The foreign exchange market (forex, FX, or currency market) is a worldwide decentralized over-the-counter financial market for the trading of currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends.
The purpose of the foreign exchange market is to assist international trade and investment. The foreign exchange market allows businesses to convert one currency to another. For example, it permits a U.S. business to import European goods and pay Euros, even though the business’s income is in U.S. dollars. Some experts, however, believe that the unchecked speculative movement of currencies by large financial institutions such as hedge funds impedes the markets from correcting global current account imbalances. This carry trade may also lead to loss of competitiveness in some countries.
In a typical foreign exchange transaction a party purchases a quantity of one currency by paying a quantity of another currency. The modern foreign exchange market started forming during the 1970s when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.
The foreign exchange market is unique because of:
- trading volume resulting in market liquidity
- geographical dispersion
- continuous operation: 24 hours a day except weekends, i.e. trading from 20:15 UTC on Sunday until 22:00 UTC Friday
- the variety of factors that affect exchange rates
- the low margins of relative profit compared with other markets of fixed income
- the use of leverage to enhance profit margins with respect to account size
Basics of Margin Trading
The main point of work on Forex market is settlement of sale-purchase operations of foreign exchange contracts with the aim to get a profit due to change of currency exchange rates in time. Foreign exchange contract trading on Forex market is based on principles of margin trading and are carried put through Market-Makers, which sell and purchase (quote) foreign currencies for prices, reflecting market state for the current moment. Here is the essence of margin trading: market participant (trader, investor) by lodging his margin money resources to a broker’s deposit is permitted to manage broker’s directed credit (leverage), which is granted on this collateral and is 10-200 times more than the amount committed. However, conditions of work with a broker don’t allow suffering losses, which would exceed the committed sum.
During margin trading each operation necessarily has two stages: purchase (sale) of foreign currency at one price, and then necessary sale (purchase) of it at the other price (or at the same price). First action is called opening of a position, and the second closing of a position. During position opening there is no real delivery of foreign currency, and a participant, who opened a position, contributes insurance deposit, which becomes a guarantee of compensation of possible losses. After closing of a position the insurance deposit is returned, and a settlement of profit or losses is made, which are usually equivalent to the amount of insurance deposit. Besides the deposit is often one hundred times less than the sum, which is given to the participant to use for this trading operation.
In activities of any companies, either investment funds, or agricultural producers, there are always financial risks. They can be connected with anything: sale of produced production, risk of devaluation of a capital, which is invested in some assets, purchase of assets. It means that during their activity companies, other juridical, and sometimes physical, persons face a possibility to have losses as a result of their operations, or the profit is not the one they expected to get due to unforeseen change of prices for the asset, with which the operations is carried out. Risk intend both possibility of loss, or possibility of profit, but people in most cases are not willing to risk, and they agree to refuse the large profit in order to reduce risk of losses. So, derivative financial tools were created for that: forwards, futures, options, and operations for reduction of risk with the help of these derivatives were called hedging.
Fundamental and Technical Analysis
There are two main methods of market situation analysis: fundamental and technical. The first evaluates situation from the political, economic point of view and a point of view of financial-credit politics. The second is based on methods of graphic research and analysis, which are based on mathematical principles.
Within limits of fundamental analysis various messages about exchange-financial events in the world, occurrences of political and economic life in both separate countries and the whole world community, which can influence development of the exchange market; also the analysis is performed in order to find out, what change of foreign currency rates they can cause. Here the information about work of Stock Exchanges and large companies of market-makers type, refinancing rates of central banks, government economic course, possible changes in political life of a country, and also all possible gossips and expectations.
Technical analysis means forecasting of price changes in future on the ground of analysis of price change in the past. It is based on analysis of time-series of prices and their diagrams – charts. Besides price-series technical analysis uses information about trading volume and other statistical information. Methods of technical analysis are often used to analyze prices that change freely, e.g. on foreign exchange markets. A lot of various tools are developed in technical analysis but the all based on one common assumption – by way of analysis of time-series of prices and trading volume it is possible to accentuate repeated patterns and trends in order to determinate the general state of the market.
One of the main aspects of trader’s work is his psychological stability. All trading manuals pay a lot of attention to this issue.
Trading is both an attraction and generation of profit but only in case if you do everything right and gradually. Trading is a business, a great business, but is nothing more than business. Trading must be regarded namely as business.
You don’t have to be a genius or to have special numerical abilities in trading. Trading is not a science, art or religion. It is only a discipline, conscious orientation to do the same thing again and again. There is no other business in the world, which would be similar to trading. At the present time this business gives everyone the best possibilities over its history of existence.
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