Overview of Forex trading systems

forex currency trading system

Basic Rules in currency trading

Forex currency trading system involves an over the counter market where buyers and sellers interact by exchanging currencies at floating exchange rate through telephone or internet. Any transaction involves buying and selling of currencies simultaneously.

In a forex market you buy a strong currency and sell off the weaker one. In a forex currency trading system, trading is always done in pairs like USD/JPY, USD/Euro etc. Once you buy a stronger currency you expect that the market price will get modified so that the currency bought appreciates in value relative to the currency you have sold. So you automatically secure a profit by buying the currency that is stronger and can buy more goods and services at the same rate.

So you buy a currency that shows a trend of appreciation in the market and by buying it the demand for the currency can increase and the probability of the currency to appreciate in future also increases. So the currency naturally appreciates and becomes stronger. In a forex currency trading system, a forex trader takes advantage of this situation to sell off the weaker currency he holds and buy the currency that shows strong potential of appreciation in near future. If the transaction is reversed then you incur a loss.

When you are buying a currency you are automatically taking along position i.e. you anticipate that the currency will appreciate more in near future. When you sell it off you know that there is no chance for the currency to become strong immediately and thus you take a short position.

In a forex currency trading system, you can buy or sell a currency pair and not close the trade by buying and selling equivalent, less or greater amount of what you have bought and sold in exchange. So the position for trade is open and you can be affected by the profit or loss you earn from market fluctuations in the same currency pair.

Direct, Indirect and Cross Rates

The International Standards Organization uses codes to abbreviate the currency pairs like USD/JPY which means US dollar vs. Japanese Yen. A currency exchange, which is a ratio of one currency compared or valued against its pair or couple and the exchange rate is always quoted for this currency pair.

If you want to buy currencies in a forex currency trading system, the exchange rate signifies how much you will pay for obtaining one unit of the base currency. If you want to sell it off, then the exchange rate signifies how much you will receive by selling one unit of the same base currency.

A 118.48/53 implies the bid price vs. the ask price for USD/JPY. Here USD is the base currency. This implies that the bid price is the price that you quote for selling one unit of the base currency. The base price represents the price you actually obtain by for one unit of the base currency. So 118.48 refer to what you get in JPY when you sell one unit of USD. This is the bid price. And 118.53 refer to what you have to pay in JPY to obtain one unit of USD. So this is the ask price.

In a forex currency trading system, spread is the difference between the bid price and ask price and the spread obtained here is 5 pips or 0.5. This might appear quite small but in reality a 1 pip higher or lower implies a huge gain or loss of the base currency in the inter bank market.

If the spread between the bid price and the ask price reduces to is zero then the market is often referred to as the choice market. This implies that at any point of time, the currencies can be bought and sold for the same price. The forex market at times closely resembles the choice market. This is true only when currency pairs are traded with a spread of only a fraction of a percent. This is possible when the market is extremely liquid and it includes a limited number of intermediaries. The spread between the USD and EUR is usually only 1 basis point, or 0.01% which is close to being referred to as the choice market.

The global forex currency trading system considers US dollar as the base currency. So, of the other currencies are traded against US dollars. The rate of exchange is referred to as direct rate. So when we see USD/CAD = 1.4500 this implies that 1 unit of USD is equivalent to 1.4500 Canadian Dollars (CAD) or in other words 1 UDS can buy 1.4500 CAD.

Indirect rates refer to the market rates for those currency pairs that include US dollar but the other currency in the pair currencies is not traded or valued against USD i.e. where USD is not the base currency but a quote currency or the secondary currency. These are British pound (GBP), Australian Dollar (AUD), New Zealand Dollar (NZD) and Euro dollar (EUR). So when we say GBP/USD = 1.5800, then we mean 1 GBP is equivalent to 1.5800 USD i.e. one GBP can buy 1.5800 USD.

When pair of currencies traded in a In a forex currency trading system does not include the U.S. dollar, then the market rate for currency trading is referred to as the cross rate. Traditionally you convert your foreign currency first into USD and then into the desired currency. The cross rate helps traders to skip this step. The GBP/JPY cross implies that you can directly convert money without having converted it into USD.

A few example of non-US Dollar currencies traded directly, are GBP/EUR or EUR/CHF and GBP/JPY. There are many currency pairs in cross currency where Euro is the base currency. These are EUR/ CAD, EUR/JPY, EUR/GBP and EUR/CHF.

Triangular Arbitrage

In this, you are converting one currency to another and again converting this to a third currency and, finally, converting it back to the original currency within a short time span. You can secure risk less profit in this process especially when the currency's exchange rates do not exactly match up.

Online traders can benefit maximum from this opportunity as this is facilitated best in an automated process and lasts for only few seconds. If you hold $1 million and the exchange rates prevailing in the forex market are: USD/GBP = 1.6939, EUR/USD = 0.8631 and EUR/GBP = 1.4600.

Now, what is the arbitrage opportunity under these exchange rate conditions and what do you actually gain assuming that this process involves no cost or taxes?

You can sell dollars for euros i.e. $1 million x 0.8631 = 863,100 euros
You can sell euros for pounds i.e. 863,100/1.4600 = 591,164.40 pounds
You can sell pounds for dollars: 591,164.40 x 1.6939 = $1,001,373 dollars

So the difference is the gain from this arbitrage which is $1,001,373 - $1,000,000 = $1,373. So this amount is a risk less profit from triangular arbitrage.

Orders in Forex market

The orders that are executed immediately in a forex currency trading system at prevailing market rates are referred to as market orders. Limit orders refer to future trade conditions that do not offset the current position of the trader. In this case the currency pair is traded when particular desired exchange rate is reached upon.

For Current / Open Positions:

When the trader clears his position by buying or selling a pair as it reaches the desired exchange rate and closes the deal by locking in the profit then such a condition is referred to as Take-Profit orders. This also implies that you are long on the currency pair that you are trading. So you lock in to the anticipated appreciated value and close your position.

Stop-Loss orders are used by a trader to limit his losses beyond a point. You are actually shorting the pair anticipating a loss and close your deal. You are safe from losing if there is a probability of further decline in price.

Spot Deal / Market

In a forex currency trading system, spot trade or cash trades are settled on the spot or immediately in the market as opposed to future deals. A spot deal is a bilateral contract between two parties one receiving a specified amount of a given currency and another delivering it at an exchange rate that is mutually agreed upon. The settlement dates are generally within two business days after the deal date.

Spot trades are just opposite to future trades that might take longer periods to close the deal and obtain the payments after the deal. Spot deals require immediate settlements otherwise would lead to loss of the trader and he is expected to be compensated for time value for the belated settlement. The settlement is done electronically and thus instantaneous.

Authorized Forex Dealer

Dealing in foreign exchange requires that the trade is properly executed through financial institutions or individuals that have received authorization or permission from a regulatory or controlling body. In a forex currency trading system, it is also important to ensure that these dealings are conducted in a legal way. National Futures Association is the regulatory body of United States that ensures legal foreign exchange practice.

The authorized forex dealers are screened through a set of rigorous selection procedures. The stages involve registration and strong enforcement of regulations upon approval.

NFA was launched in 1982. Through the execution and enforcement of regulatory behavior, NFA shields traders and investors from counterfeit and fraudulent futures activities. It also acts as a mediator and arbitrator for addressing investors problems in the futures forex currency trading system.

Basic Guides to Forex Trading

The foreign exchange currency trading market is undoubtedly the largest trading market in the world. It is much larger than the stock markets, bullion markets and also the commodities market for trading. Foreign exchange currency trading marketplace is buoyant and crowded as it has tremendous flexibility to leverage and also offers high liquidity to investors. With the average currency trading volume of about 2 two trillion dollars everyday, the forex market is miles ahead of any other similar trading market.

Forex currency trading market, just like any other market, has its own set of advantages as well as disadvantages. Among others, one of the main advantages of forex market is that it is open round the clock, five and a half days a week, except for Saturdays and Sundays. The trading hours, thus, are quite convenient for investors. Forex trading also offers other advantages like a high possible upside, high liquidity and almost zero entry or exit barriers.

Among disadvantages, the most critical one is the fact that this market is predominantly dominated by institutional buyers. So, as a retail investor, you do not really have a huge company. Also, retail players are devoid of much needed market intelligence to consistently make profit out of the Forex Market. The main players in the foreign exchange currency trading market world wide are financial behemoths and banks like Goldman Sachs, JP Morgan Chase, Citigroup, Deutsche Bank etc.

Traders have the option of trading foreign currencies at floating exchange system over the phone or by other better and affordable means of communication like, the World Wide Web. Almost all currency trading transactions are done on concept called margin. Trading on margin implies that the forex trader can trade even more than what the trader has in his account. The brokerage agency loans the trader the money to trade on margins. So if the trader has $5000 in his account and he wants to trade at 1% margin then you get a leverage of 100:1 and trade up to $500,000.

This makes foreign currency trading a high risk high gain game. While this allows as much as 100% rate of return, you hold equal chances of loosing your entire investment if the market goes against you. In the forex market, currencies are traded in pairs. This implies that you buy the stronger currency and sell of the weaker one that show chances of depreciation. The major currency pairs are US dollar vs. Japanese Yen, US dollar vs. European Pound, US dollar vs. Euro and US dollar vs. Swiss Franc.

Unlike the stock market, the forex market is free of commission payout, that is you do not pay any commission to any broker for any transaction. You just pay the spread or the difference between the actual price paid and the asked price. The smallest unit at which a pair is traded is called a pip. There are two kinds of traders-Technical and Fundamental. While Technical trading is driven by numbers, and is based on statistics and parameters, fundamental traders trade on calendar days i.e. big market events.

Excelling in currency trading requires both theoretical knowledgebase as well as hands of experience. Mock online trading platforms provide an opportunity to learn the tricks of the trade. You can select a brokerage agency and open a forex account with them. These currency trading accounts are called demo account. Your broker is the best guide who can help you use the demo account to learn the basic details about the forex market and start trading. If you can win profit using the demo account then there are high chances that you can secure a win while trading real stuff.

One of the most important components of foreign exchange currency trading is orders. There are different types of orders in the forex market. When the order is executed by the dealer thorough his intervention then it is called Manual Execution. Sometimes currency trading orders are executed through computer software, and they are called Automated Execution. This type of execution is used when online trading is performed.

Forex currency trading is a complex game, and involves various different kinds of trading options; spread over varying time frames. There are various kinds of trading options, and they cater to all kinds of trading budgets, risk appetites as well as time required. Currency trading in the forex market can be a matter of few minutes to as much as a couple of months. If you are trading for a very small period of time for small gains then this style is called scalping. This kind of trade involves multiple trading options on an intra day basis and is also called day trading. Swing Trading is linked to the market swings and profit gains vary from short to medium term swings in the market trend. Swing trading lasts for hours to days.

When a trader aims at long term gains from the forex market, then trades last for weeks to months. This kind of trading is called Position trading.

As apparent from the inherent trading styles, scalping or day trading involves a great about of intuition or gut feeling. Since the duration f such a trade is only a day or ever less than that, this kind of trading requires active involvement and supervision of the trader.

On the other hand, swing trading as well as position trading requires a through understanding of the world economic factors, and their possible repercussions on the currency rates. Currency values are a function of a number of factors- political, economic as well as geographical. Position trading generally requires a strong back office team that can handle analytics, and can theoretically predict the impact of macro economic factors on currencies.

Trading can also be discretionary and automated. When you are not trading though the internet then most of the trading decisions are taken by you after calculating the risks of gain or loss. When trade takes places through such a decision making process it is called Discretionary Trade. But while trading online most of the decisions are influenced by the computer and this is a common phenomenon in Automated Trade of currency trading.

Day trading the stock markets vs. Forex Trading

Day trading in the security market is viewed as an attractive investment vehicle in general. The stock market has been highly volatile since the last decade and this contributed to the growth of speculation in stock trading. However, the stock market is quite erratic in character and securities reflect the irrational nature that is prevalent in the stock market.

The return on investment in day trading in stocks widely varies with market fluctuations. In previous years, capital investment in day trading was common and higher return on investment was available only for non exponential investments.

The market for future stocks was attracting many investors as they could leverage more capital. The spot currency trading or day trading is another way to leverage current capital into trade. Spot currency or forex day trading provide greater options to the traders as the forex market is more buoyant and stronger than the stock market. Traders in day trading have spotted an excellent opportunity in foreign exchange trading.

Third Party Intervention

The day trading market for securities in generally crowded by middlemen or brokers. They are the negotiators, and act as an interface between buyers and sellers. This involvement of middleman often takes away a part of the profit earned by buyers or sellers. And in case of loss you have to pay the cost of involving middleman from your pocket. Trading with help of a middleman costs both time and money.

Traders conducting day trading get faster access to the forex market at lower costs. Day trading in Forex trading does not involve a third party, apart from the buyer and the seller. It can perform without the middleman and allows you to deal with the market situation directly and handle the market players responsible for pricing of currency pairs.

4 major currency pairs vs. 8000 stocks

Almost 8000 stocks are listed in New York stock exchange and NASDAQ. This is a global figure for USA. In addition to this, there are domestic stock markets. They have many such more listings in all the countries. It is really impossible to make out which one is best for you. So for day trading in stock markets you need to spend your entire time and energy to list them properly. If you are engaged in a full time strenuous job then this becomes more difficult. You engage a broker and pay the fees irrespective of the profit and loss. The situation is not quite favorable if you do not have enough time to spend in the stock market.

But in forex day trading if you have an internet connection and download the trading software then trading in 4 major markets becomes quite convenient. The market is open round the clock for five and a half days a week except for weekends. The four or five major currencies are a handful and you can easily locate your trade. You can conveniently trade in your choice of currency pairs in your spare time without disturbing your daily work schedule even while holidaying. And over and above this you will save the brokerage fee.

Free of Commission

Day trading in Forex markets requires no commissions, no government fees, no clearing fees, no brokerage fees and no exchange fees.

Control Over the market

The Stock market is highly affected by large fund buying and selling. Events like financial year ending or triple watching day largely affects the stock market. Whereas the spot or forex market is has high liquidity preference and it is less likely that a particular currency in controlled by large fund movements from banks or other financial institutions alone.

The forex market is unpredictable, and has an imperative to act accordingly. Big corporations, financial institutions, banks, FCMs, retail currency conversion houses, hedge funds, governments and individual traders have little influence or control on the market and the liquidity is exceptional. The only regulatory control to some extent can be exercised by the Central Bank of the country in times of inflation or depreciation of a currency due to a spectrum of socio-economic and political factors.

Influence on the market

The forex market generates billions of money for banks all around the globe. It is absolutely necessary to study this trend and analyze the pattern to help the forex investors have a better grip of the market dealings. Analysts work for brokerage agencies to predict a pattern and trend. Even if they have the capability it is unethical to publicly advise on buying and selling as per government recommendations. Analysts in forex market never determines the flow or the trend they just try to analyze the pattern. So the forex market is least susceptible to analysts and predictors who have least control on the movements of currencies.

No premium trade

The currency trading does not involve any premium for calling in orders. You can stop orders, limit orders and contingent orders. You will never be charged for an extra penny for using orders. A currency market offers you to place market orders at a no price qualifier option which you will never find in a stock brokerage agency.

Pyramid Strategy

The profit options are wide and better in a forex market. You can leverage your profit and gain more on that. You can use your profits to earn more and gain more by using the pyramid trading strategy. You can start with a low margin and move on higher margin trading as you gain more and more.

STOCKS vs. FOREX – the final arguments

The stock market is highly speculative and less flexible. You can do day trading only 7hours in a day or even less depending on market conditions. Liquidity is highly restricted and you cannot trade if your gains are not realized. The stock market is crowded by third party individuals who consume a substantial cost in terms of time or money. You always have to pay high exchange fees to get quotes in a securities market.

The forex market is the world largest currency transaction market where dealing are done 24/7 and throughout the week. The liquidity is very high and traders are able to trade without middlemen and paying no commissions. Forex market offers free real-time quotes for dealings. And you can do day trading even with unrealized profits.

History and development of the Forex market and Forex trading

Like many other technological, economic and sociological innovation, the concept of currency was by the Babylonians. Maritime traders from Middle-east first exchanged one currency for another and facilitated trade. So the birth of forex trading could be traced as early as middle ages when exchange of foreign currencies helped empire economies flourish.

Till 1914 the forex market was stable and without much speculative activity mainly because there was little international trade, and there were only a handful of economies. World War I marked the increased of speculative activity and the market became extremely volatile. The economic downturn and stock market crash in 1929-30 leading to the great depression spread throughout the world affecting the world economies and removing the erstwhile international gold standard.

In the Bretton woods Conference in 1944, it was unanimously decided that each currency would be pegged to dollar and dollar, in turn, would be pegged to gold. Thus the fixed exchange currency system was derived at. This was the period when the forex market went through a series of evolution till 1973.

In 1973 the failure of the Smithsonian agreement signified an official switch to the free floating exchange rate system. This system was mandated by the International Monetary Fund (IMF) 1978. 1973 to 1997 was the period when economies struggled to adjust with the free floating system and the modern forex trading market began to emerge.

However, it was not before 2006 the world saw the buoyant forex market that characterized trading and derivative trading including spread bets and CFDs.

Forex- till 1944

The major economic powers convened the Bretton woods agreement in the year 1944 with the aim of bringing in a much needed stability in the international monetary scenario. Prior to this meeting, the international economic and monetary scenario was governed by the gold exchange standard. Between 1876 to the First World War, the gold exchange standard was largely successful in providing stability to international exchange rates as currency values were backed by the value of the gold held by the country’s central bank.

However, the gold exchange standard had its own share of disadvantages. The gold exchange standard depended on the gold stock of a country, and it resulted in alternative periods of boom and bust among all open economies, before World War I disrupted international trade and inhibited movement of gold.

The Bretton Woods Accord

This conference aimed at setting up an International Monetary Fund (IMF) and IBRD (World Bank) as the inventory house of global capital where all the participating nations could subscribe to for funds and loans in times of distress. Another objective of this conference was to stabilize the currency fluctuations by introducing fixed or pegged exchange rates or rather making a single currency strong enough so that other currencies could be compared and valued against that.

Major currencies were now pegged to the U.S. dollar which in turn was pegged to gold. But in spite of all continued efforts the fixed exchange rate was not that widely acceptable in Europe and Japan and failed to bring in currency stability in these two economies.

As a part of the Bretton Woods Accord, major world economies agreed to maintain the value of their currencies within a small range of the Dollar, and not to devalue their currencies to gain trade advantage. However, the post-war resurgence of the world economy was characterized by a massive flow of capital as investments flowed from capital rich countries to cash starved economies. This led to the destabilization of the currency exchange rates as decided in the Bretton Woods Accord.

The free-floating system

Dependency to dollar and gold primarily marked the failure of pegged exchange system. In 1972 the European communities tried to trim down their dependency on dollar and launched a joint float system.

In 1973 this system suffered a miserable collapse. The free floating system was officially introduced by default. Government were now allowed to free float their currencies, peg or semi peg them as they wished. The IMF officially mandated this system of free floating currency exchange in 1978.

The Euro

Although Europeans were already very comfortable with the concept of forex trading, much of the rest of the world were still unfamiliar with the territory. The establishment of the European Union in 1992 gave birth to the euro seven years later, in 1999. The euro was the first single-currency used as legal currency for the member states in the European Union. It became the first currency able to rival the historical leaders in the Foreign Exchange market and create the stability that Europe and the forex market had long desired.

The forex trading at present

At present all the world currencies are independent and move irrespective of the fluctuation in other currencies unless affected by big global phenomena like war that affects many countries simultaneously.

The major currencies are U.S. dollar, Euro, Pound, Franc, Australian & Canadian dollar and the Yen. Personal trading or speculation at individual level is allowed even with low margins and without any commissions. The major players in forex trading market are banks, brokerage agencies, hedge funds and individual speculators.

The forex market now has an erratic momentum that influences the value of assets. It is necessary for individual forex traders and trading corporations to have a comprehensive understanding of the foreign exchange market and the forces that impacts the fluctuation in currency values. The market is still evolving and providing with new opportunities in trading options.

Introduction to Forex Trading

Definition of a Foreign exchange market:

Forex trading, or trading in Foreign Exchange involves trading in international currencies. Forex market is an OTC or over the counter market where the buyers and sellers trade in foreign currencies/exchange by viable and affordable means of communication (phone, internet etc.). It is the market where one currency is traded for another and the transactions worth a whopping $2 trillion worth of currency changing hands every day.

Forex trading is also known as the 24-hour Interbank market. The Interbank market is the bank to bank currency market that literally follows the sun around the world, moving from major banking centers around the world.

A Brief history:

The history of forex trading can be traced back to ancient times, when traders exchanged coins from different empires. However, those trading were primarily barter systems, with gold being the standardizing parameter. Foreign exchange, as we know it today, started in the early part of the 20^th century. 1944 marked the pegging of currency to dollar which was in turn pegged to gold. This process was initiated in the Bretton Woods Conference, and it marked the birth of IMF, or the International Monitory Fund. With the collapse of Bretton Woods in 1971 the US dollar no longer convertible to gold, currency became more volatile and trading opportunities in the currency market started to rise. This was the starting of the modern era of foreign exchange market.

Today, the central banking system of each country is the controlling authority for stabilizing the movements in currency of that respective country in the forex market. The free floating exchange system that propels the forex market was introduced after 1973 Smithsonian & European joint Float agreements, and foreign exchange trading has never looked back henceforth.

Why does it exist?

The existence of forex trading is critical to international trading of goods, products and services. Given the fact that all countries, apart from members of the EU, have their own currency that is not accepted in any other country, exporters as well as importers need foreign currencies to complete trade transactions. Apart from trade, inter-country financial transactions like grants, aids and loans also require third country currencies.

All these requirements are met by forex trading. Bulk forex trading is done by major international banks, though last couple of years has witnessed an increasing number of individual investors joining the forex trading system.

At present the forex market actually guides the sale of goods and services globally. Created by necessity of traders, investors, speculators, importers and exporters, the forex market is a diverse zone for hedging risks and speculation for profit. The market is controlled not by individual forex traders but by multinational big corporations and institutional investors.

The only scenario where foreign exchange trading may be abolished is when all countries accept a common currency, as Euro was accepted in the EU. However, given the diverse nature of countries, fragmented political system and their economic scenario, it is highly unlikely that a worldwide currency will arise.

Distinctive features of Forex Trading

The Forex market has no regulation on daily price fluctuation and speculative positions. Transactions are mainly negotiated and done on individual, one to one basis. Spot trading in currencies and forward cash are the main transaction features that have little or no regulatory control.

The brokerage firms and banks i.e. the forex traders in the forex market are linked through an electronic exchange network that allows conversion of world currencies. Previously forex trading was limited to central, commercial and investment banks only. With more and more of enthusiasts in the forex trading zone it has now became accessible to private investors through the internet.

The forex market in a way is the market that observes heaviest volume of transactions and highest level of participation from the traders. At the same time traders do not have to deal with gaps and price movements that are common in other lower markets. The forex market is open five and a half days per week and transactions are held 24/7 throughout the world from west to east and vice versa.

US Dollar, Euro, British Pound Sterling, Japanese Yen, French Franc, Canadian Dollar and Australian Dollar are the most commonly traded currencies in the market. The market provides maximum flexibility as a trader can trade even with very low margins.

The Global forex trading market also offers commission free trading. The spread is negligible and you do not have to pay anything more if you secure a profit or suffer a loss. Spot currency trading offers advantage of the margin rate or leverage that clients are given. The margin rate is applicable for 24 hours within the same trading day. Margin rates are between 1 to 5 percent depending on the size of transactions. This rate is unique and uniform for a trader to help him manage his transactions efficiently throughout.

Potential for profit

Forex trading is considered to be one of the most profitable trading activities, and not without reasons. The Forex market, due to its inherent volatility and huge trade volumes, offers a great scope of huge earning if proper trading strategies are followed. It is one of the most important factors that make forex trading particularly lucrative is the concept of margins. The brokerage agency with which a trader opens an account, forwards a loan to the trader on the basis of the margin. So, if the trader has ten thousand dollars in his account with the brokerage firm, and has a margin of 2%, then he gets a leverage ratio of 1:50, and can do forex trading up to a hundred thousand dollars

One of the other most important factors that is making Forex trading an attractive option is the 24/7 liquidity that it offers. Since forex markets are active 24 hours a day for all the five business days a week, there is no lock in period for any investment.

Having said that, it is critical to understand that Forex trading requires a committed and sound trading strategy. There is a certain method in this apparent madness, and a trader can be continuously successful over a long period of time only if the trading decisions are marked by authentic business intelligence.

Posted by eetees at 10:42 AM