How To Trade Forex

The answer for how to trade forex is not easy. There are people who wiped off their entire capital in forex market. However, there are people that enjoy steady income from trading forex. If you look at the people trading forex then you will realized that most people trade forex like gambling. They don’t have proper understanding of different aspect of how prices are calculated. Some Gurus also propagate the myth that following their method any one can make money in forex market. There is no magic key as far as forex trading is concerned.

Understanding forex

Before jumping in to the trillion dollar market, you must understand the basics of it.

Similar to Stock exchange, Foreign exchange is also divided in to two categories.

* Cash: It is traded in the Interbank or Dealer market. (OTC)

* Future: It is traded in the Exchange traded markets.

Cash Market

Interbank/dealer Market (OTC)

Who are the players?

• Total of 93 major players in the United States

• 82 Commercial banks

• 11 Investment banks or insurance firms

• The total volume of transactions of the reporting dealers among themselves account for $500 billion + per day.

• Most are based out of New York and account for 49 percent of all of the foreign exchange activity.

• Information is maintained at the Federal Reserve Bank of New York

• Central banks worldwide have a heavy hand in the foreign exchange market as well.

What they trade?

• Spot: Settled two days after deal date

• Pre-Spot: Settled one day after deal date

• Pre-Spot “Cash”

• FX Swap: one spot transaction plus one forward transaction

• Currency Swap: exchange of principal in two different currencies at the beginning and a re-exchange of same amount at the end.

• Currency Forwards: Customized contracts for future delivery of currency.

• Currency options: Customized contracts that grant the right, but not the obligation to receive cash.

What is OTC Currency Pairing?

• Pricing done in pairs

• The first quoted currency is known as the base currency.

• The second quoted currency is known as the counter or quote currency.

• Today’s currency movers are US Dollar, British Pound, Euro Currency, Japanese Yen, and Swiss Franc.

• Each currency is listed in five numbers with the last number known as a pip.

Generally most people focus on small groups of pairs. Followings are the hard currency pairs which consists of over 80% of OTC Forex transactions

• USD/EUR

• USD/JPY

• GBP/USD

• USD/SFR

• EUR/YEN

• EUR/GBP

Overall there are approximately 34 soft currencies.

Advantages and Disadvantages of Cash market

Advantages

1. 24 hour market

2. Margin ability of up to 500:1 leverage

3. 1.5 trillion traded daily. 3 times larger than Stock and bond markets combined

4. No overt commissions

5. Price is negotiated

Disadvantages

1. 24 hour market

2. Easy to over leverage

3. No centralized market place

4. Interest charges for holding a position too long

5. Price knowledge is limited to your dealer

In the next post we will discuss Exchange traded market and also how to trade forex sensibly.