Forex is short for foreign exchange. The act of exchanging one country’s currency for another’s is foreign exchange. When you do business in a certain country, the good or service has to be paid using the currency of that country. Thus foreign exchange happens for a variety of reasons, mainly tourism and trade.
For companies who trade with foreign companies, they use forex as a hedge. They can set the agreed rate at which a future transaction will take place. This is done by buying the foreign currency in a swap or forward market. Since the rate has already been locked down, if there are huge fluctuations in the exchange rate, it does not affect the transaction.
Since there is a market for current and future exchange rates, a speculative market grew out of it. Forex traders essentially take bets, well mostly calculated, on certain currency pairs. For example, USDSGD is the currency pair of the US Dollar against the Singapore Dollar. Forex traders take a macro view of the world economy to try to decipher whether a certain currency will rise against another. When we talk about Forex Trading, we are talking about this speculative activity.
1) The Forex Market is the largest in terms of volume
Due to the decentralised nature of Forex as compared to stocks, the Forex Market is huge. In fact, it is so huge that no one particular party can manipulate the market. Since there are so many participants in the market, it is also easy to enter and exit a position. At times, even a fraction of a second makes a difference in price.
2) Leverage
Due to the extremely liquid nature of Forex, banks or brokers offer traders leverage. Some at rather attractive rates. Leverage is useful especially since the price changes can be mere cents and leverage helps to amplify small gains. Of course, it can also amplify your losses if you place a wrong bet.
3) Limited currency pairs
This is in contrast to the tens of thousands of stocks in all the major stock markets. In Forex Trading you are trading currency pairs and essentially traders stick to a few pairs and monitor their price movements.
4) Forex Markets open 24 hours a day
A huge advantage for Forex traders is that it is available 24 hours a day. Unlike the stock market which operates during trading hours, Forex Markets are open round the clock. This allows traders to trade as and when they have the time. Many part time traders do their Forex trading after their day job working hours.
5) Understanding of the Macroeconomic environment is essential
A Forex trader has to understand Macroeconomics and how these events shape the world to accurately understand how a certain currency will fluctuate against another. Thus reading up on current affairs and understanding global trading situations is important to becoming an effective Forex trader.
In conclusion, Forex trading has an immense amount of risk due to its leveraged nature. For traders who do not have time to trade stocks during office hours, Forex trading presents an alternative platform. However, the understanding of charts is necessary. Also, an impulsive and reckless behaviour is something which should not be taken into decision making. Some investors may use Forex as a hedge against their foreign owned stocks. For example, if a Singaporean buys US stocks and the US dollar is decreasing against the Singapore Dollar, he could short the USDSGD currency pair. This way the loss in the drop in the value of the US stocks relative to Singapore Dollar would be mitigated by the gains through shorting of the USDSGD currency pair. However, in most cases, Forex trading is essentially a speculative activity. If you intend to get into Forex trading, please have the sufficient knowledge before embarking.
Yours Sincerely,
Daryl Lum
p.s. I am not a Forex coach. I personally invest in stocks and properties. I do trade Forex from time to time. This article was spawned because a friend of mine asked me about Forex trading and I decided to create an article to share what I know with anyone who is interested to read it. I am a real estate agent, I run an equity fund investing in companies and real estate and I am an avid blogger. Please take my blog post as a casual post and seek a professional if you really need proper advice on Forex Trading.
