What is it?
Also known as forex, currency trading happens to be the largest financial market in the world. It seems a little strange that the most people are totally unfamiliar and unaware that the largest market on the planet even exists. However, with the advent of online trading and the availability of information through many different media outlets, many people are now becoming aware and familiar with the forex market. Historically speaking, currency trading has been limited to large financial institutions, multinational corporations that sell their goods in various countries and hedge funds that even today, are a little bit of a mystery as to what they do.
One of the reasons why currency trading may be obscure to most is that unlike most other markets, this one is not conducted on a regulated exchange. No central controls, clearing firms to guarantee trades and no dispute mechanism. All members trade based upon credit agreements. Ironic isn’t it – the largest and most vast market on the planet is conducted based on your word and an implied handshake.
Forex trades 24 hours per day beginning at 5PM Eastern Standard Time Sunday to 4PM EST Friday. Approximately $2 Trillion changes hands each and every day.
Get this – within the forex market, there is never an exchange of a physical or electronic security. It’s all speculation. All trades are conducted as computer entries only and are settled based on market price. For example, in dollar accounts, all profits and losses are calculated in dollars and simply recorded in like form within the trader account.
What is really going on is the facilitation of exchange from one currency to another, mainly by multinational corporations who need to trade the different currencies for payroll, vendor payments and even merger and acquisition activity. This is the practical side of the business. The rest, which happens to about 75% of the volume is pure speculation by financial institutions of all types.
Currencies are always traded in pairs found mainly in the most liquid of the bunch.
USD/JPY (dollar/Japanese yen)
GBP/USD (British pound/dollar)
USD/CHF (dollar/Swiss franc)
AUD/USD (Australian dollar/dollar)
USD/CAD (dollar/Canadian dollar)
NZD/USD (New Zealand dollar/dollar)
The most popular trade within the market is called the carry trade. This trade is based on the fact that every currency in around the world has an interest rate. Short term interest rates are set by central banks of corresponding countries. A trader would “go long” the currency with a high interest rate and finance the purchase with a currency with the lowest interest rate. A trader would simply make the spread between the two currencies interest rate as profit. As you might imagine, not as easy a pie – when these trades are unwound because of a shift in interest rates, the least sophisticated investor is usually the last to know, the last out of the trade, and the one that gets wiped out of all their capital.
Currency (FX) trading can be very profitable, but extremely volatile and is usually reserved for the more sophisticated of traders. Not for the faint of heart.
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