Forex trading-also known as FX trading-refers to purchases and sales of international currencies as diverse as Euro, Japanese Yen, US Dollar, Canadian Dollar and Great Britain’s Pound Sterling. In FX lingo, these currencies bear the respective acronyms of EUR, JPY, USD, CAD and GBP. Over the last several years, FX trading has gained in investment prominence, opening the currency market to retail investors and utilizing the Internet as a central tool in spreading the good word about FX as an investment vehicle.
The 4-Trillion-Dollar Forex Market
The FX market is vast, highly liquid and operating through major financial centers, such as New York, London and Tokyo. Economists estimate that FX is a four-trillion-dollar daily market, meaning that much money is bought and sold everyday around the world by individuals and institutions. FX market players run the whole investment gamut, from sophisticated institutions like central banks, hedge funds and private equity funds to novices like retail investors and college students trying to make a quick buck.
Forex as an Investment Vehicle
Over the last decade, Forex has become an asset class by itself, meaning that investors allocate money to FX to seek a positive return on investment, not just to reduce the currency risk that is inherent to international commerce. Financial news outlet Reuters indicated that the money pot is so large and lucrative that China has created a $300 billion FX investment vehicle to improve returns on the country’s massive currency reserves. Besides institutional players, retail investors-you and me, for example-have also embarked on the FX bandwagon, opening self-managed accounts on the myriad online FX brokers that now saturate the Internet.
FX trading entails knowledge of a few basic concepts, including order types, resistance and support, time frame, swaps and overnight positions.
1. Order Types
FX orders are diverse, but the most common are market, limit entry, stop entry, stop loss, and trailing. In a market order, an investor buys or sells at the best available price. A limit-entry order seeks to either sell above the market or buy below the market at a certain price. A stop-entry order is placed to sell below the market or buy above the market at a certain price. A stop-loss order is linked to a trade and prevents additional losses if the price goes against the trader. A type of stop-loss order, a trailing stop is linked to a trade that fluctuates as prices move.
2. Resistance and Support
In FX trading, the “resistance and support” concept implies that the price of a currency will probably stop and reverse at some predetermined price levels. Technical FX traders use these levels to place buy and sell orders.
3. Time Frame
FX traders can base their techniques on time frames as narrow as one minute and as wide as 4 hours, one day or one month. The time frame used depends on the investor’s risk profile, asset-allocation strategy and time horizon.
4. Swaps / Overnight Positions
In a FX swap transaction, two parties simultaneously buy and sell the same amounts of one currency (say, EUR) for another (say, JPY) with two distinct value dates that specialists call spot and forward. An FX overnight position is a buy or sell position that a trader hasn’t closed at 5:00 p.m. New York time, which typically is the end of the FX trading day.
A piece published on behalf of Mr. Mike Jefferson-a senior Market Analyst and Financial Writer for NetoTrade, a global forex brokerage and investment company.