Aggregate turnover of the world stock and futures markets. Such high liquidity makes the foreign exchange market favorable for trading.
The Forex market is over-the-counter, meaning it does not have a central exchange for currency trading. Market participants are banks, brokers, dealers, financial organizations and individual traders from all over the world. More than 90% of transactions are made for investment and speculative purposes, and only a small part is the real currencies` conversion.
Main Trading Sessions
Trades are performed in major financial centers – Wellington, Sydney, Tokyo, Singapore, Hong Kong, Moscow, Frankfurt am Main, Zurich, London, New York. Together these financial centers form a continuous circle, allowing currency trading all day long. Choosing the right session is an important moment for the trader, because each session differs in its dynamics.
There are four main trading sessions:
Sydney 22.00 – 7.00 GMT
Tokyo 0.00 – 9.00 GMT
London 8.00 – 17.00 GMT
New York 13.00 – 22.00 GMT
The greatest currency liquidity happens at the time when trade occurs during its “home” sessions. Meaning the Japanese yen is the most liquid during the Pacific session, and the British pound during the trading hours of the London stock exchanges.
Traders continuously monitor economic calendars and release of economic data, as the influence of macroeconomic factors, political events and central banks reports on the Forex market is huge.
Hedging withthe Forex Market
As in other markets, Forex market participants are divided into speculators and hedgers. If the speculators are only interested in the price movement, then for the hedgers the price movement factor is not important, because they own physical assets.
Let`s study the following example of hedging currency risks. If an investor owns a production in France and sells the manufactured goods in Canada, then he/she will have an advantage with a strong Canadian dollar and a weakening euro. In this case, after the sale of goods in Canada and considering that the contract has been concluded in Canadian dollars, the investor will receive a larger amount in euros than expected. If the EUR / CAD rate goes up (the euro rises, the Canadian dollar falls), then the manufacturer will suffer losses, and so will receive a smaller amount in euros than planned.
Having opened a long position in the EUR / CAD pair, the investor will be able to hedge their currency risks using the Forex market. If the rate goes down, the investor will lose money on Forex, but earn more on his own product. With the accurate hedging, the currency risks will be significantly reduced.
Major Currency Pairs and Cross-Rates
The most liquid currencies are the US dollar (USD), the euro (EUR), the British pound (GBP), the Japanese yen (JPY), the Swiss franc (CHF) and the Canadian dollar (CAD). More than 80% of the total transactions volume are performed with these currencies.
In addition to the four main pairs, EUR / USD, GBP / USD, USD / CHF, USD / JPY, separately “commodity” pairs are distinguished: NZD / USD, AUD / USD and USD / CAD. The last three pairs can be of interest to the “metals and oil” trader, as the currency pairs strongly depend on price changes of these resources. As you know, Australia and New Zealand are major producers of industrial metals, and Canada is the largest exporter of oil to the United States.
Unlike the stock market, the foreign exchange market does not give the trader a wide range of opportunities to balance his portfolio. With a long position for EUR / USD, GBP / USD and short for USD / JPY and USD / CHF, the trader has approximately the same exposure, because earns profit on a weakening US dollar.
Cross-rates give the trader the opportunity to diversify his/her strategy by including several currency pairs and thus reduce dependence on the US dollar, as central banks are known to keep their reserves in US dollars. In addition, cross-rates allow you to make a more accurate bet on the effect of the output of certain macroeconomic data of the selected country.
Also such currencies as DKK, SGD, PLN, RUB, SEK, ZAR, MXN, CZK, HUF, NOK, ILS, collectively called exotic due to their low liquidity, are available for trading. They are also of interest because of the difference in interest rates.
How to Read Quotes
The currencies are quoted according to the ratio of one currency to another. There are basic and counter-currencies. Example: USD / JPY = 111.15. In this case, the US dollar is the base currency, and the yen is the counter currency, equivalent to the base currency in the yen. This quotation means that one dollar can buy 111.15 Japanese yen.
As in other markets, the market of currencies distinguishes the “Bid” prices, according to which the participants are ready to buy and “Ask” prices, according to which market participants are ready to sell. The difference between the prices of “Bid” and “Ask” is spread. Spread is the narrowest in normal market conditions. A wider spread is possible during the release of economic data and at night European time.
If the trader wants to buy this currency pair, then the transaction will occur at Ask prices, if the trader wants to sell, then at Bid prices. When buying EUR / GBP at the rate of 0.8600, the trader purchases 100 000 EUR and simultaneously sells 86 000 GBP.
Pip (or item) is the smallest change in price. For example, one item for the EUR / USD pair is 0.0001, and for XAG / USD 0.01. Basically, all currency pairs have four decimal points, except for pairs with JPY, RUB and metals, which are quoted with two decimal points.
Transfer of an Overnight Position
The cost of currency borrowing depends on the interest rates regulated by central banks. Opening a position for a currency pair, the trader has an exposition of two currencies. Depending on the difference between the rates of these currencies, the trader either earns or pays for moving the position to the next day.
For example, when buying NZD / USD, the trader has a long position in NZD and short in USD. In other words, NZD is placed on a deposit, and USD is taken on credit. On the New Zealand dollar, the investor receives income, and the US dollar is used to pay the loan interest. The difference between these two rates, taking into account the commission in terms of the US dollars, is the position transfer fee (SWAP).
Most currency pairs have a delivery date (value date) of t + 2, so every day the position moves two days forward. If the delivery falls on a holyday, then it is transferred to the next working day, and accordingly the swap is charged a few days in advance.
ALWAYS REMEMBER THAT
Operations in the FOREX market are risk-related and require relevant knowledge and experience. Any investment decision you make must be based entirely on an assessment of your personal financial circumstances and investment objectives.