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Guide to Trading Forex
The foreign exchange (currency or Forex or FX) market refers to the market for currencies. Transactions in this market typically involve one party purchasing a quantity of one currency in exchange for paying a quantity of another. The FX market is the largest and most liquid financial market in the world, and includes trading between large banks, central banks, currency speculators, corporations, governments, and other institutions.
The foreign exchange market is unique because of
- its trading volumes
- the extreme liquidity of the market
- the large number of, and variety of, traders in the market
- its geographical dispersion
- its long trading hours; 24 hours a day except on weekends
- the variety of factors that affect exchange rates
- the low margins of profit compared with other markets of fixed income (but profits can be high due to very large trading volumes)
- the use of leverage
The currency market can be split into two broad categories:
- Popular Currencies - include the most traded currency pairs like GBP/USD, EUR/USD and GBP/EUR. Popular Currencies boast very low deposits and spreads.
- Exotic Currencies - includes currencies of the developing countries and suitable only for experienced currency traders as they have much higher spreads and deposit requirements.
Market Participants
Unlike a stock market, where all participants have access to the same prices, the forex market is divided into levels of access. At the top is the inter-bank market, which is made up of the largest investment banking firms. Within the inter-bank market, spreads, which are the difference between the bid and ask prices, are razor sharp and usually unavailable, and not known to players outside the inner circle. As you descend the levels of access, the difference between the bid and ask prices widens (from 0-1 pip to 1-2 pips for some currencies such as the EUR). This is due to volume. If a trader can guarantee large numbers of transactions for large amounts, they can demand a smaller difference between the bid and ask price, which is referred to as a better spread. The levels of access that make up the forex market are determined by the size of the "line" (the amount of money with which they are trading). The top-tier inter-bank market accounts for 53% of all transactions. After that there are usually smaller investment banks, followed by large multi-national corporations (which need to hedge risk and pay employees in different countries), large hedge funds, and even some of the retail forex market makers.
Financial Spread Betting is the cheapest and easiest way for private or small investors to participate in Forex as spread betting brokers require small deposits (GBP/USD deposit can as little as £60 per pip) and spreads are very low as brokers compete for business. Compare spread betting brokers by GBP/USD spread or by overall spread index.