What is Forex?

Forex (FX) is the market in which currencies are traded. The forex market is the largest, most liquid market in the world, with average traded values that can be trillions of dollars per day. It includes all of the currencies in the world.

BREAKING DOWN 'Forex - FX'

There is no central marketplace for currency exchange; trade is conducted over the counter. The forex market is open 24 hours a day, five days a week, except for holidays, and currencies are traded worldwide.

The forex is the largest market in the world in terms of the total cash value traded, and any person, firm or country may participate in this market.

The Basics of Forex

The term foreign exchange is usually abbreviated as "forex" and occasionally as "FX."

The global foreign exchange market is the largest and the most liquid financial market in the world, with average daily volumes in the trillions of dollars. Forex transactions take place on either a spot or a forward basis. There is no centralized market for forex transactions, which are executed over the counter and around the clock. The largest foreign exchange markets are located in major financial centers like London, New York, Singapore, Tokyo, Frankfurt, Hong Kong and Sydney.

Just How Large Is the Forex Market?

The forex market is unique for several reasons, mainly because of its size. Trading volume is generally very large. As an example, trading in foreign exchange markets averaged $5.1 trillion per day in April 2016, according to the Bank for International Settlements, which is owned by 60 central banks, and is used to work in monetary and financial responsibility. 

The world's largest trading centers can be found in London, New York, Singapore and Tokyo. 

How to Trade in the Forex Market

The market is open 24 hours a day, five days a week across major financial centers across the globe. This means that you can buy or sell currencies at any time during the day.  

The foreign exchange market isn't exactly a one-stop shop. There are a whole variety of different avenues that an investor can go through in order to execute forex trades. You can go through different dealers or through different financial centers, which use a host of electronic networks

From a historic standpoint, foreign exchange was once a concept for governments, large companies and hedge funds. But in today's world, trading currencies is as easy as a click of a mouse — accessibility is not an issue, which means anyone can do it. In fact, many investment firms offer the chance for individuals to open accounts and to trade currencies however and whenever they choose. 

When trading in the forex market, you're buying or selling the currency of a particular country. But there's no physical exchange of money from one party to another. That's what happens at a foreign exchange kiosk — think of a tourist visiting Times Square in New York City from Japan. He may be converting his (physical) yen to actual U.S. dollar cash (and may be charged a commission fee to do so) so he can spend his money while he's traveling. But in the world of electronic markets, traders are usually taking a position in a specific currency, with the hope that there will be some upward movement and strength in the currency they're buying (or weakness if they're selling) so they can make a profit. 

Spot Transactions

A spot deal is for immediate delivery, which is defined as two business days for most currency pairs. The major exception is the purchase or sale of U.S. dollars vs. Canadian dollars, which is settled in one business day. The business day calculation excludes Saturdays, Sundays and legal holidays in either currency of the traded pair. During the Christmas and Easter season, some spot trades can take as long as six days to settle. Funds are exchanged on the settlement date, not the transaction date.

The U.S. dollar is the most actively traded currency. The euro is the most actively traded counter currency, followed by the Japanese yen, British pound and Swiss franc.

Market moves are driven by a combination of speculation, especially in the short term; economic strength and growth; and interest rate differentials.

Forward Transactions

Any forex transaction that settles for a date later than spot is considered a "forward." The price is calculated by adjusting the spot rate to account for the difference in interest rates between the two currencies. The amount of the adjustment is called "forward points." The forward points reflect only the interest rate differential between two markets. They are not a forecast of how the spot marketwill trade at a date in the future.

A forward is a tailor-made contract: it can be for any amount of money and can settle on any date that's not a weekend or holiday. Transactions with maturities longer than a year are relatively unusual, but are possible. As in a spot transaction, funds are exchanged on the settlement date.

Futures

A "future" is similar to a forward in that it's for a date longer than spot, and the price has the same basis. Unlike a forward, it's traded on an exchange, and can only be executed for specified amounts and dates. With a futures contract, the buyer pays a portion of the value of the contract up front. That value is marked-to-market daily, and the buyer either pays or receives money based on the change in value. Futures are most commonly used by speculators, and the contracts are usually closed out before maturity.

Differences Between Forex and Other Markets 

There are some major differences between the forex and other markets: 

  • Fewer rules: This means investors aren't held to as strict standards or regulations as those in the stock, futures or options markets. There are no clearing houses and no central bodies that oversee the forex market.
  • Fees and commissions: Since trades don't take place on a traditional exchange, you won't find the same fees or commissions that you would on another market.
  • Full access: There's no cut-off as to when you can and cannot trade. Because the market is open 24 hours a day, you can trade at any time of day.
  • Ease: Because it's such a liquid market, you can get in and out whenever you want and you can buy as much currency as you can afford. 
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How To Cope With Losing Streaks - As an FX Trader

In trading, consecutive losses are very common and some traders do not take it at heart. Instead, they try to make the best out of it, learn, adjust their strategy or money management plan if needed and just get on with it. It is not always that easy, however, to have this attitude. It is not unlikely, if you ever had a number of consecutive losing trades, to have thought that you are an incompetent trader or that you are possibly not fitted for live trading.

You may have experienced anxiety, disappointment, and anger at yourself or anyone else that is involved (such as your broker or the market). This is a natural human reaction that has a chemical basis; a losing streak activates the production of cortisol, our body’s stress hormone. While cortisol’s primary function is to prepare our body to cope with danger by increasing glucose, the prolonged exposure to it that comes in tandem with losing streaks will render us anxious or even sad.

Anxiety and sadness will then work as “containers” for negative thinking. Suddenly, we see the world through those black glasses and we may engage in various unhelpful thoughts: “ I am a loser”, “ I will never make it”, “Should have never traded”.

But what happens as you think in this manner? Your anxiety, disappointment and anger increases and with them comes a lot of confusion, feeling scattered, unsure, lacking in confidence and belief.

There are some typical ineffective behaviors that traders may then fall into such as

  • Overtrade to reduce losses
  • Revenge trade to get back at the market
  • Become extremely risk-averse and trade too small or not trade at all
  • Give up and close the trading account

Escaping The Vicious Cycle Of Losing Streaks

If you do engage in some of the ineffective behaviors mentioned above, it is likely that you will end up trapping yourself in a vicious cycle. This is because risky trading behaviors such as overtrading or revenge trading are likely to make you lose again and, therefore, evoke the same unpleasant emotions and unhelpful thoughts that led you to it.

vicious-cycle1

In order to exit the vicious cycle of losing streak psychology:

1. Become aware of the emotions that have emerged. Ask yourself: What am I feeling? Am I disappointed? Anxious? Am I Angry?

2. Understand the thinking pattern that accompanies these emotions. What is your mind telling you? Is it pulling you down, sabotaging you or maybe intimidating you?

Typical thoughts following a losing streak would be:

  • I am a lousy trader. Should have given up long time ago
  • My strategy must be wrong; I have been wrong all the way
  • I cannot afford to just let it be. I must make back the money I lost
  • It is just embarrassing to have lost more than half of my balance

3. Are you about to make trading decisions according to what you are feeling or thinking? Is this the best way to trade? Has this helped you to succeed in the past?

4. You can choose to break the cycle. Having unhelpful thoughts and emotions is very different from acting on them. Remember that if you act on them, you maintain the vicious cycle.

Instead of acting on your thoughts, keep your purpose in mind and act according to your goals:

  1. Examine if there are aspects of your strategy & methodology that need to be changed. You may opt to do so by going back trading on a demo for a while. But while demo can provide you with valuable insights about your strategy, it cannot simulate real market conditions; your psychology is going to be completely different when you trade live.
  2. Take a look at your risk/reward ratio. Are your stop losses too narrow or too wide? It often takes the time to determine the best ratio and you may have to be wrong before you get it right.
  3. When you trade, focus entirely on the present moment. Your mind may attempt to remind you of the past, or scare you with negative future possibilities. You must learn not to buy into it, because if you do, you will end up back in the vicious cycle. Your focus must be what’s happening in the market now.
  4. Keep educating yourself on trading. You could attend webinars, read online tutorials or join relevant forums.
  5. Exercise patience. You may be in the right way to achieve your trading goals and it could be that it just hasn’t happened yet. Be patient, have belief and don’t buy into negative self-talk.

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What Can We Expect in Q4

October marks the beginning of the calendar fourth quarter. Investors have been on a wild ride in 2018, but U.S. stocks have performed well overall. However, a lot could change in three months time.

Key Themes

Russell Investments recently outlined what it sees as the key themes and catalysts for investors to watch in Q4. At the top of the list of market themes are the international trade wars, the U.S. Federal Reserve, China’s economic stimulus and the strength of the U.S. dollar. Russell said in its outlook there's a low risk of a U.S. recession, and Europe also appears poised for improving growth.

China and other emerging markets have been major weak spots in recent months. Russell said EM stocks are oversold, but the ongoing trade war may prevent a bounce-back in the near-term.

U.S. Earnings Slowdown

The U.S. economy is firing on all cylinders, but Russell said the 9-percent year-to-date rally in the S&P 500 is finally triggering some overbought indicators in the U.S. market. In addition, Russell said U.S. companies have an exceedingly high bar to clear to beat earnings expectations in the third and fourth quarters. At the same time, borrowing costs and wages are marching steadily higher, creating an earnings headwind.

“A slowdown in earnings growth will take away one of the main supports for U.S. outperformance relative to other markets,” Russell said in the report.

Other Asset Classes

For the first time in a long time, Russell said fixed income investments are starting to look appealing as well, especially the 10-year U.S. Treasury rate of around 3 percent.

On the currency front, Russell said there will likely be more upward pressure on the U.S. dollar in 2019, but the Japanese yen is currently 20 percent undervalued relative to purchasing power parity.

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Will we see war and famine? 

Time will tell, but for now:

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Forex is short for foreign exchange, but the actual asset class we are referring to is currencies. Foreign exchange is the act of changing one country's currency into another country's currency for a variety of reasons, usually for tourism or commerce. Due to the fact that business is global, there is a need to transact with other countries in their own particular currency.

After the accord at Bretton Woods in 1971, when currencies were allowed to float freely against one another, the values of individual currencies have varied, which has given rise to the need for foreign exchange services. This service has been taken up by commercial and investment banks on behalf of their clients, but it has simultaneously provided a speculative environment for trading one currency against another using the internet.

Forex as a Hedge

Commercial enterprises doing business in foreign countries are at risk due to fluctuations in the currency value when they have to buy or sell goods or services to another country. Hence, the foreign exchange markets provide a way to hedge the risk by fixing a rate at which the transaction will be concluded at some time in the future.

To accomplish this, a trader can buy or sell currencies in the forward or swap markets, at which time the bank will lock in a rate so that the trader knows the exact exchange rate in order to mitigate his or her company's risk. To some extent, the futures market can also offer a means to hedge currency risk, depending on the size of the trade and the actual currency involved. The futures market is conducted in a centralized exchange and is less liquid than the forward markets, which are decentralized and exist within the interbank system throughout the world.

Forex as Speculation

Since there is constant fluctuation between the currency values of countries due to varying supply and demand factors such as interest rates, trade flows, tourism, economic strength and geopolitical risk, an opportunity exists to bet against these changing values by buying or selling one currency against another in the hopes that the currency you buy will gain in strength or that the currency you sell will weaken against its counterpart. (For additional reading, see "Top 6 Questions About Currency Trading.")

Currency as an Asset Class

There are two distinct features to currency as an asset class:

Why We Can Trade Currencies

Until the advent of the internet, currency trading was limited to interbank activity on behalf of their clients. Gradually, the banks themselves set up proprietary desks to trade for their own accounts, which was followed by large multinational corporations, hedge funds and high net worth individuals.

With help from the internet, a retail market aimed at individual traders has emerged, providing easy access to the foreign exchange markets, either through the banks themselves or brokers making a secondary market. (For more on the basics of forex, check out "8 Basic Forex Market Concepts.")

Forex Trading Risks

Trading currencies can cause some confusion related to risk due to its complexities. Much has been said about the interbank market being unregulated and therefore very risky due to a lack of oversight. This perception is not entirely true, though. A better approach to the discussion of risk would be to understand the differences between a decentralized market versus a centralized marketand then determine where regulation would be appropriate.

The interbank market is made up of several banks trading with each other around the world. The banks themselves have to determine and accept sovereign risk and credit risk, and for this they have many internal auditing processes to keep them as safe as possible. The regulations are industry- imposed for the sake and protection of each participating bank.

Since the market is made by each of the participating banks providing offers and bids for a particular currency, the market pricing mechanism is derived from supply and demand. Due to the huge flows within the system, it is almost impossible for any one rogue trader to influence the price of a currency. In today's high-volume market, with between $2 trillion and $3 trillion being traded per day, even the central banks cannot move the market for any length of time without the full coordination and cooperation of other central banks. (For more on the interbank system, read "The Foreign Exchange Interbank Market.")

Attempts are being made to create an Electronic Communication Network (ECN) to bring buyers and sellers into a centralized exchange so that pricing can be more transparent. This is a positive move for retail traders who will gain a benefit by seeing more competitive pricing and centralized liquidity. Banks of course do not have this issue and can, therefore, remain decentralized.

Traders with direct access to the forex banks are also less exposed than those retail traders who deal with relatively small and unregulated forex brokers, which can (and sometimes do) re-quote prices and even trade against their own customers. It seems that the discussion of regulation has arisen because of the need to protect the unsophisticated retail trader who has been led to believe that forex trading is a surefire profit-making scheme. (See also "Why It's Important to Regulate Foreign Exchange.")

For the serious and educated retail trader, there is now the opportunity to open accounts at many of the major banks or the larger, more liquid brokers. As with any financial investment, it pays to remember the caveat emptor rule – "buyer beware!" (For more on the ECN and other exchanges, check out "Getting to Know the Stock Exchanges.")

Pros and Potential Cons of Trading Forex

If you intend to trade currencies, in addition to the previous comments regarding broker risk, the pros and potential cons of trading forex are laid out as follows:

Pro: The forex markets are the largest in terms of volume traded in the world and therefore offer the most liquidity, thus making it easy to enter and exit a position in any of the major currencies within a fraction of a second.

Potential Con: As a result of the liquidity and ease that a trader can enter or exit a trade, banks and/or brokers offer leverage, which means that a trader can control quite large positions with relatively little money of their own. Leverage in the range of 100:1 is a high ratio, but not uncommon. Of course, a trader must understand the use of leverage and the risks that leverage can impose on an account. Leverage has to be used judiciously and cautiously if it is to provide any benefits. A lack of understanding or wisdom in this regard can easily wipe out a trader's account. (For more on leverage, check out "Forex Leverage: A Double-Edged Sword.")

Pro: Another advantage of the forex markets is the fact that they trade 24 hours around the clock, starting each day in Australia and ending in New York. The major centers are Sydney, Hong Kong, Singapore, Tokyo, Frankfurt, Paris, London and New York.

Potential Con: Trading currencies is a "macroeconomic" endeavor. A currency trader needs to have a big-picture understanding of the economies of the various countries and their inter-connectedness in order to grasp the fundamentals that drive currency values. For some, it is easier to focus on economic activity to make trading decisions than to understand the nuances and often closed environments that exist in the stock and futures markets where microeconomic activities need to be understood. However, an understanding of a company's management skills, financial strengths, market opportunities and industry-specific knowledge are not necessary in forex trading. (Take a look at "Economic Factors That Affect the Forex Market" to learn more.)

[Note: One of the underlying tenets of technical analysis is that historical price action predicts future price action. Since the forex market is a 24-hour market, there tends to be a large amount of data that can be used to gauge future price movements. This makes it the perfect market for traders that use technical tools. If you want to learn more about technical analysis from one of the world's most widely followed technical analysts, check out Investopedia Academy's Technical Analysis course.]

Two Ways to Approach Forex Trading

For most investors or traders with stock market experience, there has to be a shift in attitude to transition into or add currencies as a further opportunity for diversification.

1. Currency trading has been promoted as an "active trader's" opportunity. This type of opportunity suits brokers because it means they earn more due to the nimbleness that accompanies active trading.

2. Currency trading is also promoted as leveraged trading, and therefore, it is easier for a trader to open an account with a small amount of money than is necessary for trading in the stock market.

Besides trading for a profit or yield, currency trading can be used to hedge a stock portfolio. For example, if someone builds a stock portfolio in a country where there is potential for the stock to increase in value, but there is downside risk in terms of the currency (i.e., the U.S. in recent history), a trader could own the stock portfolio and short the dollar against another currency such as the Swiss franc or euro. In this way, the portfolio value will increase, and the negative effect of the declining dollar will be offset. This is true for those investors outside the U.S. who will eventually repatriate profits back to their own currencies. (For a better understanding of risk, read "Understanding Forex Risk Management.") Opening a forex account and day trading or swing trading is most common with this profile in mind.

A second approach to trading currencies is to understand the fundamentals and the long-term benefits. It is beneficial to a trader when a currency is trending in a specific direction and offering a positive interest differential that provides a return on the investment plus an appreciation in currency value. This type of trade is known as a "carry trade." For example, a trader can buy the Australian dollar against the Japanese yen. If the Japanese interest rate is .05% and the Australian interest rate is 4.75%, a trader can earn 4%. (For more, read "The Fundamentals of Forex Fundamentals.")

However, if the Australian dollar is strengthening against the yen, it is appropriate to buy the AUD/JPY and to hold it in order to gain in both the currency appreciation and the interest yield.

The Bottom Line

For traders – especially those with limited funds – day trading or swing trading in small amounts can be a good way to play the forex markets. For those with longer-term horizons and larger fund pools, a carry trade may be an appropriate alternative.

In both cases, traders must know how to map out the timing their trades through charts, since good timing is the essence of profitable trading. In both cases, as in all other trading activities, the trader must know their own personality traits well enough so that they do not violate good trading habits with bad and impulsive behavior patterns. (To determine what type of trading is best for you, see "What Type of Forex Trader Are You?")

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