With over $3 trillion in daily turnover, the foreign exchange market is 5 times the size of the US futures market, making it the largest market in the world. Surprisingly, this sleeping giant is unfamiliar terrain for most individual traders and investors. Until the popularization of Internet trading a few years ago, forex was primarily the domain of large financial institutions, multinational corporations, and secretive hedge funds. But times have changed: the US dollar has fallen to record lows, and everyone from your local car dealer to bartender is waking up to the impact of currencies.
Unlike the trading of stocks, futures, or options, currency trading does not take place on a centralized exchange, but instead through different forex brokers. At first glance, this ad hoc arrangement must seem bewildering to investors who are used to structured exchanges such as the NYSE or CME. However, this arrangement works exceedingly well in practice: participants in forex must both compete and cooperate with each other, and self-regulation provides an effective amount of control over the market. Furthermore, reputable retail forex dealers in the United States become members of the National Futures Association (NFA), and by doing so, they agree to binding arbitration in the event of any dispute. Therefore, it is critical that any retail customer who contemplates trading currencies do so only through an NFA-member firm.
Here are 4 other factors that make the currency market different from other markets that are sure to raise eyebrows:
Unlike the trading of stocks, futures, or options, currency trading does not take place on a centralized exchange, but instead through different forex brokers. At first glance, this ad hoc arrangement must seem bewildering to investors who are used to structured exchanges such as the NYSE or CME. However, this arrangement works exceedingly well in practice: participants in forex must both compete and cooperate with each other, and self-regulation provides an effective amount of control over the market. Furthermore, reputable retail forex dealers in the United States become members of the National Futures Association (NFA), and by doing so, they agree to binding arbitration in the event of any dispute. Therefore, it is critical that any retail customer who contemplates trading currencies do so only through an NFA-member firm.
Here are 4 other factors that make the currency market different from other markets that are sure to raise eyebrows:
- Simple Bet—Pro-Dollar and Anti-Dollar. When it comes to trading any of the dollar- based currency pairs, the general idea is simple: you are either pro-dollar or anti-dollar. Because 90 percent of all currency transactions involve the US dollar, the outlook for the greenback and US economic data tend to dominate the price action of the currency pairs.
- Forex Trades on Public Data—No Fraud Like Enron. Since the currencies that we offer for trading are the ones of the most developed countries in the world, such as the US, UK, euro zone, and Australia, accounting fraud is not an issue in currency trading. Also, economic data is released at the same time to everyone, which means that there is no such thing as insider trading. CNBC, for example, will announce the non-farm payrolls number the instant that it is released, leveling the playing field for all investors.
- The Ability to Earn Rollover. Rollover is the interest paid or earned for holding a position overnight. Each currency has an interest rate associated with it, and because forex is traded in pairs, every trade involves not only 2 different currencies, but their two different interest rates as well. If the interest rate of the currency you bought is higher than the interest rate of the currency you sold, then you will earn rollover (positive roll). If the interest rate on the currency you bought is lower than the interest rate on the currency you sold, then you will pay rollover (negative roll). Rollover can add a significant extra cost or profit to your trade.
- 24-Hour Trading. The currency market is the most liquid and fluid market in the world. It trades 24 hours a day, from 5 PM (EST) Sunday to 4 PM (EST) Friday, and it rarely has any gaps in price. Its sheer size (it trades over US$3 trillion each day) and scope (from Asia to Europe to North America) also makes the currency market the most accessible market in the world. You can trade before work, during work, or even after work, and there will always be a market that is open.
A pip stands for "percentage in point," and it is the smallest increment of trading in forex. In the forex market, prices are quoted to the fourth decimal point. For example, if a bottle of water in the drugstore were priced at $1.20, in the forex market, the same bottle of water would be quoted at 1.2000. The change in that fourth decimal point is called 1 pip, and it is typically equal to 1/100th of 1%. Among the major currencies, the only exception to that rule is the Japanese yen. One yen is now worth approximately US$0.08; so, in the USD/JPY pair, the quotation is only taken out to two decimal points (i.e., to 1/100th of yen, as opposed to 1/1000th with other major currencies).
Which Currencies are Traded?
Although some retail dealers trade exotic currencies such as the Hungarian forint or the Malaysian ringgit, the majority trade the eight most liquid currencies:
1. US dollar (USD)
2. euro (EUR)
3. British pound (GBP)
4. Japanese yen (YEN)
5. Canadian dollar (CAD)
6. Australian dollar (AUD)
7. New Zealand dollar (NZD)
8. Swiss franc (CHF)
Collectively, they form the seven most actively traded currency pairs in the world:
. EUR/USD (euro/dollar)
. 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)
All About the Majors
Let’s take a deeper look at the key characteristics of each of the major currencies:
US Dollar
. Nicknames: Greenback, Buck
. Reserve currency of the world
. Represents 90% of all trading activities
. Critical to settlement of trade in major commodities, including foodstuffs and industrial metals, but most importantly—OIL
. Responds to growth and interest-rate data
Euro
. Nickname: Anti-dollar
. Represents the second largest economy in the world
. The only currency that can challenge the hegemony of the dollar
. The currency without a country
. Central bank fears strong currency because of export-dependent economy
Nicknames: Cable, Sterling
. Former reserve currency of the world��. Fourth largest economy, a magnet for free market principles in Europe
. Business-friendly regulations promote—acquisitions
. UK: Member of the EU but NOT the EC
Japanese Yen
. Nickname: None
. Represents the dominant economy in Asia
. Serves as a free-market proxy for the Chinese yuan
. Laden with speculators, short carry, interest rate the focus
. Major oil importer
Canadian Dollar
. Nickname: Loonie
. Highly correlated to oil—second only to Saudi Arabia
. The only G-7 nation with BOTH a trade and budget surplus
. Benefits from Chinese demand
Swiss Franc
. Nickname: Swissie
. The safe-haven currency of choice but losing that luster
. Stronger growth and better balance sheet than its next-door neighbor
Australian Dollar
. Nickname: Aussie
. World’s second largest producer of gold
. Huge beneficiary of China's growth
New Zealand Dollar
. Nickname: Kiwi
. Liquid because of its proximity to Australia
. Highest interest rates in OECD
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