Forex trading

Forex trading is quite different from share trading. Only a small part of Forex trading is done by investors. The Forex market is many times larger than the stock market and is the most liquid market there is. This size makes it virtually impossible to manipulate the market, due to which economists consider the FX market as the most perfect market. This means that the difference in return between currency traders is determined by the difference in trader quality.

Players in the Forex

The major players in the foreign exchange market are banks, hedge funds, multinationals and governments. A multinational company may, for example, purchase raw materials in Australia, produce its goods in China, pay its employees in Swiss franks, and receive income in euros. This creates large worldwide money flows. The Forex is also often used by export companies to cover their risks (hedging). One example: Japanese companies exporting goods to the USA will see their income go down when the value of the USD decreases relative to the Yen. By opening a position that makes money when the Yen is on the rise, the risk of exchange rate fluctuations is covered. Companies often outsource their hedging activities to the treasury desks of banks.

How the trading works

There are various brokers facilitating Forex trading. The trading is done using an online platform where the trader can choose from a large quantity of currency pairs to trade with. Currency pairs are combinations of two currencies. In the EUR/USD combination, for example, the euro is the base currency and the US dollar the quote currency. Currency pairs can be bought or sold. The EUR/USD pair will rise if the euro increases in value, and it will fall if the US dollar increases in value.

How the trading works is best explained using the above screenshot of the MT4 trading platform. The purchase and selling prices of all currency pairs are shown at the top right. Next to them, a number of graphs of the currency pairs have been plotted. These graphs can be represented in different time units. The platform enables traders to use various indicators and to make their own analyses. In the lower half of the screen you can see the order portfolio with the current orders at the top, a bar indicating the balance, equity and margin. Below the bar, you can see the orders that have been placed. In order to place such an order, you need to fill in at what price you want to buy or sell. You can also fill in the rate you want to sell at (take profit) or the rate where you will take your loss (stop loss).

The Forex market is open 24 hours a day

One of the main differences with the trade in shares is that Forex trading is not bound to a physical location. Forex trading is done on a global scale and, because of the different time zones, it is a 24-hour business. The table below shows the approximate length of the trading sessions per continent. Europe is considered the best location for Forex trading as the trade volume of the total Forex market is largest during the European working hours. During the hours that the European and the American stock exchanges are both open, there is a sharp rise in trade volume.

High liquidity enables direct trading

The Forex market is the most liquid market there is. Because this market is so large, there are always potential buyers or sellers in the market. This enables traders to buy or sell directly at the price of the moment at almost any time of the day. Banks and other major players that want to trade tens of millions or more therefore have to do so in several steps.

Leverage generates big profits from small movements

Leverage allows investors to maximize their profit potential in currency trading. Leverage means that trading is done with an amount that is several times larger than the amount in the account. Forex traders usually use a leverage ratio of 1:100. Generally speaking, currency pairs do not move more than 1% per day. By using leverage, talented traders can generate huge returns very quickly.