Introduction to Foreign Exchange

1. What is Forex?

Forex is an acronym for foreign exchange and it is a process of a nation's currency exchanged for another in order to gain profit as well as to do business internationally. When a currency is traded, the transaction is carried out on the Foreign Exchange market (also referred to as the Forex or FX market).

Forex involves exchanging one currency for another currency in anticipation of a price change in the trader's favour. There are quite a number of currencies involved in Forex and these include USD (The US Dollar), YEN (The Japanese Yen), EUR (The European Euro), GBP (The British Pound) and CHF (The Swiss Franc).

In order to perform a transaction successfully on the foreign exchange market, a currency pair is an absolute essential. Unlike other monetary exchanges and financial transactions such as the stock exchange market, forex does not really need a physical location to operate but rather, it operates through a global network of banks corporations and individuals trading, all involved in the buying and selling of national currencies.

Traditionally, the Forex market was only accessible to organizations such as banks and other large financial institutions. However, the rapidly progressing world with which advanced with equal pace over the years, the Forex market is now available to money managers as well as individual Forex traders.

2. Who can get involved and benefit from forex?

In one simple word...anyone! Yes, anyone with some initial capital (as low as $200 with CMS Forex), and a computer with an internet connection can become a participant in this global and liquid financial market.

3. Advantages

Forex is the largest financial market in the world with an average traded value that exceeds $1.9 trillion per day and includes all of the currencies in the world. The foreign exchange market also has growing liquidity. Liquidity simply means the degree to which an asset or security can be bought or sold in the market without affecting the asset's price. Liquidity is characterized by a high level of trading activity.

In the foreign exchange market, there are buyers and sellers at any time, in any location thus making the Forex market the most liquid market in the world. Foreign exchange is done all day long, corresponding to the opening and closing of financial centers, because the forex market is open 24 hours a day, 5 days a week and currencies are traded worldwide.

Among the major financial centers across the world are London, New York, Tokyo, Zürich, Frankfurt, Hong Kong, Singapore, Paris and Sydney. The most appealing factor about the around the clock trading is the fact that no matter what time of the day or night it is, the forex market is always moving, traders do not have to wait for the equities market to open in the morning and people with full time jobs have the convenience of trading after their work hours.

In the forex market, traders can profit in both bull and bear markets. Bull markets are characterized by optimism, investor confidence and expectations that strong results will continue. It's difficult to predict consistently when the trends in the market will change. Part of the difficulty is that psychological effects and speculation may sometimes play a large role in the markets.

On the other hand, a bear market is a market condition in which the prices of securities are falling, and widespread pessimism causes the negative sentiment to be self-sustaining. As investors anticipate losses in a bear market and selling continues, pessimism only grows.

Profits have the potential to be made in both these upward-trending and downward trending markets. The forex market also has customizable leverage and it has 50 times more leverage than trading stocks. Leverage is one of the most appealing and risky factors of the forex market. Leverage helps both the investor and the firm to invest or operate.

The foreign exchange market is an excellent platform for trading because it has minimum slippage and errors. This simply means that most traders are able to stop-loss and limit orders on up to a certain number of standard lots as well as provide instantaneous trade executions from real-time quotes.

The forex is the perfect market for technical analysis because since the forex is a 24-hour market, there tends to be a large amount of data that can be used to gauge future price activity, thereby increasing the statistical significance of the forecast. This makes it the perfect market for traders that use technical tools, such as trends, charts and indicators.

The forex market also has lower transaction costs and there will be no middleman involved in it because currency trading bypasses expensive middlemen that are always associated with trading stocks. With forex, clients are able to interact directly with the currency market, and can buy and sell at the simple click of a mouse.

3. Disadvantages

There are limited options in forex for traders, unless they keep up with expiring contracts, they are subject to physical delivery. Apart from that, commissions and brokerage fees can be high in the foreign exchange market.

4. Types of traders

There are two types of traders in the foreign exchange market including consumer traders who desire a long term ownership and is not too anxious about the daily price movements as well as speculative traders who are totally concerned with

the daily price movements and they keep a close watch on it.

5. Important terms involved in Forex

Spread

Spread is the difference between the buy price and the sell price of a specific currency. The spread for an asset is influenced by a number of factors including supply or "float" (the total number of shares outstanding that are available to trade), demand or interest in a stock as well as total trading activity of the stock.

Pipe

Pipe is the acronym for percentage in point, a pip is the smallest price unit for a currency. It is the smallest price change that a given exchange rate can make. Since most major currency pairs are priced to 4 decimal places, the smallest change is that of the last decimal point - for most pairs this is the equivalent of 1/100 of 1 percent, or 1 basis point.

Leverage

Leverage is the process of borrowing a broker's money to trade. It is also the use of various financial instruments or borrowed capita, such as margin, to increase the potential return of an investment.

Lots

Lots is the buying or selling currency in units is referred to as lots. In the financial markets, a lot represents the standardized quantity of a financial instrument as set out by an exchange or similar regulatory body. For exchange-traded securities, a lot may represent the minimum quantity of that security that may be traded. Two types of lots involved are the regular lot which is worth $100,000 and the mini lot which is worth $10,000.

Bulls

Bulls is a financial market of a group of securities in which prices are rising or are expected to rise. The term "bull market" is often most often used to refer to the stock market, but can be applied to anything that is traded, such as bonds, currencies and commodities.

Bears

Bears are investors who believes that a particular security or market is headed downward. Bears attempt to profit from a decline in prices. Bears are generally pessimistic about the state of a given market.

Market Order

Market order is an order placed to enter or exit the market at the current market price. It is an order to buy or sell a stock immediately at the best available current price. A market order is sometimes referred to as an "unrestricted order". A market order guarantees execution, and it often has low commissions due to the minimal work brokers need to do.

Limit Order

Limit orders are orders placed with a brokerage to buy or sell a set number of shares at a specified price or better. Limit orders also allow an investor to limit the length of time an order can be outstanding before being cancelled. Depending on the direction of the position, limit orders are sometimes referred to more specifically as a buy limit order, or a sell limit order.

Stop Order

Stop orders is an order to buy or sell a security when its price surpasses a particular point thus ensuring a greater probability of achieving a predetermined entry or exit price, limiting the investor's loss or locking in his or her profit. Once the price surpasses the predefined entry/exit point, the stop order becomes a market order. Also referred to as a "stop" and/or "stop-loss order".

Slippage

Slippage is the difference between the expected price of a trade, and the price the trade actually executes at. Slippage often occurs during periods of higher volatility, when market orders are used, and also when large orders are executed when there may not be enough interest at the desired price level to maintain the expected price of trade. Slippage is a term often used in both forex and stock trading, and although the definition is the same for both, slippage occurs in different situations for each of these types of trading.