entering and exiting a position in major currencies becomes easier.
Owing to the liquidity and ease of entrance/exit, brokers and banks offer leverage, which gives a trader power to control very large positions with little of their money. Forex markets also trade round the clock. Forex trading is a macroeconomic endeavor and one needs to have insight in the economies of different countries and how they are interconnected.
Currency trading is referred to as an “active trader’s” opportunity, which is a kind of opportunity that best suits brokers because active markets are nimble and that means they make more money. Currency trading is also referred to as leveraged trading and traders can open an account with less money than is needed for stock trading.
Traders with limited funds, through swing trading and day trading in small amounts can play the Forex markets, while those with larger pool funds and longer-term horizons may prefer a carry trade. For both cases, timing is very important.
The Forex market (also known as Foreign Exchange or FX) is among the most thrilling, fast-paced markets you can ever find. For quite some time, central banks, financial institutions, hedge funds, corporations, and the super wealthy dominated foreign exchange trading in the market.
The introduction of the internet changed everything and has made it possible for average individuals to participate in the buying and selling of currency, even from the comfort of their living rooms via online brokerage accounts. Daily currency fluctuations are not usually significant. A lot of currency pairs do not move more than one cent in any given day, which translates to a currency value change of not more than 1%.
Therefore, foreign exchange can be termed as the least volatile financial market in the world. In that case, most currency speculators depend on the availability of huge leverage to boost the value of expected movements. Leverage can go as high as 250:1 in the retail forex market. Higher leverage tends to be very risky.
However, the deep liquidity and round the clock trading enables foreign exchange brokers to make high leverage a standard in the industry, making the movements more meaningful for the currency traders. The presence of high leverage and extreme liquidity contributes in spurring the forex market’s speedy growth and has also made it an attractive investment for many traders. The positions can be easily opened or closed in minutes or even held for a longer time.
Currency prices are usually determined by objective considerations of the forces of demand and supply; Manipulation is almost impossible, thanks to the size of the market—largest players like central banks cannot alter the prices whenever they want. There are numerous opportunities for investors in the foreign market.
Nevertheless, to make it there, a currency trader must know the basics that influence currency movements. This Forex tutorial aims at offering a foundation for traders or investors who are newbies in the foreign exchange markets. The basics of exchange rates are covered, along with the history of the market and any other major details that you should know before participating in the market. You will also find tips to help you start trading currencies and various tactics that you can employ for your success.