It’s the largest financial market in the world. Open 24 hours a day, 5 days a week, and traded globally, it’s the most liquid market in the world.
Where Did Forex Come From?
The Forex, or FX, market originally existed for multinational corporations needing to trade currencies for payroll, payments, acquisitions, cost of goods between nations, and so on. Now, that’s only 20% of the day-to-day trade activity.
Prior to internet trading, FX trading was handled by large financial institutions, multinational corporations, and secretive hedge funds. The advent of internet trading made it possible for anyone to hop in and trade on the FX market. Currently, approximately 80% of FX trades are speculative, done by hedge funds, corporations, and individuals with opinions on current economic and geopolitical events.
How is Forex Different from Traditional Stock Trading?
Here’s where the FX market sounds a bit like the wild wild west. Forex has no regulated exchange, no governing body, and no clearing houses. It’s all self regulated. There’s also no such thing as insider trading and no limit to the size of the trade. Also, unlike the stock market, there’s technically nothing being traded. It’s all speculative. There are also no broker commissions, because there are no brokers. Instead there are dealers, who make their money through the bid-ask spread.
The large number of currencies traded means high levels of volatility and continuous opportunities for reward… and risk.
What is the Bid-Ask Spread?
The bid is what the investor offers to pay. The Ask is what the seller wants. In liquid trades, like that of currency (remembering the FX market is all currency), the bid-ask spreads are very small, often measured in pips.
What are Pips?
Pip means percentage in point and is the smallest increment of trade. FX prices go to 4 decimal points (with rare exceptions). If a pack of gum is 1.00 in a store, in the FX market, it would be 1.0000.
How is Currency Traded?
Currencies are traded in pairs: EUR/USD. (Side note: What an investor buys, they’re long on. What they sell, they’re short on. Example: you go to the store and buy a pair of shoes for $80. You’re now long a pair of shoes and short $80. The store is short a pair of shoes and long $80.)
What Currencies are Traded? What Currencies are the Most Popular to Trade?
Some exotic currencies are traded, but the most seven most liquid currency pairs are the most traded:
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 last three pairs are called commodity pairs because they’re heavily influenced by changes in their commodities markets. Traders take advantage of these pairs when they’re looking to gain exposure to commodity fluctuations.
There are only 18 pairs or crosses (crosses are trades not involving the USD), yet the FX market is far more concentrated than the stock market.