There are differences between the equity and forex markets. In the equity marketplace, investors typically only do their trades with other individuals, or institutions, like mutual funds. In the forex marketplace, additional players are on the field, and they have agendas unlike those found in the equity marketplace. So, it’s critical to learn and comprehend the roles and agendas of the primary players within the forex marketplace.
While foreign currency trading has the potential to make a lot of money, it also has some inherent risks like other asset classes. This section will take you through various benefits of forex trading as well as various risks associated with it. In addition, we are also going to discuss various differences between equity and forex market to help you understand the inner workings of forex market.
Pros and Cons of Forex Trading
In the previous sections, we have already covered various factors including volatility, global structure as well as size of the forex market that have all contributed to its popularity. The highly liquid nature of foreign exchange market allows investors to trade extremely large amounts without affecting the underlying exchange rate. Most of the brokers in this industry allow traders to trade at a low margin and this is the reason that traders can take big positions in this market.
Inside the market of equities, fundamental analysis intends on measuring the true value of a company, in order to base their investment on calculations of this sort. To a certain extent, the same activity is performed in the market of retail Forex were fundamental traders evaluate different currencies and countries, along with companies and economic announcements, in order to have an idea of what’s the true value of the currency.
All of the economic data, political events and news reports which come out regarding a particular country are analyzed in a similar fashion to news which come out about a certain stock – they are used by investors as a way to determine value. Naturally, that value changes according to a wide array of factors such as financial strength and economic growth. Fundamental traders often look at all this type of information in order to evaluate the currency in a certain country.
The foreign exchange market (FX or Forex for short) is among the most fast-paced and exiting markets in the world. Forex trading within the currency market, until recently, had been reserved for very wealthy individuals, hedge funds, central banks, corporations and large financial institutions. This has all changed with the emergence of the Internet and technology. Average investors now have the opportunity to easily buy and sell currencies through just the click of one mouse via online brokerage accounts.
Usually daily currency fluctuations are very small. A majority of currency pairs move less than a percentage point per day. This represents less than a 1% change in a currency’s value. That makes foreign exchange among the least volatile of all financial markets. Therefore, a majority of currency speculators rely on the high amount of leverage that is available for increasing potential movement value. Leverage can be as high as 250:1 within the retail Forex market. High leverage can be very risky. However, due to deep liquidity and round-the-clock trading, foreign exchange brokers have successfully made high leverage a standard within the industry so that currency traders can have meaningful movements.
Extreme liquidity and high leverage being widely available have helped with spurring the rapid growth of the market and transformed it into an ideal place for numerous traders to invest. Positions can be held for many months, opened and closed in just a couple of minutes, or somewhere in between. Supply and demand considerations form the basis of currency prices. They cannot be easily manipulated due to the fact that the market is so large that not even the biggest players, like central banks, are able to move currency prices at will.
There is lots of opportunity provided by the Forex market for investments. However, a currency trader must have a good understanding of the basics that are behind movements in currency in order to succeed.
Beginners in the currency trading market often get confused when it comes to the currency quotes. In this session, we’ll take you through currency quotations and how these quotations work in the currency trading market.
How to Read a Quote?
As you are aware, the quote for a currency is always done with respect to another currency. In simple terms, a currency quote reflects the value of a particular currency with respect to another currency. So, when you are trying to figure out the exchange rate between US dollar and Japanese yen, the quote would look something like this:
USD/JPY = 116.50
This is called a currency pair. The currency on the left side is called the base currency whereas the currency on the right side of the quote is known as counter currency or quote currency. In this case, the base currency is USD and the quoted currency is Japanese yen.
This quote shows the amount of Japanese yen you will get in exchange for one unit of base currency (USD). In simple terms, it means US$1 = 116.50 JPY. If you want to exchange USD for Japanese yen, you will get 116.5 Japanese yen for one US dollar. The forex quote given above uses the currency abbreviations for these particular currencies.
Difference between Direct and Indirect Quote
Currencies are quoted directly as well as indirectly. In fact, this is the biggest source of confusion for beginners in the foreign currency trading market. Here is a brief guide on the difference between direct and indirect currency quote.
In simple terms, a direct currency quote is defined as a currency pair where the quoted currency or counter currency is the domestic currency. On the other hand, the base currency is the domestic currency in case of an indirect quote. So, if you want an indirect quote for Canadian dollar versus US dollar, it will be quoted as CAD/USD whereas the direct currency quote for this currency pair would be USD/CAD.
Another way to remember this concept is to keep in mind that in case of direct quote, the domestic currency varies with regards to the foreign currency or base currency, and the base is fixed at one unit. The opposite happens in case of indirect quote where the domestic currency remains fixed at one unit whereas the foreign currency varies with respect to the domestic currency.