FOREX TRADING: JOURNEY FROM INSTITUTIONAL TO HOME BASED BUSINESS
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In the world of forex trading stakes are high and so are the returns

By KAMAL YOUSUF,
General Manager, KalPoint.com
GM@KalPoint.com

Aug 16 - 22, 2004
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The stock market has traditionally received the lion's share of attention in the trading industry, but foreign currency (Forex) trading has surged in recent years. Inter-bank forex market, also called Over the Counter Forex OTC market and Spot market, is world's largest market, its daily turnover is over 1.5 trillion US dollars daily, even greater than all other trading markets put together.

Forex or FX stands for Foreign Exchange, 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 $1,200 billion per day.

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 possible for individual investors to trade via intermediaries.

Forex trading offer endless short-term and long-term cashing opportunities simultaneously it exposes traders to higher levels of risks and therefore it should not be undertaken without proper training and knowledge.

Forex trading 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 and experience.

The growth in this area of the trading industry has been very rapid, especially as equity and futures traders realize the approaches they've been using for years in their respective markets, particularly price-based techniques based on technical and quantitative analysis are equally applicable to Forex.

From a price-action perspective, currencies rarely spend much time in tight trading ranges and tend to develop strong trends. More than 80 percent of currency trading volume is speculative in nature and, as a result, the market frequently overshoots and then corrects.

WHO REGULATE THE MARKET?

Forex Market is not regulated by any authority, Central banks such as the Federal Reserve Bank of the US, provide to some degree oversight. But in general, the currency markets are much more lightly regulated than stock or bond trading.

MEDIUM:

Typically Internet is used as the medium of trading, investors have to open their account with an intermediary called Broker (Market Maker) and send their funds via wire transfer or demand draft to their Brokers to open a live trading account. They can start trading as soon as the amount is credited into their accounts.

 

 

MARKET MAKER/BROKER:

A Broker is a firm which provides the infrastructure to individual investors to trade in inter-bank forex market. These are typically very large companies with huge trading turn over by their clients. They charge no commission and their interest is limited to the spread. Spread is the difference between the buying and selling price of a currency pair. Suppose the spread on a currency pair in the inter-bank market is 2 pips (a pip is the smallest unit of a lot, if the rate buying rate of a pair is 1.8243, the last digit "3" is a pip) the Broker may charge 3 or 5 pips on each roundabout trade and it has to be given to the Broker regardless of the outcome of a trade.

ADVANTAGES OF FOREX TRADING:

HIGH LIQUIDITY: Since FX traders directly deal in real money, they do not have to wait for long time to cash their investments.

HIGHLY LEVERAGED: Here in the FX market you have the leverage of 1:100 and some brokers even offer 1:200, that is, in order to buy and benefit from a lot of US$ 10,000 you only have to commit your US$ 100, rest of the amount is leveraged by the Market Maker/Broker.

SERVICE TO THE NATION: Earning US dollars by trading in forex market and bringing the same back home is a service to the nation, it would help build stronger foreign exchange reserves which strengthens the economy.

24 HOURS MARKET: FX market is a truly 24 hours and 5 days a week market with highest volume trading occurs at London time and New York.

PROFITING EITHER WAY: In FX market you can profit in both directions, when a currency pair is increasing in value and also when it is going the other way round.

TOTAL CONTROL: You have the total control, at the time of taking a position, you can precisely define how much you want to profit from the trade and how much you are willing to loose, if the market goes against you. Doing so relieves you from the burden of watching the computer screen during that trade.

ZERO COMMISSION: The intermediary, called Market Maker/Broker typically charges no commission.

DISADVANTAGES OF TRADING FOREX:

HIGH VOLATILITY: It is a highly volatile market, which on one hand offer the opportunities to capitalize and on the other hand it has the potential of great losses.

HIGH LEVERAGE: Leverage is a 2 way weapon, on one hand it lets traders to profit on a lot size of 100 times larger than their investments. On the other hand it exposes them to the losses of equal magnitude.

HOW DO TRADERS TRADE FOREX?

Forex trading requires analysis of market conditions and forecasting the future on the basis of historical data (in case of technical trading) and different macro economic indicators (in case of fundamental trading). There are two schools of thought in the area of Market Analysis for decision making, these are:

FUNDAMENTAL ANALYSIS:

Fundamental analysis focuses on the macro-economic, social and geo-political forces that drive supply and demand. Fundamental analysts look at various macroeconomic indicators such as economic growth rates, interest rates, inflation, and unemployment, etc. Changes in all such macro-economic indicators of countries whose currencies are being traded have impact on the forex market. Important macro-economic figures of are released on weekly, monthly, and quarterly basis and there lie the opportunities to cash on. As soon as the figures are released traders take positions in the direction of the prevailing trend and ride the trend, till it bends. Since, most of the time, on such occasions market first over-shoots and then corrects, traders can capitalize on both way movements.

 

 

TECHNICAL ANALYSIS:

Technical analysis focuses on the study of future price movements on the basis of historical data. Historical currency data is used to forecast the direction of future prices. The premise of technical analysis is that all current market information is already reflected in the price of that currency; therefore, studying price action is all that is required to make informed trading decisions. The primary tools of the technical analyst are charts. Charts are used to identify trends and patterns in order to find profit opportunities. The most basic concept of technical analysis is that markets have a tendency to trend. Being able to identify trends in their earliest stage of development is the key to successful technical trading. FX market moves in any of the three directions, that are, upward, downward or sideways. When the market of a specific currency pair is upward or downward it is called to be in a trending market and money can be made both ways. However, if it is sideways, it is called a range-bound market. There is a large variety to technical indicators which are used on charts to pin point the entry and exit points as well as strength of the trend. Charting software connect to their server to update charts in the real time. Most widely used technical indicators are Moving Averages, Bollinger Bands, Parabolic SAR, ADX, RSI, Fibonacci Retracement, MACD and Stochastic.

TECHNICAL ANALYSIS OR FUNDAMENTAL ANALYSIS?

Most traders abide by technical analysis because it does not require hours of study and reading news and macro-economic indicators on daily basis. Technical analysts can follow many currencies at one time. Fundamental analysts, however, tend to specialize due to the overwhelming amount of data in the market. Technical analysis works well because the currency market tends to develop strong trends. Once technical analysis is mastered, it can be applied with equal ease to any time frame or currency traded.

In my opinion, a good trader is one who masters both, a technical trader who trades only with the help of charts is not aware of the intricacies of the underlying macro-economic factors which are the foundation of movements in the market and therefore may a position which will turn disastrous after the release of a key macro-economic indicator.

RISK MANAGEMENT:

Forex trading, on one hand, offers spectacular opportunities to capitalize on, on the other hand it is quite risky for those who do not fully understand and employ:

Market Fundamentals
Technical Analysis
Fundamental Analysis
Money Management
Discipline and
Emotional Control

These topics will be discussed in upcoming articles of the series. It is therefore advised not to trade without sound knowledge and experience of the above mentioned pre-requisites and practice a lot on a demo account, employing the strategies pertaining to these requisites, till the time you are able to make consistent monthly profits.

SELECTING A BROKERS OR MARKET MAKERS:

In order to trade forex, one has to open an account with a Broker/market maker, as told earlier a broker provides the infrastructure to trade. Although brokerage firms are spread across the globe one may select a broker/market maker on the basis of the size of its spread (difference b/w buy/sell price), quality of trade execution, including anti-slippage guarantee, efficiency to handle trades during highly volatile periods, wire transfer cost to bring profits back home and minimum account size requirements.

ACCOUNT TYPES:

Most of the forex brokers offer two types of accounts, mini and regular. Mini account can be opened from as low as US$300 and regular account can be opened from US$2000.

The size of the account is less important, more important is the minimum lot size, in mini account typically a lot size can not be lower than US$ 10,000 and US$ 100,000 per lot for a regular account.

Taking the advantage of 1:100 leverage, a mini trader can open a position by committing only US$ 100 to open a position worth US$10,000 (10K) and a regular with regular account holder can open a position worth US$100,000 (100K) by committing only US$1,000 from his account.

 

 

CURRENCY PAIRS:

Currencies are traded in pairs; most heavily traded pairs are EUR/USD, GBP/USD, USD/CHF and USD/JPY. Each pair represents 2 currencies a base currency and a quoted currency, the first currency in a pair is called base currency and the second one is called quote currency. Example, EUR/USD means number of United States Dollars that can be purchased in 1 EURO, the pair will increase in its value if EURO tends to strengthen or US Dollar starts to weaken.

CONCLUSION:

Foreign Exchange trading in the International Forex Market is a fairly new field for individual investors, even in United States not many people know about it. It offers great opportunities and risks. If you are interested to play in this arena, you should, like any other business, do some homework and acquire reasonable amount of knowledge and experience.

The good thing about forex trading is that, you can evaluate your strategies and skill, by trading on a mini or regular demo account, without you need not invest a penny. Most of the brokers allow downloading their real trading platform software with a free demo account. No matter how long it takes, but before switching to real account you must be able to make consistent profits on the demo account.

Whether you are a technical trader or a fundamental one or both, you must never undermine the importance indispensable pre-requisites of any successful forex trading strategy; these pre-requisites are money management, discipline and emotional control.