Forex is short for foreign exchange, and the actual asset for trading referred here is currencies. Foreign exchange is the act of changing one country’s currency into another country’s currency for a range of reasons, typically for tourism or commerce.
Before the internet, currency trading activities was limited to interbank truncation on behalf of their clients. Over the time, banks arrange proprietary desks to trade for their own accounts. Then this was followed by large hedge funds, multinational corporations, and high net-worth individuals.
A retail market aimed at individual traders has sprung up that provides easy access to the foreign exchange markets with the rise of internet, either through the banks themselves or brokers making a secondary market.
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Trading Forex: Pros and Cons
The forex markets making it easy to enter and exit a position in any of the major currency within a short amount of time, because the market itself is traded within large quantity and therefore provide the most liquidity. As result of the liquidity and ease, the trader can exit or enter a trade, banks and/or brokers provide large leverage. It means that the traders have the ability to control large positions with the small money of their own. This is of course imposed risk and deep understanding or wisdom in this regards of a trader is required. In addition to that, forex market is literally available 24 hours with major centers are in the biggest cities in the world such as Sydney, Hong Kong, Singapore, Tokyo, Frankfurt, Paris, London and New York.
It can be said that trading currency is a macroeconomic venture. What currency traders need to have a holistic understanding of the economy globally and interconnectedness of these countries in order t understand the basic and fundamentals that determine currency values.
Trading Forex: The Approaches
For most investors or traders with stock market experience, there has to be a shift in attitude to transition into or to add currencies as a further opportunity for diversification. Firstly, currency trading has been introduced and promoted as an active trader opportunity. This suits the brokers because it means they earn more spread when the trader is more active.
Secondly, currency trading is also promoted as leveraged trading, and therefore, it is easier for a trader to open an account with a small amount of money than is necessary for stock market trading.
Currency trading can be used to hedge a stock portfolio besides trading for a profit. If, for instance, one builds a stock portfolio in a country where there is potential for the stock to increase value but there is downside risk in terms of the currency, for example in the U.S. in recent history, then a trader could own the stock portfolio and sell short the dollar against the Euro or Swiss franc. By doing this, the portfolio value will increase, and the harmful effect of the declining dollar will be offset. Thus it is quite common opening a forex account and day trading or swing trading is most common considering the situation above.
The second approach to trading currencies is to understand the fundamentals and the longer-term benefits when a currency is trending in a specific direction and is offering a positive interest differential that provides a return on the investment plus an appreciation in currency value. This type of trade is known as a carry trade. For instance, a trader can purchase the Australian dollar against the Japanese yen. Let’s say, the Japanese interest rate is .05% and the Australian interest rate last reported is 4.75%, thus a trader can earn 4% on this trade.
An important note is that positive interest needs to be seen in the context of the actual exchange rate of the AUD/JPY before an interest decision can be made. If the Australian dollar is strengthening against the yen, then it is appropriate to buy the AUD/JPY and to hold it in order to gain in both the currency appreciation and the interest yield.
In conclusion for most traders with limited funds, day trading or swing trading for a few days at a time can be a good way to play the forex markets. For those with longer-term horizons and larger fund pools, a carry trade can be an appropriate alternative. In both cases, traders must equip themselves to use charts for timing their trades. The reason is that good timing is the essence of profitable trading. And in both cases, as in all other trading activities, the trader must recognize their own personality traits so it can avoid bad impulsive behavior pattern that violates the trading.
