Article by Investazor.com
What is Forex?
First of all let us get to know what Forex actually is. The name Forex comes from foreign exchange and it is specific to currencies market. After the accord from Breton Woods, that took place in 1971, the currencies were allowed to change freely against one another so their value started to vary. The commercial and investment banks took the opportunity and offered the process of exchange to their clients creating this way a speculative environment for trading on currency against another. The foreign exchange market started to be better known with the help of the internet and the online brokers.
The stock exchange is a regulated market in which you know the traded volume, the traders and why the stock is traded. Forex is a OTC (Over the Counter) market because, simply said, it incorporates every currency exchange done anywhere at any time, so it is pretty hard to regulate something that doesn’t have a headquarters and the trades cannot be registered.
Practically if you want to change dollars for euros you go to the bank and change them, but you can also get some euros for your dollars from a European friend. Both ways you take part in the Forex market, but it doesn’t mean that you can move the Euro – Dollar pair exchanging 100$, 1.000$ or even 1.000.000$. Forex has the biggest amount of money involved every day. As you can see in the chart, an estimate daily volume is about 3.98 trillion dollars, more than on any other regulated exchange.
The biggest players in the Forex market are usually the Commercial Banks followed by investment funds, hedge funds, corporations and brokerage houses. The highest liquidity it is found at the biggest players so if an exchange is needed it can be done with banks with a huge spread (bid/ask difference) if the sum of money is small and with a very small spread if the sum of money is considerable.
Why Forex?
Foreign exchange came first as a necessity. If an US investor would like to invest in another country he would have to use that countries money so he would have to change the US dollars in the other currency. If a company would like to make a purchase of another company from another country it will have to change between currencies and the examples can go on.
Because of the fluctuating value of one currency an investment would suffer from the currency devaluation so the need to hedge came next. From here it was only one step to speculation. Nowadays speculation is one of the most important features of the Forex market and it is done starting with the biggest players all the way to a retailer.
Banks traded huge amounts of money with low costs. If a retails would like to do the same exchange with a lower volume he will get big costs that eventually will not pay for the bother. For this the financial system invented derivatives like futures and CFDs which gives you the benefit of leverage. Using the leverage with a brokerage house will give the retail not only the possibility to win more, but also lower costs for the trade. Keep always in mind that higher leverage brings bigger wins but also bigger losses.
To conclude if you have a big amount of money to invest the forex market will give you an opportunity to make some profits, but it can do the same for a trader with a smaller account thanks to leverage and brokerage houses which offers this services.
4 myths in Forex trading
It is well known that less than 20% from the forex traders are winners, around 15% are keeping themselves on the breakeven and about 65% are been thrown out of this environment.
1. Leverage is one reason to blame for the losses. It is not true, at least not entirely. The leverage increases the possibility of win and loss but as a trader you will always be in charge of your trading volume. The trader can adjust his investment to respect a certain money management. A trader can always cut his losses using tools like Stop Loss and leave his profit pile up if the market runs in his favor. If a trader losses money trading with leverage than he will certain lose money trading without leverage.
2. News Feed and information are considered to be another factor that sends traders to losing money. Again nothing could be less true. Banks, investment funds and other type of investors have access to the same news and economic data as any other trader or investors. The only difference is the services that are used to get the news. A paid service will give you a head start while a free service will give you the news with a lag. A trader can always adjust his strategy to combat this issue so that it will not be a problem in his day to day trading.
3. The money invested will always make a difference between traders. It is well known that there is a higher probability to erase the deposit if the amount is a small one, especially if it comes to a novice trader. When it comes to a professional trader the amount of money invested will not be a problem because he will always know to portion his every trade so that he will put and earn more money on the high probability trades. Each investment fund, bank or private investor has its own money management strategy suited for the investment.
4. Volatility is a factor that should be taken into consideration while trading. Forex market is known for its high liquidity and volatility and sometimes traders blame them for their losses. In fact volatility is the one that helps the professional traders to make more money. They adjust their system to the market; they modify their strategy and the money management so that the volatility will bring them an important income. Options are usually used in volatile markets.
A trader that has lost money will easily blame the leverage, the lack of information, the market volatility or the fact that he did not have enough money in his trading account. But the main reasons for the loss sit in his lack of knowledge and discipline, not having a strategy that includes a good money management and probably the most important he is driven by his emotions.(we will talk about them in our next articles).
Our recommendation
Even though it seems a very simple and accessible domain in which anyone can invest from as little as 10 bucks to millions of dollars, you should always bear in mind that it involves risks of losing money. Starting your trading experience in Forex could result in empting your account, but the good part is that you can start with a smaller balance than in stock or futures trading.
As a beginner you should better start with an amount of money that you can lose and consider it your education fee. The experience of trading on real account it does not resemble with the experience of trading on a demo account. The majority of mistakes done by traders are caused by emotions like fear and greed which appear while trading with real money.
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