Unlike the other financial markets, the Forex market has no physical location and no central exchange; this makes the Forex market an OTC or over-the counter market. It operates through a global network of banks, corporations and market makers trading one currency for another. The lack of a physical exchange enables the Forex market to operate on a 24-hour basis, spanning from one time zone to another in all the major financial centres of the world.
Traditionally, private traders only means of gaining access to the foreign exchange market was through banks that transacted large amounts of currencies for commercial and investment purposes. Trading volume has increased rapidly over time, especially after exchange rates were allowed to float freely in 1971.
Over resent years the way the interbank currency market operates has changed dramatically. The Forex market has become accessible to private traders. The market makers have achieved this through a combination of low margin and high leverage and providing the professional tools and services needed to trade effectively in an independent atmosphere.
For the active trader, foreign exchange should be no different than other investments or financial instruments such as equities, commodities, bonds, notes, bills, etc.In fact because of the globalisation of the economic world and the consolidation of whole economic regions such as the European Union, having currencies as part of a diversified portfolio simply makes sound portfolio and investment sense.
Just like these other investment alternatives mentioned, foreign exchange offers private traders and investors a market where they can buy and sell an investment product. In this case it is a specific Currency Pair. The currency pair may be the Euro versus the US Dollar, the US Dollar versus the Japanese Yen, the British Pound versus the US Dollar, the Euro versus British Pound, or a number of other currency combinations.
The different currency combinations
Represent nothing more than the value of one currency versus the value of another. That relationship is represented by a single price. In foreign exchange, the price of a currency pair is the markets expectations at that time of the value of that currency vis-à-vis another currency given the current and expected economic and political situation of the two countries. In equity terms, it would be the price of the stock.
If for example, a country's inflation and interest rates are low and stable. If it’s economy is strong and politics are stable and the expectations are for more of the same, then one can expect “in general” for that country's currency to remain strong versus a less fundamentally favourable currency. Keeping in mind that all comparisons are relative to that of other economic regions.
Contrasting that with equity, if the domestic and global economy is strong and inflation is not running away. If competition is not taking away market share or eating into margins as well product demand and growth are strong. If the companies internal "politics" are such that the workers are happy and productive, and expectations are for more of the same, then you can expect that companies stock to remain strong versus a company with less favourable fundamentals within the same sector.
Like equities there are other factors that determine the short-term value of a product including technical analysis, short-term supply and demand, seasonal capital flow patterns, the current price of the instrument, etc. By analysing the pricing dynamics and combining that with sound money management discipline like stop loss orders, the trader can insure greater success in his foreign exchange trading. |
