Put simply, forex markets provide a decentralized system where currencies trade. Forex is an exchange between two currencies, known as pairs.
The most liquid and largest market in the world, the average daily volume exceeds $5 trillion. Unbelievably, this total is greater than the world’s stock markets combined.
Table of contents [Hide]
Who Trades Forex?
Several players in the forex market buy and sell currencies.
When businesses want to buy or sell products or services with companies in other countries, they rely on banks to help them complete the transaction.
For example, if a farmer wants to sell his soybeans to China, the farmer will sell in U.S. dollars and the buyer will pay in Chinese yuan. In the foreign exchange market:
- The bank will sell U.S. dollars and buy Chinese yuan if it doesn’t have yuan on hand.
- Another bank will sell the first bank’s Chinese yuan at the current exchange rate.
- The selling bank’s profits will be the difference between the bid and the ask.
Large banks will also trade for themselves as well as for clients’ portfolios.
Commodity buyers, sellers, and traders
When a producer sells barrels of oil, the producer may have clients in several countries. In order to complete the transactions, these sellers or buyers need to be able to trade in a common currency.
Depending on the terms of sale, the buyers, sellers, or even banks will go into the forex market to exchange currencies for the following reasons:
- To complete transactions with buyers or sellers in other countries.
- To hedge risk of production in another country.
- To pay expenses in other currencies such as labor or permitting.
Investment and hedge funds
Behind the banks, portfolio managers trade in the forex market. This collection of players trade for pension funds, high-net-worth clients (often for hedge funds). Managers who hold stocks exposed to international risks may use currencies to offset fluctuations in returns.
Based on their own analysis of the markets or governmental actions, individuals trade forex for many of the same reasons as large banks. Just like large funds, they trade currencies to offset the risk of international stock holdings.
Pros and Cons of Forex Trading
Trading foreign currencies present its own unique sets of benefits and drawbacks.
Pros of trading forex:
- Leverage: currency markets allow traders to control large amounts of money with very little capital. This allows traders to profit from small movements in currency pairs.
- Liquidity: Forex markets provide the highest liquidity of any market, virtually guaranteeing a counterparty for your trades.
- Continuous trading: The forex market operates 24 hours a day and is closed during the weekends from 5 p.m. EST on Friday until 5 p.m. EST on Sunday. Since it’s a global market, it also operates through most major U.S. holidays.
Cons of trading forex
- No volume shown: Unlike most markets, the forex market does not show volume traded. This limits some forms of analysis investors use such as order flow, point of control and other types of technical indications.
- Volatility from events: Just like when a company’s stock moves during earnings, currencies may move rapidly due to interest rate announcements or other geopolitical events
- Less regulatory protection: Unlike the stock market, forex markets operate over-the-counter and brokerages are subject to less regulation. This leads to more problems with forex brokerage firms that are otherwise found with equity firms.
- Less residual return options: Outside of some select strategies such as carried interest, forex trading doesn’t provide for continuous returns in the way that stock dividends and share buybacks increase shareholder returns.
How to Analyze the Forex Market for Beginners
Do a quick search in Google and you’ll see high-net-worth claim to show you how to profit from forex trading. If you browse through enough material you’ll notice that most investors fall into two camps:
Analysts who study the fundamentals of a foreign exchange market look at economic and geopolitical factors to evaluate price movements.
They look to central banks for interest rate guidance, governments for policy decisions and economic and trade data for economic output. Fundamental analysts focus on how these relationships interact with one another and their influence on currency supply and demand.
Technical analysts rely on using mathematical interpretations and chart depictions of a currency’s movement over time to predict where price will go. They believe past price movements forecast the future.
By looking at price action, these analysts study market behavior like game theory. Traders don’t need to stick with one type of analysis exclusively. Many traders often look to both fundamental and technical analysis to develop their own trading styles.
The stock market and forex market are fundamentally very different. If success eludes you when you trade stocks, you may do well-trading forex. Conversely, don’t assume you’ll be successful trading forex just because you successfully trade stocks.
Becoming a profitable forex trader requires study and practice. Even if you start out by copying someone else, the more time you spend with the forex market, you’ll discover your own trading style.
If you want to start trading forex, check out some of our picks for the 2018 Best Forex Brokers in the USA. Here are a few quick picks.
Benzinga's #1 Breakout Stock Every Month
Looking for stocks that are about to breakout for gains of 10%, 15%, even 20% potentially or more? The only problem is finding these stocks takes hours per day. Fortunately, Benzinga's Breakout Opportunity Newsletter that could potentially break out each and every month. You can today with this special offer: