To many experienced stocks and futures traders, foreign exchange (forex) market is a whole new world to them. It's almost considered the wild, wild West to them since there is no central location where transactions take place in a single organization with strict compliance to a governmental body.
Here are some facts:
1. Forex is a single biggest market in the world, trading over $1.9 trillion day. This volume overshadows the daily volume of all US exchanges. Liquidity is the number one reason why speculators prefer to trade this market.
2. The market opens 24 hours with liquidity at almost all hours, especially in the biggest currencies. Getting out of a position, no matter how large, is normally not a problem.
3. The market is de-centralized, only market participants create and control these transactions. This makes a collection of data about the transaction difficult or incomplete.
4. Since it's a 24-hour market, there is more than one session in a single day. The London, New York and Tokyo session make up the three most liquid and important sessions.
5. Forex is unique in that it takes two currencies to create a market. The pip (tick in futures or cent in stocks) is the minimum movement and calculated normally to 4 decimal places, while others are 2 decimal places, depending on which pair discussed.
6. The leverage set by forex brokers is higher than other markets, going from 50 up to 200 times the cash provided by the clients. With this high leverage, little starting capital is required. At the same time, it takes just as little to get margin call.
7. Gaps rarely occur. If they do it's usually the beginning of the weekend break where the closing on late Friday and opening on late Sunday due to some political or economic events that take place while the market was closed.
8. There are correlations between pairs. Similar to stocks in the same sector or similar futures, combining a few pairs to create a strategy can be done.
9. Although technical analysis plays a major role, currencies are more in tuned with fundamental analysis than in stocks where earnings play a major influence. In forex, currencies are especially sensitive to macro-economic policies. These policies involve two countries that make up the pair.
10. Forex brokerage firms are not as well regulated as the futures, options and stocks brokers where there are no exams or certifications required to be brokers. Brokers mainly charge no commissions but make their revenues by taking the spreads.
11. Spreads differ from pair to pair. Despite being a liquid market, the spread can be a hindrance to trade profitably. These spreads are created by the brokers and not to due lack of liquidity. Even most liquid pairs have wide spread, according to each broker and account type. Institutional accounts have lower spreads in general.
12. No volume is revealed - due to the decentralized market, there is no centralized collection of total volume in real-time or even on daily basis.
13. No market depth - same as volume, market depth is only seen by each bank's own order flow from their own clients. Other than that, they cannot see the market's overall order flow.
Approaches to forex trading require:
1. Continuous 24 hour trading alertness. Depending of each strategy and style, but in general markets can move at any time. For US traders, many times market move during sleeping hours. Holding periods are longer than normal due to the nature of the markets.
2. Fundamental and economic analysis and knowledge is not entirely required but play a bigger role than stocks. They tie very closely in with economic reports, such as interest rate, non-farm payroll, inflation, gross domestic product, international trade, among others. Report release time directly affect the markets. A macro-economic view can be useful in evaluating the general market condition and direction. Technical analysis can help time the entries and exits.
3. A different style of trading. Forex market trends more than equities or futures. Swing trade holding periods are longer. Scalping can be done but mainly during news release periods.
4. Difference set of chart reading and technical analysis. Since there is no market depth and volume, using other types of charts and indicators are required. Some use tick charts to substitute the lack of volume. Volume-based indicators are useless while price-based indicators such as MACD and Stochastics do serve their purpose.
5. Important consideration for spreads (slippage). This will have the biggest impact on profitability. However, many new traders tend to ignore this and instead consider them an advantage since commissions are waived. But spreads can turn a profitable trading system into a losing one in the long run if they are not seriously considered. Backtesting results have proven spreads are a crutch to sustained success in forex.
6. Understanding of how pairs correlate and affect each other. There are many traders who specifically focus on a single pair while others trade a few pairs as well as hedge each other. But watching a few other pairs help keep a bigger picture of a specific currency.
Forex trading requires a different set of preparation and tools than from other markets. Take time to learn the nuances, pros and cons as well as personalities of each pair. In addition, learn what news affect prices, when reports are released (in two countries!) as well as other routines of the market movements.
For more facts on investing and trading stocks, futures, and forex, visit Newbie Trader's Lounge.
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