The global marketplace has changed dramatically over the past several years. New investment strategies are becoming more important in order to minimize risk, as well as to maintain high portfolio returns. Among the most rewarding of the markets opening up to traders is the Foreign Exchange market. Why?
Money or currency is the ultimate commodity. Every time a company or government buys or sells products and services in a foreign country, they are subject to a foreign currency trade; the exchanging of one currency for another. Many individuals and organizations also trade currencies for speculative purposes. In contrast to the world’s stock markets, foreign exchange is traded without the constraints of a central physical exchange. Transactions are instead conducted via telephone or online. With this transaction structure as its foundation, the Foreign Exchange Market has become by far the largest marketplace in the world. With all of these currency transactions going on daily, it is no wonder that the foreign currency exchange market, also known as "forex" or "fx" market, is the largest financial market in the world. It is much bigger than all of the U.S. stock markets combined, with a daily trading volume larger than that of all the world's stock markets. In addition, it is also the least regulated market providing the greatest liquidity to investors.
Trillions of dollars of foreign exchange activity takes place every day. From 1997 to the end of 2000, daily forex trading volume surged from US$5 billion to US$3.0 trillion in 2007. The forex market continues to grow at a phenomenal rate. This high volume is advantageous from a trading standpoint because transactions can be executed quickly and with low transaction costs (i.e., a small bid/ask spread).
Before the internet came along, only corporations and wealthy individuals could trade currencies in the forex market through the use of the proprietary trading systems of banks. These systems required as much as US$1 million to open an account. Thanks to advancements in online technology. Self-directed investors with only a few thousand dollars and smaller financial firms can have access to the forex market 24 hours a day today with the same liquidity as larger market participants.
For traders, forex trading provides an alternative to stock market trading. While there are thousands of stocks to choose from, there are only a few major currencies to trade (the Dollar, Yen, British Pound, Swiss Franc, and the Euro are the most popular). Forex trading also provides a lot more leverage than stock trading, and the minimum investment to get started is a lot lower. Add to that the ability to choose flexible trading hours (forex trading goes on 24 hours a day), identifiable trading patterns, as well as comparatively low margin requirements, have rewarding trading opportunities for many and you have the reason why so many stock traders have flocked to day trade currencies. As a result, foreign exchange trading has long been recognized as a superior investment opportunity by central banks, major banks, multinational corporations, individual investors and speculators, and other institutional funds and hedge funds.
Trading, or speculation, makes up 95% of the daily volume. The other 5% of daily volume consists of governments and commercial companies converting one currency into another from buying and selling goods and services.
Spot foreign exchange (Forex) is always traded as one currency in relation to another - currency pair. One currency is bought and the other sold. For example, you buy Euro with Dollar, anticipating, the Euro to increase in value relative to the Dollar. Vice versa, a trader who believes that the dollar will rise in relation to the Euro, would sell EUR/USD.
The following list a guide for quoting conventions:
Symbol Currency Pair Trading Terminology Commonly
GBP/USD British Pound / US Dollar Cable Yes
EUR/USD Euro / US Dollar Euro Yes
USD/JPY US Dollar / Japanese Yen Dollar Yen Yes
USD/CHF US Dollar / Swiss Franc Dollar Swiss or Swissy Yes
USD/CAD US Dollar / Canadian Dollar Dollar Canada or Loonie
AUD/USD Australian Dollar / US Dollar Aussie Dollar Yes
EUR/GBP Euro / British Pound Euro Sterling
EUR/JPY Euro / Japanese Yen Euro Yen
EUR/CHF Euro / Swiss Franc Euro Swiss
GBP/CHF British Pound / Swiss Franc Sterling Swiss
GBP/JPY British Pound / Japanese Yen Sterling Yen
CHF/JPY Swiss Franc / Japanese Yen Swiss Yen
NZD/USD New Zealand Dollar / US Dollar New Zealand Dollar or Kiwi
USD/ZAR US Dollar / South African Rand Dollar Zar or South African Rand
GLD/USD Spot Gold Gold
When quoting currency pairs, the first currency is referred to as the base currency and the second, the counter or quote currency. The base currency is always equal to 1 monetary unit of exchange, for example, 1 Dollar, 1 Pound, 1 Euro. The dominant base currencies . When a currency is quoted against the US Dollar it is called a direct rate. Any currency not against the US Dollar is referred to as a cross rate. Example shows that 1 EUR equals to 1.0120/1.0126 US dollars. We will explain why 1 EUR equals to the two numbers (1.0120/1.0126) later.
There are four dominant currency pairs:
EUR/USD – the Euro
USD/JPY – the Yen
GRP/USD – the British pound
USD/CHF – the Swiss franc
Almost 85% of the world currency are transacted using the above four pairs