Crash Course on Forex ( Forex Basics)
History of Forex
1944 – Bretton Woods Accord is established to help stabilize the global economy after World War II.
1971 – Smithsonian Agreement established to allow for greater fluctuation band for currencies.
1972 – European Joint Float established as the European community tried to move away from its dependency on the U.S. dollar.
1973 – Smithsonian Agreement and European Joint Float failed and signified the official switch to a free-floating system.
1978 – The European Monetary System was introduced so other countries could try to gain independence from the U.S. dollar.
1978 – Free-floating system officially mandated by the IMF.
1993 – European Monetary System fails making way for a world-wide free-floating system.
The foreign exchange market (FX or Forex) as we know it today originated in 1973. However, money has been around in one form or another since the time of Pharaohs. The Babylonians are credited with the first use of paper bills and receipts, but Middle Eastern moneychangers were the first currency traders who exchanged coins from one culture to another. During the middle ages, the need for another form of currency besides coins emerged as the method of choice. These paper bills represented transferable third-party payments of funds, making foreign currency exchange trading much easier for merchants and traders and causing these regional economies to flourish.
From the infantile stages of Forex during the Middle Ages to WWI, the Forex markets were relatively stable and without much speculative activity. After WWI, the Forex markets became very volatile and speculative activity increased tenfold. Speculation in the Forex market was not looked on as favorable by most institutions and the public in general. The Great Depression and the removal of the gold standard in 1931 created a serious lull in Forex market activity. From 1931 until 1973, the Forex market went through a series of changes. These changes greatly affected the global economies at the time and speculation in the Forex markets during these times was little, if any.
The Bretton Woods Accord
The first major transformation-the Bretton Woods Accord, occurred toward the end of World War II. The United States, Great Britain and France met at the United Nations Monetary and Financial Conference in Bretton Woods, N.H. to design a new global economic order. The location was chosen because, at the time, the U.S. was the only country unscathed by war.
Most of the major European countries were in shambles. Up until WWII, Great Britain's currency, the Great British Pound was the major currency by which most currencies were compared. This changed when the Nazi campaign against Britain included a major counterfeiting effort against its currency. In fact, WWII vaulted the U.S. dollar from a failed currency after the stock market crash of 1929 to benchmark currency by which most other international currencies were compared. The Bretton Woods Accord was established to create a stable environment by which global economies could restore themselves. The Bretton Woods Accord established the pegging of currencies and the International Monetary Fund (IMF) in hope of stabilizing the global economic situation.
Now, major currencies were pegged to the U.S. dollar. These currencies were allowed to fluctuate by one percent on either side of the set standard. When a currency's exchange rate would approach the limit on either side of this standard the respective central bank would intervene to bring the exchange rate back into the accepted range. At the same time, the US dollar was pegged to gold at a price of $35 per ounce further bringing stability to other currencies and world Forex situation. The Bretton Woods Accord lasted until 1971. Ultimately, it failed, but did accomplish what its charter set out to do, which was to re-establish economic stability in Europe and Japan.
The Beginning of the free-floating system
After the Bretton Woods Accord came the Smithsonian Agreement in December of 1971. This agreement was similar to the Bretton Woods Accord, but allowed for a greater fluctuation band for the currencies. In 1972, the European community tried to move away from its dependency on the dollar. The European Joint Float was established by West Germany, France, Italy, the Netherlands, Belgium and Luxemburg. The agreement was similar to the Bretton Woods Accord, but allowed a greater range of fluctuation in the currency values.
Both agreements made mistakes similar to the Bretton Woods Accord and in 1973 collapsed. The collapse of the Smithsonian agreement and the European Joint Float in 1973 signified the official switch to the free-floating system. This occurred by default, as there were no new agreements to take their place. Governments were now free to peg their currencies, semi-peg or allow them to freely float. In 1978, the free-floating system was officially mandated.
In a final effort to gain independence from the dollar, Europe created the European Monetary System in July of 1978. Like all of the previous agreements, it failed in 1993.
The major currencies today move independently from other currencies. The currencies are traded by anyone who wishes. This has caused a recent influx of speculation by banks, hedge funds, brokerage houses and individuals.
Central banks intervene on occasion to move or attempt to move currencies to their desired levels. The underlying factor that drives today's Forex markets, however, is supply and demand. The free-floating system is ideal for today's Forex markets. It will be interesting to see if in the future our planet endures another war similar to those of the early 20th century. If so, how will the Forex markets be affected? Will the dollar be the safe haven it has been for so many years? Only time will tell.
Understanding Forex quotes
Reading a foreign exchange quote may seem a bit confusing at first. However, it's really quite simple if you remember two things: 1) The first currency listed first is the base currency and 2) the value of the base currency is always 1.
The US dollar is the centerpiece of the Forex market and is normally considered the 'base' currency for quotes. In the "Majors", this includes USD/JPY, USD/CHF and USD/CAD. For these currencies and many others, quotes are expressed as a unit of $1 USD per the second currency quoted in the pair. For example, a quote of USD/JPY 120.01 means that one U.S. dollar is equal to 120.01 Japanese yen. When the U.S. dollar is the base unit and a currency quote goes up, it means the dollar has appreciated in value and the other currency has weakened. If the USD/JPY quote we previously mentioned increases to 123.01, the dollar is stronger because it will now buy more yen than before.
The three exceptions to this rule are the British pound (GBP), the Australian dollar (AUD) and the Euro (EUR). In these cases, you might see a quote such as GBP/USD 1.4366, meaning that one British pound equals 1.4366 U.S. dollars. In these three currency pairs, where the U.S. dollar is not the base rate, a rising quote means a weakening dollar, as it now takes more U.S. dollars to equal one pound, euro or Australian dollar. In other words, if a currency quote goes higher, that increases the value of the base currency. A lower quote means the base currency is weakening.
Currency pairs that do not involve the U.S. dollar are called cross currencies, but the premise is the same. For example, a quote of EUR/JPY 127.95 signifies that one Euro is equal to 127.95 Japanese yen. When trading Forex you will often see a two-sided quote, consisting of a 'bid' and 'offer'. The 'bid' is the price at which you can sell the base currency (at the same time buying the counter currency). The 'ask' is the price at which you can buy the base currency (at the same time selling the counter currency).
Forex, Stock and Future
Forex vs Stock
Historically, the majority of the general public has viewed the securities markets as an investment vehicle. In the last ten years securities have taken on a more speculative nature. This was perhaps due to the downfall of the overall stock market as many security issues experienced extreme volatility because of the irrational exuberance displayed in the marketplace.
The implied return associated with an investment was no longer true. (If indeed it ever was.) Many traders engaged in the day trader rush of the late 90's only to realize that, from a leverage standpoint, it took quite a bit of capital to day trade, and the return while potentially higher than long-term investing was not exponential. After the onset of the day trader rush, many traders moved into the futures stock index markets where they found they could leverage their capital greater and not have their capital tied up when it could be earning interest or making money somewhere else. Like the futures markets, spot currency trading is an excellent vehicle for pattern day traders who desire to leverage their current capital to trade. Spot currency or Forex trading provides more options, greater volatility and stronger trends than currently available in stock futures indexes. Former securities day traders have an excellent home in spot foreign exchange (Forex).
Centralized exchanges provide many advantages to the trader. However, one of the problems with any centralized exchange is the involvement of middlemen. Any party located in between the trader and the buyer or seller of the security or instrument traded will cost them money. The cost can be either in time or in fees. Spot currency trading does away with the middlemen and allows clients to interact directly with the market maker responsible for the pricing on a particular currency pair. Forex traders get quicker access and cheaper costs.
Buy/Sell programs do not control the market
How many times have you heard that "fund A" was selling "X" or buying "Z"? Rumor had it that the funds were taking profits because of the end of the financial year or because today is "triple witching day", all as an explanation of why this stock is up or the market in general is down or positive on the session. No matter what your broker says the stock market is very susceptible to large fund buying and selling, and it is not uncommon for a fund to run a particular issue for a few days. In spot currency trading, the liquidity of the Forex trading market makes the likelihood of any one fund or bank to control a particular currency very slim. Banks, hedge funds, FCM's, governments, retail currency conversion houses and large net-worth individuals are just some of the participants in the spot currency markets where the liquidity is unprecedented.
Analysts and brokerage firms are less likely to influence the market
Have you watched TV lately? Heard about a certain Telecomm stock and an analyst of a prestigious brokerage firm accused of keeping its recommendations, such as "buy" when the stock was rapidly declining? It is the nature of these relationships. No matter what the government does to step in and discourage this type of activity, we have not heard the last of it. IPO's are big business for both the companies going public and the brokerage houses. Relationships are mutually beneficial and analysts work for the brokerage houses that need the companies as clients. That catch-22 will never disappear. Foreign exchange, as the prime market, generates billions in revenue for the world's banks and is a necessity of the global markets. Analysts in foreign exchange don't drive the deal flow; they just analyze the Forex trading market.
8000 stocks vs 4 major currency pairs
There are approximately 4,500 stocks listed on the New York Stock exchange. Another 3,500 are listed on the NASDAQ. Which one will you trade? Got the software? Got the time? In spot currency trading, you have 4 major markets, 24 hours a day 5.5 days a week. You have approximately 34 second-tier currencies to look at in your spare time (if you are so inclined). Concentrate on the majors and find your trade. Spend your afternoon on the golf course or with your kids (instead of with your eye doctor trying to diagnose why you are seeing double).
Simply put: no commissions*, no clearing fees, no exchange fees, no government fees, and no brokerage fees. Sure there may be different names for different fees at different places, but in spot currencies no commissions* means just that- NO COMMISSIONS*.
Same price for broker assisted trades
No premium for calling in orders, whether or not you trade Forex via the phone, use market orders, stop orders, limit orders or even contingent orders. In spot currency trading you do not have to worry about extra charges. Ever wonder why a securities brokerage house charges you more if they have to guarantee you a price than if you give them a market order with no price qualifier? Well you don't have to worry about it if you trade the currency markets.
Trade off your profits. Ever been up on a stock and wished you could leverage that profit and get in a little more of the issue? In spot currency trading you can. Use your open profits to add to your positions. As you gain experience, experiment with pyramid trading strategies. The options are endless because the market is cutting edge.
With a daily trading volume that is 46x larger than the futures market, there are always broker/dealers willing to buy or sell currencies in the FX markets. The dealing volume will reach 2 trillion USD dollars, but in the future market, the volume only reaches 3 million USD dollars. The liquidity of this market, especially that of the major currencies, helps ensure price stability. Traders can almost always open or close a position at a fair market price. Because of the lower trade volume, investors in the stock market are more vulnerable to liquidity risk, which results in a wider dealing spread or larger price movements in response to any relatively large transaction.
No Hidden Fees
Though some speculators are unaware, all financial markets have a spread (the difference between the bid and ask price). In the futures market you are not only paying the spread, but you are also paying commission charges, clearing and exchange fees on top of the spread. Ticker prices in the futures market typically signify the last traded price, not the spread. Global Forex Trading offers you commission-free* trading on tradable prices. In a sense, what you see is what you get, allowing you to make quick decisions on your Forex trades without having to account for fees that may affect your profit/loss or slippage between the price you have just seen on the ticker and the price upon which the order will be filled.
The large spot market and stable prices allows you to deal with a better leverage. In addition, you can select the proportion of leverage. If it didn't state expressly, MultiBank FX will give you the largest leverage rate. However, the real leverage rate will set according to the size of the account. For example, if you have USD 30000 in your account, the margin of each lot is USD 1000, then, margin accounts for 5% of the contract unit leverage rate is 1.20 In comparison with the futures market, Forex market trades 24 hours a day. Sydney opens the market at EST 5:00 pm Sunday, and then Tokyo opens at 7:00, London begins its dealing at 2:00 am., at last ,New York opens at 8:00 am. And this allows the investors to deal trades at any time. In contrast, the trading time of Chicago Board of Trade and Philadelphia Exchange is limited. For example, Chicago Board of Trade deals between 8:30 am and 2:00pm. If it also has some important data in UK and Japan after market has closed, the market will fluctuate heavily as the market opens in the next day.
Real Time Trading
Since the forex market, in a sense, follows the sun around the globe the market, it rarely experiences periods of illiquidity. What this means is that any trader in any time zone can trade forex at any time during the day or night. You no longer have to wait for the market to open when news has already hit the streets or have to stop trading because the CME, CBOT or other American futures pits have closed for the day. This gives the forex trader added flexibility and continuous market opportunities that just aren't available in futures. Foreign exchange is one of the few true 24-hour markets. When trading forex, clients enjoy unparalleled liquidity 24 hours a day. In many futures markets, however, the overnight access available to traders is simply window dressing. The lack of liquidity and restrictions on what types of orders a client can place make trading and protecting positions a nightmare.
Foreign exchange is the principal market of the world. If you study any market trading through the civilized world everything is valued in money, the root of all pricing. Global finance is the distribution and redistribution of money throughout different channels and different financial derivatives. Trading spot currencies can be done with many different methods and you will find many types of traders. From fundamental traders speculating on mid-to-long term positions based on worldwide cash flow analysis and fixed income formulas, to the technical trader watching for breakout patterns in consolidating markets or the Gann fanatic looking to duplicate the techniques of W.D. Gann, the methods for trading foreign exchange are many. Spot currencies are a great market for the "trader". It is where "big boys" trade and can provide both large profit potential as well as commensurate risk for the speculator.