Compared to other financial markets, the forex market offers many advantages, such as 24h trading, no commissions and margin trading. Most of the advantages forex trading offers are listed here below.
Advantages of forex trading
Although the forex market is by far the largest and most liquid in the world, day traders have up to now focused on seeking profits in mainly stock and futures markets. This is mainly due to the restrictive nature of bank-offered forex trading services.
Advanced Currency Markets (FXEURASIA) offers both online and traditional phone forex trading services to the small investor with minimum account opening values starting at 5000 USD.
There are many advantages to trading spot foreign exchange as opposed to trading stocks and futures. Below are listed those main advantages.
1. Bid/Ask Spread rates
Spread rates have tightened dramatically in the last years. Most online forex brokers offer a spread of at least 3 pips on EURUSD which is the most widely traded and liquid currency pair. FXEURASIA offers a 2 pip spread on EURUSD. In stock trading, only liquid stocks offer tight spreads. Those spreads often represent on average between 0.04% and 0.06% of the value of the stock. In comparison FXEURASIA offers a 2 - 3 pip spread on all major currencies, this equates to approximately between 0.015% and 0.025% on the underlying dollar value.
Exact percentages at current rates (November 2008):
EURUSD 2 pips 0.015%
GBPUSD 3 pips 0.02%
USDJPY 2 pips 0.020%
USDCHF 3 pips 0.025%
In the futures market spreads can vary anywhere between 5 and 9 pips and can become even larger under illiquid market conditions (which tends to happen substantially more often in futures currencies).
2. Forex trading commissions
FXEURASIA offers forex trading commission free. This is in sharp contrast to (once again) what stock and futures brokers offer. A stock trade can cost anywhere between USD 5 and 30 per trade with online brokers and typically up to USD 150 with full service brokers. Futures brokers can charge commissions anywhere between USD 10 and 30 on a round turn basis.
3. Forex trading margins requirements
FXEURASIA offers a forex trading with a 1% margin. In layman's terms that means a trader can control a position of a value of USD 1'000'000 with a mere USD 10'000 in his account. By comparison, futures margins are not only constantly changing but are also often quite sizeable. Stocks are generally traded on a non-margined basis and when they are, it can be as restrictive as 50% or so.
4. 24 hour forex trading
Forex trading market occurs over a 24 hour period picking up in Asia around 24:00 CET Sunday evening and coming to an end in the United States on Friday around 23:00 CET. Although ECNs (electronic communications networks) exist for stock markets and futures markets (like Globex) that supply after hours trading, liquidity is often low and prices offered can often be uncompetitive.
5. No Limit up / limit down
Futures markets contain certain constraints that limit the number and type of transactions a trader can make under certain price conditions. When the price of a certain currency rises or falls beyond a certain pre-determined daily level traders are restricted from initiating new positions and are limited only to liquidating existing positions if they so desire. This mechanism is meant to control daily price volatility but in effect since the futures currency market follows the spot market anyway, the following day the futures market may undergo what is called a 'gap' or in other words the futures price will re-adjust to the spot price the next day. In the OTC market no such trading constraints exist permitting the trader to truly implement his trading strategy to the fullest extent. Since a trader can protect his position from large unexpected price movements with stop-loss orders the high volatility in the spot market can be fully controlled.
6. Sell before you buy
Equity brokers offer very restrictive short-selling margin requirements to customers. This means that a customer does not possess the liquidity to be able to sell stock before he buys it. Margin wise, a trader has exactly the same capacity when initiating a selling or buying position in the spot market. In spot trading when you're selling one currency, you're necessarily buying another.
Foreign exchange history, origins of the forex |
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In order to gain a complete understanding of what forex is, it is useful to examine the reasons that lead to its existence in the first place. Exhaustively detailing the historical events that shaped the foreign exchange market into what it is today is of no great importance to the Fx trader and therefore we will happily omit explanations of historical events such as the Bretton Woods accord in favor of a more specific insight into the reasoning behind foreign exchange as a medium of exchange of goods and services.
Originally our ancestors conducted trading of goods against other goods this system of bartering was of course quite inefficient and required lengthy negotiation and searching to be able to strike a deal. Eventually forms of metal like bronze, silver and gold came to be used in standardized sizes and later grades (purity) to facilitate the exchange of merchandise. The basis for these mediums of exchange was acceptance by the general public and practical variables like durability and storage. Eventually during the late middle ages, a variety of paper IOU started gaining popularity as an exchange medium.
The obvious advantage of carrying around 'precious' paper versus carrying around bags of precious metal was slowly recognized through the ages. Eventually stable governments adopted paper currency and backed the value of the paper with gold reserves. This came to be known as the gold standard. The Bretton Woods accord in July 1944 fixed the dollar to 35 USD per ounce and other currencies to the dollar. In 1971, president Nixon suspended the convertibility to gold and let the US dollar 'float' against other currencies.
Since then the foreign exchange market has developed into the largest market in the world with a total daily turnover of about 3.2 trillion USD. Traditionally an institutional (inter-bank) market, the popularity of online currency trading offered to the private individual is democratising forex and widening the retail market.
In the last years, the foreign exchange market has expanded from one where banks would execute transactions between themselves to one in which many other kinds of financial institutions like brokers and market-makers participate including non-financial corporations, investment firms, pension funds and hedge funds.
Its' focus has broadened from servicing importers and exporters to handling the vast amounts of overseas investment and other capital flows that currently take place. Lately foreign exchange day trading has become increasingly popular and various firms offer trading facilities to the small investor.
Foreign exchange is an 'over the counter' (OTC) market, that means that there is no central exchange and clearing house where orders are matched. Geographic trading 'centers' exist around the world however and are: (in order of importance) London, New York, Tokyo, Singapore, Frankfurt, Geneva & Zurich, Paris and Hong Kong. Essentially foreign exchange deals are made between participants on the basis of trust and reputation to deliver on an agreement. In the case of banks trading with one another, they do so solely on that basis. In the retail market, customers demand a written legally accepted contract between themselves and their broker in exchange of a deposit of funds on which basis the customer may trade.
Some market participants may be involved in the 'goods' market, conducting international transactions for the purchase or sale of merchandise. Some may be engaged in 'direct investment' in plant and equipment, or may be in the 'money market,' trading short-term debt instruments internationally. The various investors, hedgers, and speculators may be focused on any time period, from a few minutes to several years. But, whether official or private, and whether their motive be investing, hedging, speculating, arbitraging, paying for imports, or seeking to influence the rate, they are all part of the aggregate demand for and supply of the currencies involved, and they all play a role in determining the exchange rate at that moment.
Foreign exchange is traded essentially in two distinctive ways. Over an organized exchange and 'over the counter'. Exchange traded foreign exchange represents a very small portion of the total currency market the great majority of foreign exchange deals being traded between banks and other currency market participants 'over the counter'.
1. Exchange traded currencies
In the case of an organized exchange like the Chicago Mercantile exchange (CME) in the US, standardized currency contract sizes that represent a certain monetary value are traded in the International money market (IMM). A central clearing house organizes matching of transactions between counter-parties. There are various disadvantages to trading currency futures as outlined in the chapter Advantages of trading FX.
2. Currency market
In comparison the over the counter market is traded around the world by a multitude of participants and price quality, reputation and trading conditions determine who a participant wishes to trade with. It is probably the most competitive market in the world and brokers like FXEURASIA must insure they live up to the highest standards of service and be compliant with market standards and practices if they want to acquire new customers and retain their existing ones. In 2007 a survey under the auspices of the Bank for International Settlements (BIS), global turnover of reporting dealers was estimated at about USD 3.2 trillion per day, representing a more than 60% increase since 2004.
Among the various financial centers around the world, the largest amount of foreign exchange trading takes place in the United Kingdom, even though that nation's currency, the British pound is less widely traded in the currency market than several others. As shown in the graph underneath, the United Kingdom accounts for about 34 percent of the global total; the United States ranks a distant second with about 17 percent, Switzerland is third with 6.1 percent, whereas Japan is only fourth with 6 percent.
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