FX trading or foreign exchange trading is the buying and selling of currencies between two or more parties. Many people do not know how foreign exchange impacts them on their day to day lives. Without FX, international business is not possible.
For example, an individual or company from the United States wants to import wine from France. For that transaction to work, the party from the United States will have to change their dollars to Euros in order to make that transaction successful.
This means that every international transaction involves either buying or selling of the currencies in order to satisfy the given mode of payment. This aspect makes the FX market the biggest financial market and the most liquid market on earth.
This can be confirmed by comparing the amount of money transacted on a daily basis, the FX market has transactions of over U.S $6 Trillion per day. This amount changes everyday depending on the number of transactions made, although this figure acts as an average.
Even the stock market does not have this amount of transactions on any given day; their average is U.S $2 Trillion per day. So this makes the FX market the most liquid market on earth.
What is FX Trading?
The FX market as massive as it is does not have a centralized exchange. The transactions are made over the counter (OTC) facilitated by a network of computers between traders from all around the world.
This makes this market efficient, it is a 24 hour market open for five and a half days a week, this means traders from everywhere around the world can access the markets and trade it.
The FX market is generally most active during the major stock market sessions and because of this most traders who trade the FX, align their trades with this periods.
For example one might trade during the London session and since it overlaps with the New York session, he or she can continue trading as opportunities arise.
Types of FX Trading
The FX market is broken into various types, they are; the FX spot market, the forward market and the futures market. FX can be traded by either of the fore mentioned. They are all going to be discussed in detail below.
The Spot market involves buying and selling of currencies at the current exchange rates. The spot market is the most traded type in the FX market; all the other types are based on it.
This type of trading can be traded long term and short term alike. This being the most traded makes it the favorite among traders since they can speculate by trading extremely short term that is scalping the market for short term opportunities.
The spot market is characterized by various things, the interest rates of a particular currency, the supply and demand of a particular currency, the economic performance, the political sentiment and lastly the future performance of currency staged against another.
When two parties get to an understanding then one party offers the other party a specified amount of money at a given rate of exchange. When this is finalized it is considered a spot deal, this transaction is settled in cash.
The futures market as it is called is dependent on a settlement agreed upon at a future date. The futures market is done in contracts. The futures contracts are exchanged at particular public location that handles commodity sales, for example the London Commodities Exchange.
The futures have specific details, the number of contracts traded, the delivery date and the settlements date, the minimum price adjustments that cannot be changed. The exchange helps the trader clear and settles the transaction.
The forward market involves two parties, they transact OTC, and they also decide on the transaction terms. They also transact in contractual basis, meaning they buy and sell currency based on varying contract sizes.
The Benefits of FX Trading
This market being so liquid has attracted a large group of individuals who want to have a go at it. Because of this, there are some benefits to trading the FX market. They’re:
- Since the FX market is highly liquid, one can put on massive positions without affecting the exchange rates.
- One can be able to manage massive amounts of money with quite a small sum made as the margin. This is made possible by the leverage; this means the broker can front you up to 500 times your initial deposit. This makes the FX market very lucrative.
- The FX market is a 24 hour market and this makes it appealing to everyone who has a day job and wishes to invest in the FX markets can trade at any time. The best times to trade is during the various major stock market sessions, during this times the FX market is very active, and aligning your trading with the various major stock market session will offer better opportunities.
- An investor can make money both ways trading the FX market. That means, you can buy and make money and sell and make money doing it, and since the currency pairs are denoted in pairs, for example, EUR/USD, this means that when one is selling the Euro, he or she is in turn buying the Dollar. This makes it very captivating to the investor or trader.
There are some disadvantages trading the FX market too, they are:
- The high leverages offered are very risky to whoever uses it, and it is extremely damaging for those who do not understand how the market really works. The high leverage is destructive because the losses become so large based on the size of the leverage.
- The numbers of currency pairs tradable are few compared to the number of equities that are tradable. This limits the trader if they are looking to speculate over a large number of currency based assets.
Basically the FX market is broad and it is extremely lucrative.