What is Forex?
The term Forex stands for Foreign Exchange and it is used to describe the most liquid financial market on the globe, the currency market. It’s a bit misleading to call it one market, though, as it is actually an intertwined, but decentralized network of different trading “hubs”, run by ‘broker’ dealers, and multilateral and bilateral connections between banks and other large players seeking the best deals with as minimal risk.
Understanding the basic dynamics of this buzzing segment of the financial world is an absolute must before one begins trading currencies. First, let’s take a look at the how Forex markets are organized:
The concept of currency trading is as old as money itself and with the onset of globalisation and the parabolic rise in global trade, the need for such transactions skyrocketed. The fall of the gold standard laid down the foundation of today’s market, as wild fluctuations became everyday occurrences and Forex markets turned into a medium of investing and speculating on economic trends.
The segment also got a real boost as the internet became a basic utility in the last 20 years, from an influx of new players and providers that entered the field. Forex markets offer an easy, attractive, but somewhat tricky, and risky opportunity to trade with financial assets.
Why is that? To answer that question, we must understand some basics about Forex.
- Forex is a network of independent markets with different structures, participants, and backgrounds
- As an over-the-counter (OTC) type of market, there is no centrally regulated exchange, as opposed to stock markets, for example.
- Every broker and trading hub has its own independent price for every pair, besides its own trading conditions and rules.
- Forex is traded in terms of currency pairs, such as EUR/USD, GBP/JPY, and price changes are measured in pips (1/10,000th of a single unit of currency for all pairs except JPY pairs which are 1/100th of a unit of JPY). While a pip might seem like a very small point of measure, Forex pairs can move very quickly.
- Forex markets have no official opening hours, but brokers are usually open 24 hours a day, 5 days a week, with some providers even offering limited trading over the weekend.
- Forex markets are prone to some level of manipulation by authorities, with the exchange rate being a prominent tool for executing government policies.
- Forex is typically traded on a leveraged basis (1:10, 1:50: 1:100, etc.) While this means people can take advantage of smaller pip changes, it also means Forex can be very risky.
The leverage and the non-stop action mean that forex markets and can experience elevated volatility (experience very strong movements in the market that can change direction quickly), so new entrants into the world of Forex should be wary that the risks are high. Also, the uncentralized structure means that you must understand the broker you are dealing with and the method that you actually use to reach the market, to fully understand the risks that you might face.
The methods of Forex trading
The decentralized structure of the segment means that even seemingly similar brokers might have a totally different business model and their revenues could originate from rather surprising sources.
This, of course, means that as a new entrant, you might be treated in a radically different way depending on which provider you choose. New traders should also understand that every broker is different and have differing capabilities regarding facilitating price and liquidity.
Given its OTC nature, Forex markets are ‘made’ by banks, and other financial institutions or ‘broker’ dealers who price directly to the market, thereby internalising trades and directly taking on risk. Agency brokers typically employ a Straight Through Process (STP), which sees trades passed to a market. This can provide pricing through:
- Direct market access (DMA) by utilizing access to markets that exist outside of an exchange. In the context of FX, this means access to liquidity provided by banks and institutions.
- Alternately, brokers may use an Electronic Communications Networks (ECN) which aggregates the best prices offered by liquidity providers on the network.
On the other hand dealing desk brokers (or market makers) usually trade “against” their clients by effectively taking the other side of the trade or pairing the order with an order of another client or clients. This can lead, to conflicts of interest between broker and client, and sometimes could end in controversial situations, especially in volatile trading environments.
*Global Prime stands firmly against taking the other side of client’s trades or any conflict of interest between broker and client. To prove that all trades go to market, we will where necessary provide trade receipts proving which bank filled a specific trade. We believe that this should be standard practice across all brokers, to ensure transparency and trust between broker and trader.
With the presence of market makers, it is easy to see that broker agencies themselves are important players in the world of Forex.
Forex markets are shaped by players with different interests, goals, methods, and resources. Before we go into the details about some of the peculiarities of forex market, lets take a look at what types of traders trade Forex.
- Speculators, those who have a view on the direction of a currency pair. This view might be based on different theories, approaches, and strategies. Risk appetites and expertise levels vary considerably within this group, with all kinds of holding periods, trading techniques, and strategies.
- “Natural” buyers, entities in need of liquidity in another currency. Think of companies that export their products and services or import something for their production. These participants are the least “price sensitive”, as they will usually enter the market no matter what the conditions are. That said, these players can be very important in shaping the long-term trends in currencies.
- Hedgers, those looking to reduce risk, typically corporations with large exposure to foreign currencies. They are different from natural buyers because they hedge future transactions, and that translates to different behavior
- Arbitrageurs, those who search for pricing discrepancies within or between markets and asset classes and take advantage of them to make risk-free With the vast number independent market centers, Forex markets, in theory, provide a fertile ground for these strategies. In practice the large professional arbitrageurs leave little ground for small players, and automated systems make even the slightest opportunities disappear in the matter seconds.
- Central banks and other public institutions, with several, sometimes conflicting goals and intentions. If you remember last year’s scandalous moves by the Swiss Central Bank, which made headlines all over the world, it might be no surprise that central authorities are indeed actively present in Forex markets. But besides trying to directly influence the exchange rate, government institutions have other, more commonplace reasons to engage in Forex, such as paying down debts, financing projects and so on.
On another note, in today’s market, the notion that a “participant” or “person” is on the other side of the trade is more and more just a figure of speech. Orders executed by algorithms and trading robots make up an ever larger portion of the total traded amount.
While this means that even smaller players can profit from the advantages of automated trading, some market moves are exaggerated by these machines and trading is getting faster and more volatile every day.
So, what’s special about Forex trading?
Probably the most important perk of Forex is that, because of the lack of central regulation, virtually anyone can engage in trading and there are brokers out there targeting every kinds of client. This might sound intriguing, but some providers are simply too risky for the average trader or can involve themselves in unethical practices. Remember, often their final goal is merely to maximize their profits.
*Global prime is entirely transparent with its processes and our genuine goal is to provide the best possible trading environment for our clients. If you have any questions, feel free to get in touch via email, phone or live chat at the bottom of this screen.
New entrants to the world of Forex should be aware of the opportunities as well as the risks of trading currencies. The wide selection of currency pairs and the “always on” nature of Forex markets mean that something is always happening, and this effects both the chances for profit as well as losses.
But Forex is not just about trading, well thought out strategies that rely on economic trends and macro-differences between nations can provide sustainable profits for the patient investor. Also, the highly competitive nature of the FX markets means that hedging your exposure to foreign currencies has never been cheaper, with the possibility of trading with the most exotic currencies out there.
At the end of the day, it’s up to the trader to benefit from the opportunities that Forex presents while making sure to manage and minimise the risks and avoid the undeniable pitfalls!
If you would like any more information, please don’t hesitate to give us a on +612 8379 3622, email us at firstname.lastname@example.org or simply use the live chat right here on the website!
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