The forex market has gathered enormous appeal over the past decade, causing traders in other mediums to wonder if they could easily expand their opportunity horizons beyond stocks to include global currencies in their trading universe.
As the first part of this series delineated, there are many similarities between stock and currency trading; but the differences are subtle enough to require a brief learning period to adapt your previous trading skills to a new environment.
Here are a few differences to take note of:
No Single Exchange: The forex market is classified as a decentralized over-the-counter market because there are no exchange floors where market makers shout out bids and take orders or where centralized electronic systems do the same thing as with the NASDAQ stock exchange. The market makers here are the banks themselves. Over 50% of the forex market is known as the Interbank market where large movements of capital, averaging over $5 million per transaction, are moved about daily to facilitate international trade and commerce. All information is proprietary. Forex brokers contract with these participants to gain access to the market to serve their clients.
No Daily Fixed Trading Period: There is no opening or closing bell in the forex market. It literally opens in New Zealand on Sunday afternoon, our time, and then follows the Sun across the globe. The market consists of many single exchanges that informally participate, but there are no volume figures or specific bids recorded as an official rate. After New Zealand, Sydney and then Tokyo join in, with London, the largest market participant, and New York joining later. Actual exchanges then overlap, setting up trading opportunities when one exchange closes while another one is open. London typically closes at noon, New York time. Short squeezes happen with more regularity when there is uncertainty as to the next moves in the market;
No Intrinsic Value: Shares of stock have "intrinsic" value, whereas currencies always come in pairs and have "relative" value. If a company goes bust, the value of its shares may plummet to zero, but this scenario cannot happen in the forex world, at least not with major currency pairs. Yes, currencies can be devaluated, but these scenarios usually transpire with currencies that are not traded in the first place. Their exchange rates are "fixed" by government decree. For the "majors"; i.e., the seven major currencies paired with the U.S. Dollar, their movement patterns are always wave-like in structure, ebbing and flowing over time. "Minor" currencies move similarly, but "Bid/Ask" spreads are wider and liquidity less, mush as with small-cap stocks;
Leverage: Forex brokers will allow you to "leverage" your invested dollars. For major currency pairs in the U.S., the statutory rate is "50:1". In the stock world, you may borrow on the margin up to 50% on certain shares of stock and pay interest on the advances. Leverage, however, is allowed without a charge. A $1,000 investment can then control a $50,000 lot position. If the market moves 2% in your favor, you have doubled your initial investment. Leverage can also magnify losses, so caution is always advised, no matter what the level.
While stock and currency trading have much in common, there are still a few twists and curves that must be addressed before success in this new medium can be a possibility. At the end of the day, knowledge and experience are important, but the lack of emotional control can bring you down in both genres. A disciplined approach that is almost habitual by nature will block emotional interference.
Before venturing into Forex trading, the investor would be well advised to find a teacher or mentor. This mentor is expected to firstly explain the theory behind Forex trading; then guide the investor through sample trades using pen and paper; and finally guide the investor through Forex trading in real time using real money. Further, the investor would be able to draw upon the mentor's experiences and avoid the common errors he may have otherwise committed.
Forex trading in itself is safe if the investors were to be realistic in their expectations and have done their initial preparation. The investors would realize that it is hard work and can provide a profession or a source of income to them. However, the investors must be on their guard against scamsters like in any other business.