TO casual observers, the world of forex trade would seem to be the domain of the large banks, corporations and finance whiz investors. While it’s true that large players still contribute the biggest portion of the $ 4 Trillion daily forex trade turnover, the internet has opened the doors for retail investors join and cash in the world’s largest financial market. In fact, a closer look at the forex market will reveal that more small players are now participating in the forex trade than ever before.
Compared to other financial markets, forex trade is much less complicated than say, investing in the equities market or other instruments. In the stock market investors have to observe and study different issues while in the forex market traders normally follow the seven major currencies which account for 70-80% of all trades.
Big players like banks and other financial institutions often just focus on to 3 or 4 currency pairs as part of their forex trade activities. Forex trade beginners similarly can just pick 1 or 2 major currency pairs to start out their trades.
Other advantages with forex trade are:
- Investors can engage in forex trade anytime with anyone, anywhere
Forex traders can transact 24 hours a day from Mondays to Friday with the rest of the world. While other financial markets depend on the opening and closing sessions of their respective exchanges (the NYSE for example), the foreign exchange market doesn’t have any such limitations. A trader from the USA can trade forex freely with European and Asian in case the markets close for the night in North America.
All forex trade is done over the counter (OTC), meaning traders directly buy from or sell to a second party without any middle man involved.
- Forex trade involves little or no commissions
Forex trade players pay no commissions to the broker unlike the stock market. Forex brokers earn from the “ask” or “bid” currency rates. In most cases, investors and traders are informed of the spreads or margins that brokers earn. The absence of transaction fees is one major factor why forex trade has become attractive to retail traders.
- Lesser outside interference on forex trade prices
Foreign currency prices are influenced by global events making forex trade more difficult to be manipulated by an individual or a single company. The sheer size and daily forex trade volume is deters most people from playing around with currency prices.
- Down or up: Earn either way
A bearish or bullish market behavior can bring down or pull up all stocks. This doesn’t happen with forex trade because traders earn from the currency price movements and not from the prices itself. Investors can always buy (long) or sell (short) whichever way the price direction goes and earn from it.
- Forex trade leverage
The forex market offers much higher leverage than the other markets. Leverage is basically a loan given by the brokers to their clientsand potentially increases an investor’s forex trade profits (and losses) many times. Stock market and commodity trades normally allow leverages but a much lower ratio.
How the forex trade works
The forex trade works by following the basic business principle of buying low and selling high. While this may look simple, the
Traders make money from the price fluctuation of foreign currency pair. Forex trade is done in bundles or groups of 10,000 to 100,000 units of a currency called lots. These are then put up for sale called the “ask price” or offered price which is different from the official quoted rate called the spot price.
In forex trade practice, the spot price is the rate that is meant for immediate payment and delivery of a bought currency. A “bid price” on the other hand is the price quoted by traders looking to buy and position themselves more forex trade. The difference between the asked price and bid price is called the spread or margin called pips.
An example of a typical forex trade would be that of the Euro and US Dollar pair (EUR/USD) with a spot price of 1.3000 which means 1 Euro is selling for USD 1.3000. Traders usually aim to buy currency pairs at a lower price to create margins of profit however this may not be successful at times and have to settle for the spot price.
If a trader buys 5 lots of the EUR/USD pair at the spot price of 1.3000 and then sells the same pair when the price fluctuates to 1.3006, the spread or margin for this forex trade is at 0.0006 or 6 pips. If the transaction involved 5 lots of 100,000, then this forex trade has earned the trader $300.