Beginners Guide to Forex - Module 3
Module 3: So, What’s the Big Deal?
The forex market is the largest market on Earth with some $4 trillion changing hands on an average day. The retail segment of the forex market is growing rapidly as investors discover the advantages it offers and technology makes it easier to access. Listed below are just some of the benefits of trading this global market.
You know the old adage about putting all your eggs into one basket, right? The long and the short of it is, don’t. The forex market offers investors another option in portfolio diversification beyond equities, bonds and real estate.
For many people, it is hard to trade stocks during regular exchange hours without giving up your day job. Often people scramble home from a long day at work, eat dinner, play with the kids and peer at their charts for a few hours before shuffling off to bed. The forex market is open 24 hours a day, 5.5 days a week. This means your two hours of chart watching in the evenings can be accompanied by actual trading.
One of the big bonuses to forex trading is the volatility. Prices move continuously throughout the day, reacting to fundamental news, rumours, sentiment, technical levels and data releases. Although the percentage moves are often small, the use of leverage amplifies the impact of all price movements, both positive and negative.
With $4 trilion per day flowing through the forex market, it is usually one of the most liquid markets around. This results in very little slippage and extremely low transaction costs. Most of the liquidity is concentrated in the major currency pairs – the EUR/USD, USD/JPY, GBP/USD, AUD/USD and USD/CHF. Although pairs such as the USD/CAD and USD/MXN trade well in North American daylight hours and USD/NOK trades well in European daylight hours, volumes may dry up in these smaller currency pairs (known as ‘crosses’ and ‘thirds’) when the sun moves on to the next time zone.
The spread is simply the difference between the bid price and the ask price. If the bid price for EUR/USD is 1.4490 and the offer is 1.4492, the spread is 2 pips. Using this example where EUR/USD is quoted at 1.4490/1.4492, if you wanted to buy EUR/USD (buy EUR & sell USD) you would pay 1.4492. If you wanted to sell EUR/USD (sell EUR & buy USD) you would do so at a price of 1.4490. In recent years, many retail platforms have started to quote FX prices to a fifth decimal place – So, a EUR/USD quote might instead appear as 1.44905 / 1.44924, giving a spread of 1.9 pips. This allows for finer tuning of the spreads.
Access to the foreign exchange market has never been easier. You simply fill out an online account application, submit any additional ID that might be required, then fund your account and you are ready to trade. Most brokers will let you open a mini account for as little as $250.
Leverage allows you to control a position in the market that has a face value many times greater than the amount on deposit in your account. The amount of leverage available to you depends on local regulation. In the US, leverage is capped at 50:1 for the majors while in Australia and many other parts of the world, you can access leverage of as much as 400:1. That means that every dollar in your account allows you to control $400 worth of FX. Or, to put it another way, with leverage of 400:1 you would need only to have $2,500 in your account to control a position with a face value of $1,000,000. As prices move, your account receives the full impact of the price move on the total face value of the trade. It is important to remember that leverage is a double edged sword and can work in your favour as well as against you. The forex market is an exciting and energetic place to trade. Just make sure to stay disciplined!
Many traders find it useful to write down a trading plan. Without one, you may be tempted to take short cuts or drift into following bad trading habits.
*The leveraged nature of FX trading means that any market movement will have an equally proportional effect on your deposited funds. The possibility exists that you could sustain a total loss of initial margin funds and be required to deposit additional funds to maintain your position.
Forex trading is one of the riskiest forms of investment available in the financial markets and suitable for sophisticated individuals and institutions. The possibility exists that you could sustain a substantial loss of funds and therefore you should not invest money that you cannot afford to lose.
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