T2W Trading Community

The foreign exchange market owes its existence to the 1971 abandonment of the Bretton Woods accord and the subsequent unwinding of the regime of universal fixed exchange rates.

According to the 2001 triennial survey by the Bank of International Settlements (BIS), global foreign exchange turnover amounts to more than $1,200bn per day, over 50% of which is transacted on the London market alone. Global turnover, however, is markedly down on the 1978 BIS survey figure of $1,490bn. The BIS attributes this to the launch of the euro, banking mergers, the growth of electronic broking at the expense of voice and telephone dealing (leading to fewer transactions) and non-banking consolidations that have reduced the need for foreign exchange.

1. The players

Although currency trading is inherently governmental (central banks) and institutional (commercial and investment banks), the foreign exchange market is also the province of non-banking international corporations, hedge funds and individual private investors and speculators. However, technological innovations like the internet have made it feasible for private investors to monitor currency markets and to trade via intermediaries.

2. The attraction for private investors

The main attractions of currency dealing to private investors are:-

• 24-hour trading, 5 days a week with continuous access to global dealers
• An enormous liquid market making it easy to exchange most currencies
• Volatile markets offering profit opportunities
• Recognised instruments for controlling risk exposure
• The ability to profit in rising or falling markets
• Leveraged trading with low margin requirements
• Zero dealing commission

3. Five ways to trade forex

Private investors can trade directly or indirectly in foreign exchange through:

• the spot market
• forwards and futures
• options
• contracts for difference
• spread betting

We shall examine each of these instruments in turn, but first a risk warning.

4 Margin trading: risk and reward

All the aforementioned forex instruments are margin products, which means that your investment exposure can be a multiple of the cash that you lay down (i.e. the margin).

The main advantages of margin are that:-

• Margin enables private investors to trade in markets with high minimum units of trading (e.g. the spot market where the minimum size trade is 100,000 units of the base currency).
• Margin trading enhances the rate of profit.

The principal disadvantage of margin trading is that it has the habit of inflating rates of loss, on top of systemic risk. For example, currency options are inherently riskier than spot market trades, because a small change in the underlying spot rate can generate a disproportionately large change in options prices. Sell naked call options and there is no limit to potential losses. Add leverage to the cocktail and you have the potential for large profits and large losses.

5 Learning to trade forex

Forex is still relatively fresh territory for private investors, having really only been rendered feasible by the advent of the internet. Like any financial discipline, the best investment is a sound and practical education.