Inhaltsverzeichnis
History of the Forex Market
Traders love the forex or foreign exchange market for its great range of opportunities. Forex trading calls for sound previous knowledge and experience, though, as it is principally subject to a commensurate risk. But before going into the details of how forex trading works and its peculiarities, a short review seems opportune to provide an idea of its history first.
The origin of trading in various currencies lies far back in the past. The Greeks already traded in currencies in antiquity: This took the shape of various traders, most of whom had travelled there from the Middle East, offering their currencies in exchange for the goods of their trading partners from Europe. Currency trading was still kept very simple in those days, with exchanges principally based on the weight and material of the currency in question.
In the 16th century, foreign exchange trading was largely dominated by trading nations and influential merchant families such as the Medici from Italy, for example. A first institutionalization of currency trading then finally came about towards the end of the 19th century, when opening personal accounts in foreign countries and accumulating the respective currencies there became possible for the first time. Later developments include the International Monetary Fund, World Bank and Bretton Woods agreement, which refers to the new international monetary system created after WWII, with the US dollar as the so-called anchor currency.
This was initiated by an agreement between the various central banks to intervene in very intensive currency fluctuations. But these restrictions were lifted after some time, so that the currency rates can freely rise and fall nowadays. Severe national crises have partly led to interventions by central banks and/or even their respective states, though, so that serious weaknesses of currencies could be compensated.
Forex – What is it?
The term „forex“ is a contraction of foreign exchange market. The terms FX market and currency market are also commonly used in this context. The foreign exchange market generates sales of over five trillion US dollars a day. The forex market basically permits the participating traders to buy and resell currencies.
The process somewhat resembles the changing of currencies on holidays. German tourists travelling to Australia, for example, can exchange their euros for AUD even before setting out on their journey. How many Australian dollars each holidaymaker will get is calculated on the basis of the latest exchange rates. Upon their return to their home country, these tourists can then have any Australian dollars to remain changed back into euros. If the exchange rate is higher now than before, they will even make a profit from the exchange. But if the exchange rate has fallen in comparison to where it was before, they will lose money in the process.
The exchange market can thus be understood as a network of traders dealing in various currencies at agreed rates. Besides the FX market’s uses with a practical background (as in the example with the holidays), most of the currency trading serves the intention of making a profit. The development of exchange rates can tend to be highly volatile, however, and precisely these drastic fluctuations are what makes currency trading so interesting for traders. This because they significantly raise the chances of high profits, but also the risk at the very same time.
Market players in the forex market
The forex market basically permits the currency of one country to be fairly exchanged for that of another. It is therefore also interesting to know about the market players in currency trading. They first of all include banks, which generally engage in forex trading in the hope of profiting from the fluctuations in currency exchange rates.
Another important group of participants besides this are fund managers, who are usually active currency traders. They normally buy currencies needed for cross-border investments.
Some currency traders – primarily also hedge funds – show a highly speculative behavior in the forex market, similar to private traders. Hedge funds can either trade on a discretionary basis under human control, or also machine-controlled by algorithms.
Over and beyond this, there are also a number of other players who preferably participate in the currency market. These can include large industrial companies, for example, as well as private traders, exchange brokers and trading companies. Particularly noteworthy is also the participation of central banks.
This because central banks are able – given a corresponding economic and/or financial reason – to intervene and initiate measures to equilibrate the forex market. Besides the central banks, there are also a number of global investment banks such as JP Morgan and Deutsche Bank, for example, that also participate in the currency market.
This usually occurs in cooperation with the central banks and major companies. In contrast to the stock exchanges, a large part of the forex trading takes place off-market in the so-called „interbank trade“.
Unique features of the forex market
The forex market has a number of unique features that distinguish it from the stock market. One significant characteristic is that the currency market is not an open outcry market as the participants usually trade with one another by way of banks and brokers. Another difference is that trading in the currency market can even be profitable when other markets are low, and prices are falling.
The forex market is also neither tied to times nor geographical framework conditions. Except for weekends, currencies can be traded every day for almost 24 hours. This sharply distinguishes the forex trading from stock trading, which is on the one hand tied to the respective exchanges, and to their opening times on the other. Plus the fact that basically anyone can participate in currency trading, and that completely location-independent, i.e. from anywhere in the world (assuming an internet connection, naturally).
How is the currency market regulated?
In contrast to the stock market, the currency market is regulated without interference from the outside, meaning that it largely regulates itself. Which is why the currency market is also referred to as an „OTC“ or „over the counter“ market. OTC in this case meaning that the pricing and performance of currency transactions are the sole responsibility of all the persons involved in a trade.
Accordingly, currency trading has no need of an exchange, as all the transaction processes take place directly between the traders. A broker is not to be regarded as a regulating institution either, but rather as a mediator. There not being any direct authority for regulating the currency trades, one could now be tempted to assume that there are no rules for the trading. A number of rules do exist, however, and especially where brokers are concerned. Brokers are subject to the regulations of the competent authority for their location. The German authority for this is the Federal Financial Supervisory Authority (BaFin). The various players of the currency market form a broad decentralized network where the exchange rates are very classically regulated by the supply and demand. A proper regulation is thus not provided yet at this point in time (discounting the regulations for brokers).
Currency market segments
As we have seen, currencies are not traded at exchanges, but directly between the two involved parties in an OTC market. The forex market is meanwhile controlled by an international network of banks distributed across four trading centers in various time zones: London, New York, Sydney, and Tokyo. As there is no single trading center, currencies can principally be traded 24 hours a day. A distinction is meanwhile made between three different segments of the currency market:
- Forex spots: This concerns physical currency exchanges performed at a precisely defined time. The name „spot“ is short for „on the spot“ as the trade is performed immediately and/or within a short subsequent time window.
- Forex forwards: Forex forward trades involve the buying or selling of a currency at a corresponding rate. In contrast to forex spots, the transaction may be performed at a predefined time or also within a time window in the future.
- Forex futures: Forex futures trades involve a specific currency amount being bought or sold at a corresponding rate at a time that is still in the future. In contrast to forex forwards, forex futures are legally binding, though.
Currency pairs
As already mentioned, the exchange rates of the currencies in question have a major role to play in the forex market. The term exchange rate refers to the amount of a specific currency required to buy another currency. Further synonyms for this include the terms FX rate or simply rate. These rates are subject to fluctuations, naturally, that rise or also fall depending on the demand for the currency concerned.
Let us take a brief look at the most frequently traded currencies in the forex market first.
| United States dollar | USD |
| Euro | EUR |
| Japanese yen | JPY |
| British pound | GBP |
| Australian dollar | AUD |
| Swiss franc | CHF |
| Canadian dollar | CAD |
| Mexican peso | MXN |
| Chinese Yuan renminbi | CNY |
| New Zealand dollar | NZD |
| Swedish krona | SEK |
| Russian ruble | RUB |
| Hong Kong dollar | HKD |
| Norwegian krone | NOK |
| Singapore dollar | SGD |
| Turkish lira | TRY |
| South Korean won | KRW |
| South African rand | ZAR |
| Brazilian real | BRL |
| Indian rupee | IDR |
As you can see, each currency is composed of three letters, with the first two denoting the respective region, and the last the currency itself.
A classic reason for a currency’s exchange rate to rise can be the high export rate of a country. All trades in the forex market meanwhile involve „currency pairs„, with traders betting on the development of a specific currency’s exchange rate.
Which is why the most commonly traded currency pairs are to be briefly explained here. The right-hand column shows the forex market trading volume of the respective currency pair in percent (status 2010).
| US-Dollar/Euro | 28% |
| US-Dollar/Japanese yen | 14% |
| US-Dollar/British pound | 9% |
| US-Dollar/Australian dollar | 6% |
| US-Dollar/Canadian dollar | 5% |
| US-Dollar/Swiss franc | 4% |
| Euro/Japanese yen | 3% |
| Euro/British Pound | 3% |
| US-Dollar/Hong Kong Dollar | 2% |
| Euro/Swiss franc | 2% |
| US-Dollar/South Korean won | 1% |
| US-Dollar/Swedish krona | 1% |
| US-Dollar/Indian rupee | 1% |
| Euro/Swedish krona | 1% |
| US-Dollar/Chinesische Yuan Renminbi | 1% |
| US-Dollar/Brasilian real | 1% |
| US-Dollar/South African rand | 1% |
| Japanischer Yen/Australian dollar | 1% |
| Euro/Canadian dollar | <1% |
| Euro/Australian dollar | <1% |
The currency mentioned first in a currency pair is also referred to as the base currency, and the second as the counter currency.
Forex trading thus always involves a specific currency being traded for another, which is also why they are quoted in pairs. The base currency meanwhile defines the measure, which is always set to one unit. If the currency pair EUR/USD is quoted with 1,10, for example, this would mean that € 1.00 has a value of $ 1.10. The basis for this is the current exchange rate, which is also referred to as the spot rate and/or cash price. In most cases, one of the two currencies in currency pairs will be US dollars as they are proportionally traded most frequently. If currency pairs consist of two other currencies than the US dollar, one also refers to them as cross currency pairs or simply „crosses“.
To keep the currency trading manageable, providers usually group the currency pairs in various categories:
- Majors: These are the currency pairs making up ca. 80 % of global forex trading (see top currency pairs above).
- Minors: The group of the minors includes all currency pairs tending to be traded less frequently. These are often currency pairs of majors, but without the US dollar, e.g. EUR/AUD, EUR/CHF, GBP/JPY.
- Exotic currency pairs: Pairs are referred to as exotic if a major is coupled with a small currency (e.g. that of a developing country), e.g. USD/MXN, GBP/PLN, JPY/CZK.
- Regional currency pairs: This refers to currency pairs within specific regions, e.g. AUD/NZD, EUR/NOK.
The forex vocabulary
As there are a number of forex terms that have a major role to play in currency trading, it will probably make sense to take a closer look at some of them below.
Majors and minors
The terms „majors“ and „minors“ basically refer to nothing else but frequently and not so frequently traded currency pairs. Majors are pairs that are traded very frequently and thus accorded a major economic role (currency pairs of EUR, JPY, GBP, USD, etc.). Whereas minors are currency pairs that tend to be traded less frequently.
Pips
The term „pip“ denotes a unit that is used a lot in forex trading and enables rate changes of a currency pair to be quantified. One could for instance say that a trader has made a „profit of ten pips“ with a specific currency pair. A pip is the smallest unit that can be listed for a currency, normally the fourth decimal place. Looking at this with EUR/USD, for example, a pip thus amounts to 0.0001 US dollars per euro. If the exchange rate of this currency pair climbs from 1.1500 to 1.1504, it has gone up by 4 pips.
How do pips affect the forex trading?
Let us take a somewhat closer look at this now using an example. Trader Marcus has analyzed the market and comes to the conclusion that the euro is gaining strength against the US dollar, i.e. appreciating in value in comparison. Marcus consequently invests his capital of 5,000 US dollar to buy 4,346.31 euros at an exchange rate of 1.1504. The impact of changes in the exchange rate of the currency pair in our example is determined by the size of the position, set to 5,000 US dollars here. The pip value can now be calculated as follows:
Let us assume that the EUR/USD rate now climbs from 1.1504 to 1.1524, in which case Marcus‘ forecast has proved right and the euro has indeed appreciated in value against the US dollar. If we want to calculate the profit Marcus has made from his investment now, we need to use the following equation:
EUR 4346.31 x 1.1524 = USD 5,008.68
The increase of 20 pips thus enabled Marcus to make a profit of 8.68 US dollars. It is important to know, though, that daily rate fluctuations of 100 pips are nothing out of the ordinary with currency pairs like this one. In addition to which the 5,000 US dollars invested would only make for a very small trade. Especially as the standard minimum position at many brokers is set to 1 lot (= 100,000 euros). Traders with little capital can also trade in position sizes like this with the help of the margin (= deposited security), however.
Lot
The „lot“ is a unit of measure in forex trades. A lot amounts to 100,000 units of a specific currency pair. A trade involving three lots of the currency pair EUR/USD hence equals a position size of 300,000 euros. On a smaller scale, there are also „mini-lots“ amounting to 10,000 units, and even „micro-lots“ for the popular currency pairs, which only include 1,000 units.
Leverage
Leverage enables very large profits to be made in currency trading by multiplying them if the rate rises after buying. Various leverages are available for use by the traders, depending on the broker. The higher the leverage, the higher will also the security be that needs to be deposited with the broker. And as the leverages also work the other way round, they also imply a high risk, which can potentially lead to serious losses, too.
Slippage
Unintended differences that occasionally arise when currency positions are bought or sold are referred to as slippage. They can be caused by very fast rate movements just at that instance, with the difference arising from an abrupt rate change of a currency position at the precise moment of being bought or sold. Although this is relatively rare as a rule, and only amounts to one or two pips, it can still make a major difference if the position size is immense.
Margin
The so-called margin plays a key role in trades with leverage. The margin denotes a security payment that the trader needs to deposit at the respective broker. It determines the permitted maximum leverage. When trading in currencies with a margin, one should hence bear in mind that the amount required for it changes depending on the broker and trade size concerned.
The margin is customarily defined as a percentage of the position size. To illustrate this with a practical example: If the margin required for a EUR/USD forex trade amounts to 3.00 % of the total value, the payment required to trade with one lot (100,000 euros in this case) only amounts to 3,000 euros.
Spread
This refers to the difference between the buying (bid) and selling rate (ask) of a currency. The spread is usually small in forex trades, especially with the popular currency pairs, and expressed in pips. As is the custom in many other financial markets, too, two prices are also offered when a position is opened in the forex trade.
One of the options available here would be to open a long position. In this case the trade is based on the buying rate (also referred to as the money rate), which is usually a little higher than the current market rate. The other option would be to open a short position. The trade is then based on the selling rate, which is also referred to as the ask price. The selling rate is a little lower than the current market rate, however. The bid/ask spread itself and/or currently quoted rate is also referred to as the „quotation„.
Which factors affect the forex market?
The forex market permits the currencies of all the world’s countries to be traded. This makes forecasting the development of exchange rates somewhat difficult, as the number of influencing factors able to contribute to possible rate fluctuations is so great. Just like most the financial markets, forex trading also largely depends on supply and demand. It is therefore crucial to gain a corresponding understanding of all the influencing factors able to make rate fluctuations possible in the forex market.
Central banks
First of all, the central banks have a major role to play. They are able to exert a major influence on exchange rates by their regular announcements. As the central banks control the supply, so to speak, the reach of their influence should not be underestimated either. An increase in the quantity of a currency, for example, would lead to its devaluation as a consequence.
News and economic data
Banks and other investors generally prefer to invest their available funds in economic systems with a correspondingly good credit rating. The background being that these countries can tendentially be regarded as safe investments, which is rather less the case with countries with low credit ratings .
It is consequently not that surprising that journalism can also influence the forex market in certain ways. This because positive news about specific regions can promote investments there, which will ultimately also increase the demand for the respective currency in this region. If the supply then fails to grow in direct proportion to the demand for the currency, the result will be an imbalance between supply and demand, which will then lead to a hike in the currency’s exchange rate.
In the opposite case, negative news can obviously also lead to drops in the exchange rate of a currency. Loosely speaking, currencies thus generally map the economic wellbeing of the region they stand for.
Market sentiment
Market sentiment often follows the news and economic data, and its importance for the composition of currency exchange rates should not be underestimated, either. If traders are of the opinion that the exchange rate of a currency will move upward, for example, they will also invest accordingly and convince other people to do the same, as well. This, too, can lead to the demand rising and/or falling as a consequence.
How does forex trading work?
The exchange rates of the currencies traded in the forex market are subject to a high volatility. Traders bet on the exchange rate of a currency rising or falling in comparison to another currency. The profit from a trade equals the difference between the two currencies based on the exchange rates, with the broker’s fee and taxes still needing to be deducted in the end. Trading in the forex market is principally also possible with relatively little capital.
Forex trading is also quite similar to CFDs (contracts for difference) in a number of aspects. The leverage level in forex trading is many times greater, though.
Exchange rates will often only experience very small fluctuations, which only show up in the third or fourth decimal place. Trading with leveraged currencies is therefore the norm. This leverage effect enables very large profits to be made from even the smallest currency fluctuation. The example below will serve to illustrate this.
As before, Marcus wants to bet on the euro gaining value against the dollar again, but this time using leverage. In our example with an exchange rate of € 1.00 for $ 1.10, Marcus can buy 100,000 euros for 110,000 dollars. The unique feature now is that there is no need to provide the broker with the full amount of 110,000 dollars in cash. It will suffice instead to merely deposit a margin of 1 % with the broker, for example, equaling a mere 1,100 dollars. Let us take a look at two possible scenarios now, one assuming that Marcus makes a profit, and the other that he makes a loss.
Forex trade with a profit:
Marcus sells the 100,000 euros he bought for 113,000 dollars initially and thus makes a profit of 3,000 dollars, after getting the margin back from the broker in the end. So Marcus has managed to multiply his original investment of 1,100 dollars and generate a profit of +272.72 %. The fees for the broker and taxes will still need to be subtracted from this gross profit, however, to arrive at the net total.
Forex trade with a loss:
In the adverse case, Marcus sells the 100,000 euros for 108,000 dollars, making a loss of 2,000 dollars in the process.
As the loss exceeds the deposited margin, additional payments become due. The broker hence keeps the 1,100 dollars and issues a margin call requiring Marcus to pay 900 dollars, to compensate the incurred loss. As the costs for the broker will also need to be paid in the end, the loss is added to once more.
Currency carry trade
A particularly interesting option for trading in the forex market is the so-called „currency carry trading„. But what exactly is this supposed to mean?
The carry trade can be categorized as a long-term strategy and is based on differences in the interest rates of various currencies. What this looks like in practice is that the trader sells a currency with a relatively low interest rate and then invests the proceeds in a currency with a higher interest rate. This way investors can profit from the appreciation of the acquired currency’s value on the one side and from the interest rate differential on the other.
The following example illustrates this for a better understanding:
Marcus takes out a loan in Japanese yens because he only needs to pay a low interest rate of 0.3 percent for them. Then he exchanges the borrowed yens for US dollars and invests them in a deposit paying 3 percent interest. As a consequence, Marcus will receive a whopping 3 percent interest for his invested capital after one year, while only needing to pay 0.3 percent interest on selfsame capital. Meaning that he is making a profit. In addition to which this profit could be significantly enlarged if some leverage were used.
A certain risk also needs to be considered with the currency carry trade strategy, naturally. If the dollar were to significantly diminish in value in comparison to the yen, for example, it may even prove impossible to compensate this with the positive interest differential.
Trading hours in the forex market
In contrast to the stock exchange, the forex market is open for trading around the clock on five days a week. Currencies are thus traded uninterruptedly during the week, and that in all time zones around the world. As money is known to never sleep, companies and investors need to be able to access the market at all times. The forex market is broken up into various trading sessions, partly with some overlap between them.
Seen from Germany and all the countries in the same time zone, the trading week always starts on Sunday at 11 p.m. with the Asian session and ends on Friday with the North American session. It is also good to know that the forex market is even open on public holidays (with very few exceptions) as they tend to differ in the various countries.
It is meanwhile important to bear in mind that the times on the trading platforms are usually set to the locality where the respective broker is based! The time difference between the platform and the trader’s own local time should thus never be neglected under any circumstances – and that especially if news and economic data are relied upon as decision aids in the trading.
Looking at the activity level in relation to the trading volume, this is the highest in Europe and the North American session. And especially when the two overlap (daily from 1 p.m. to 5 p.m.), essential economic data are frequently published, which can result in significant movements in the market, and thus also a high volatility.
In the Asian session, however, the currency pairs tend to show a rather calm behavior in comparison, unless important financial data are published in this time window.
The forex market has principally four different main trading periods. These are determined by the trading hours in the cities New York, London, Tokyo, and Sydney.
The four main trading periods:
- Sydney time: GMT (Greenwich Mean Time) + 1
- Tokyo time: GMT + 9
- New York time: GMT – 4
- London time: GMT + 1
Forex trading strategies
One does not necessarily have to be a highly professional trader to be able to participate in the forex market. But there is one thing one should mull over carefully before starting to trade in currencies: a suitable strategy. Which objective is to be achieved in the currency market? Is the trader more interested in trading brief rate impulses, or would he or she rather prefer to bank on long-term trends? Depending on how these questions are answered, the strategy development will also differ.
What is clear from the start, though, is that there is no real mixing of strategies in this matter. The characteristics of the forex market – especially the permanent trading and „crossrates“ (autonomous crosslinks between the currencies) – virtually exclude hybrids of short- and long-term strategy building. One accordingly needs to opt for one of the two strategic directions at the start. The distinction here is between a „long-term investment“ on the one side and „scalping“ on the other.
Long-term investment – trend following
If time is in short supply or the trader is simply not all that interested in lying in wait for short-term rate impulses with particular agility, a long-term trend following strategy is recommended.
Short-term fluctuations in the forex market admittedly tend to be more volatile in most cases (as exchange rates often tend to register massive increases one day, only to then plummet rapidly again the next). And this is also precisely what significantly complicates a medium-term strategy. Looking at certain currency pairs over longer periods, however, one can often detect clear trends that one can profit from as a long-term investor.
This also emerges in the chart for the EUR/USD currency pair below, showing the development of the exchange rate to be dominated by a clear downward trend in recent months.
Scalping: Exploiting ultra-short-term impulses
On the other side, there is also a strategy for ultra-short-term trading called „Scalping„. Scalping aims to detect short-term impulses, respond to them, and make profits within the shortest time. It is therefore not all that surprising that traders need to follow the currency market in very tight time grids (ranging from an hourly down to a minute level) to do this. Time grids of one, two or also five minutes are not unusual in this, and tend to be the rule, rather than the exception.
Traders enjoying the pursuit of such trading options can definitely be successful in the forex market, given the corresponding approach and discipline. The natural assumption being that they trade with high investments, so that even the smallest impulses on a pip level will be profitable.
The chart below, for example, shows the rate fluctuations of the EUR/USD currency pair over a period of a mere two hours.
The next step now raises the question how to best proceed after selecting the respective strategy. Especially as there are a number of trading tools one can work with as a trader and/or investor, both for the long-term investment strategies and for the scalping.
Trading tools in forex trading
While there is nothing principally wrong about having a broad range of trading tools, one should not go overboard with them either. Especially as the classic technical analysis and indicators of the candlestick charts have already proven their worth on many occasions in the past. But one should also avoid betting on too many indicators at the same time as this can result in contradictory signals.
Which is why it is usually best to focus on a small number of tools and use them for one’s own analyses. But one thing should be clear even then: No tool in the world can deliver perfect statements. This is because external factors (political changes, bank measures and/or news) can trigger totally unexpected impulses at any time. It will thus be impossible to close all trades with a profit. The objective should rather reside in registering more winning than losing trades, and limiting possible losses to the greatest possible extent. Some of the most commonly used tools in forex trading are detailed below.
- Classic chart method with trends, support and resistance
- MACD (moving average convergence/divergence trend following indicator: This indicator can be used as a confirmation of a technical chart signal.
- The moving average
- Candlestick signals
Which forex brokers are there?
Forex brokers are generally ten a penny these days. This raises the question, especially as a novice, which provider to go for in order to be able to trade as effectively and inexpensively as possible. The following will thus briefly and manageably introduce three tried-and-tested brokers, just as a first overview.
IG
IG – also known as IG Markets in the past – has proven a popular and proven broker for traders and investors since its establishment in 1974. These days, IG is leading the global comparison where the trading of CFDs and forex are concerned. IG offers its clients a large range of over 16,000 markets to select from. Let us take a brief look now at the general features and benefits of IG as a provider:
- Spread starting from 0.6 pips in EUR/USD currency pair
- 1 point spread in the DAX
- No minimum investment required
- Registration for free demo account possible
- Qualified customer service
- Comprehensive introduction program for novices as well as the more advanced
LYNX
The Dutch broker LYNX was established in 2006 in Amsterdam. Although the head office is still located there, the online broker has meanwhile also opened branches in many other locations, including Germany, amongst other countries. The most important characteristics are briefly summarized below.
- The required minimum investment is 2,000 euros
- Over 80 currency pairs to choose from in forex trading
- Over 7,000 tradable instruments to be used via CFDs
- Over 200,000 tradeable certificates
- Spread starting from 0.1 pips in EUR/USD currency pair
- No securities account fees to be paid
IC Markets
IC Markets was established in Sydney in 2007 and numbers amongst the globally engaged true ECN forex brokers. These trading platforms are particularly distinguished by short latencies and an above average liquidity. Their special features include the following aspects.
- Over 60 currency pairs available in forex trading
- The true ECN platforms partly offers 0.0 pip spreads
- Registration for free demo account possible
- Latency under 1 millisecond
- Up to 50 different liquidity providers
- The required minimum investment is 200 euros
Trading 212 – read more about this online broker
Advantages of forex trading
Low trading costs
Maintaining a forex account is usually free, or only subject to a very small order fee, and there is also principally no account maintenance charge. If trading costs become due, then only as a „markup„, i.e. a surcharge on the spread. The only things to be paid besides a commission are the forex spread for buying at the ask price and selling at the bid price. If the spread is low, reaching the profit zone is all the easier.
There is also another positive factor: The small initial payment required for account activation. This makes the entry threshold much lower in the currency market than in many other financial markets. It is not least of all for this reason that the forex market has been able to register such an increase in traders and investors.
And while the trading software and analysis tools can only be acquired for a fee in many exchanges, they are also usually free for traders in the forex market, depending on the broker.
No great starting capital required
Another advantage of the forex market is that one does not necessarily need a lot of starting capital in the beginning. With the help of the leverage effect, large profits can still be made with a relatively small amount of capital, too.
A new ESMA restriction on the marketing, distribution and sale of CFDs that came into force in August 2018 limits the leveraged trading to a certain degree, however: While professional clients can still work with leverages of up to 1:500, retail clients (small investors) need to make do with a maximum leverage of 1:30 for the majors. But even this relatively small leverage will still enable profits to be made from minor rate fluctuations with relatively little capital, and multiply potential winnings. And with a risk management to match, the risk can also be limited to a certain extent.
Liquidity in currency trading
One key reason for its worldwide popularity is the high liquidity level of the forex market. With globalization advancing more and more, there are also an ever-increasing number of opportunities for interested traders and investors to trade. In this context, we will next look at a number of interesting facts to do with the liquidity volume of the forex market: The turnover of the forex market exceeds the annual GDP of Japan in a day. It should be noted at this juncture that Japan is the world’s third-largest economy! Most of this trading revolves around the majors, as mentioned earlier – ca. 80 percent of all the transactions effected.
Easy market access
What is more, all you need for forex trading is a functioning internet connection. Once the trader’s own data have been verified by the platform, an account can be opened and the first deposit made on the very same day. It should be noted here that it makes sense to try out forex trading with a demo account first, especially as a beginner. This because it presents an opportunity to familiarize oneself with the MetaTrader trading software, and the trading itself, without any financial risk and completely for free.
Drawbacks of forex trading
No real regulation
As the forex market is decentralized, and thus also location-independent, there is no centrally controlled regulation of it either. This fact can occasionally complicate the search for a suitable broker of trust. But many countries already do have authorities responsible for licensing and supervising the brokers.
One should exercise care with so-called offshore brokers, however, as they are not regulated in the country they provide their services in. Watch out for red flags such as a highly non-transparent website (no address and/or contact data, etc.), for example.
Market knowledge is required
The forex market is no shortcut to getting rich quickly, alas. While it is definitely possible to make money – even a whole lot of it – with currency trading, this also requires an intensive engagement with the subject. Besides an understanding of the application of the respective tools, the rates in the forex market can also be affected by many other factors. It is therefore vital to look closely at the various markets around the world, follow the news, and draw the correct conclusions at the right moment.
High risk
Besides the high gains indeed achievable in the forex market, the risk should not be neglected either. Especially when trading with leverage, possible losses will also be multiplied. It can thus happen, as shown in the example earlier, that one not only suffers the loss of the margin paid in at the start, but also further losses based on margin calls. One should principally always trade with prudence and a corresponding risk management. Which is why a certain emotional discipline plays an important role in forex trading.
Emotional discipline in trading
This because even the best strategy and best tips are no guarantee that one will always succeed in trading. And when things have not been going so smoothly, it can occasionally happen that the emotions get the upper hand. In this case beginners, especially, will tend to throw their initially elaborated strategy overboard and start acting emotionally in the forex market, which will make the whole thing even worse in most cases.
One should resist this urge, then. Own strategies, tools, and market analysis routines will help to take responsibility for one’s actions in the forex market. This way, the entire trading process as such will be prioritized over short-term profits, sustainably enabling successful trading for the long term.
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