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Why forex?

12 Dec 2011


Faced with a vast array of markets and securities to trade it’s small wonder that retail traders often ask why they should specialise in forex and not equities, futures, or commodities? What are the major benefits to trading forex over and above trading other markets? What has underpinned the massive growth in the retail forex market over the past ten years?

Not all traders are ‘fans’ of forex trading and justifiably they’ll point out the faults, some of which we’ll talk through and debunk during this article to arrive at the conclusion as to why trading the FX markets, as a retail trader, makes perfect sense.

Limited Choice
When you consider that there are circa 4,500 stocks listed on the New York Stock exchange, 3,500 on the NASDAQ and that this is only one country’s bourses which equities will you decide to trade? Will you simply trade any equity according to; fundamentals, the noise from the squawk, or Bloomberg or Reuters, will you attempt to get in front of their numbers and results? Perhaps you’ll choose to do some technical analysis, the most basic being is the equity “overbought” or “oversold” in relation to its sector? An impossible management task for even the most sophisticated hedge funds, investment banks and algorithms.

I know equity traders who only trade certain sectors and drill down their trading to only a select few US stocks in that sector, for example, Google, Apple, Microsoft, Verizon. The irony is that these contacts of mine are adopting the same principles a successful forex trader would adopt, by only selecting 3-4 equites to trade they are mimicking similar behaviour to that of an FX trader who selects perhaps 4 pairs to monitor for the right set up.

Low Barriers to Entry
Many ‘anti’ FX traders will refer to the low barriers to entry in the FX market as a draw back when in fact it’s a huge benefit. Many traders will arrive at the markets due to a change in personal circumstances or a desire to seek out a new direction or challenge. Why should that desire be hampered by restrictive entry capital? Used correctly the leverage permitted in FX trading can always work to the trader’s advantage. Far better to risk and obligate €5000 to your new business venture as opposed to risking €50000, surely whilst learning any new self employed profession the less risk you take the better?

Liquidity and Size of Market
The FX market dwarfs all stock markets in volume. The figures for FX transactions are put at circa $4 trillion each day. Estimates put the New York Stock Exchange (NYSE) trading at circa $30 billion a day. The entire U.S. stock market trades circa $200 billion daily. The Futures market trades circa $500 billion daily. In terms of liquidity nothing surpasses the FX markets and whilst there are times during the day when the trading of certain pairs falls away, the market is, (during the Sun – Fri open) always ‘open’. The forex market is a seamless 24-hour market. The vast majority of brokers are open for business from Sunday at 4:00 pm EST until Friday at 4:00 pm EST, with their dedicated customer service divisions usually available 24/7. With the ability to trade during the U.S., Asian, and European market hours, you can easily customise your own trading schedule to fit around these market times.

Spotting Your Trades
In spot currency trading there are dozens of currencies traded, the majority of market players trade the four major pairs. Four pairs are much easier to trade than thousands of stocks. Even if you look for the same set up to occur on more currency pairs, (perhaps as many as nine pairs before correlations render it excessive), traders can monitor this level of activity quite simply.

Low Costs
The vast majority of reputable forex brokers charge little or no commission or additional transactions fees to trade currencies online or over the phone. Combine this with the tight, consistent, and fully transparent spreads and you quickly realise that forex trading costs are lower than those of any other market. Most brokers are compensated for their services through the bid/ask spread. The spread you’re charged is their profit.

Straight Through to the Market, No Intervention
Your forex trades are instantly executed under normal market conditions. Under these conditions, usually the price shown when you execute your market order is the price you get. You’re able to execute directly off real-time streaming prices. However, many brokers only guarantee stop, limit, and entry orders under normal market conditions. Trading during a market event, such as NFP day, or a Greece prime minister putting his country’s EU membership to a referendum, would not fall under the description of “normal market” conditions. Fills are instantaneous most of the time, but under extraordinarily volatile market conditions order execution may experience slight lagging delays.

Limited Risks
Forex trading offers the advantage of limited risk, one of the biggest advantages over the futures market. When you buy a futures contract, you are obligated to buy or sell a specific amount of a specific security or commodity at a specific time for a specific price. If you buy a futures contract to sell oil and news breaks that Renault are giving away water powered trucks and cars and Ford etc will follow suit, then the price on your contracts will drop through the floor, limits will drop, and you could be buried in your position finally taking massive losses. This could not happen in the forex market were you can simply exit your position.

No Restrictions
There are no restrictions on short selling in the currency market. Trading opportunities exist in the currency market regardless of whether a trader is long or short, whichever way the market is moving. Since currency trading always involves buying one currency and selling another, there is no structural ‘bias’ to the market. Therefore you always have equal access to trade in a rising or falling market.

Lower Margin Requirement
Margin requirements are significantly lower in forex trading than equity or futures trading. Whilst the level of margin allowed is determined by each broker, the restrictions are usually much less stringent when trading forex. Margin allows the investor to leverage, theoretically you borrow from the broker to invest in your own account. While this can be risky, it can also be very lucrative and profitable.

For example, you have €10,000 of your own money to invest, if you open up a margin account at an equity broker, you can usually margin up to 50% of the value of stock. So if you buy €10,000 in Apple stock, you can borrow another €5,000 to own a total of €15,000 in value. With your forex account, the margin requirement is often as low as 1%. Which means that if you buy €10,000 in Euros, you can use your broker’s money to buy another €1,000,000. So technically you own over $1 million in Euros.

If the value of each investment increases by 10% then your €15,000 in Apple stock is now worth €16,500. You then sell it, ‘pay back’ the €5,000 you borrowed, and you remain €1,500 in profit. Your return on investment (ROI) is 15%. If your Euros went up 10%, your €1 million is now worth €1.1 million. After selling and repaying your broker, your profit is €100,000 before any interest. That’s a return on investment of over 1,000%. Naturally you have to be careful when trading on margin, if the transaction highlighted went against you then you’d be in a much bigger drawdown in the forex scenario, however, you can close the trade before you reach such extremes. The potential for enormous gain is obvious, the major reason why forex trading attracts serious investors.

No Middleman
Centralised exchanges can provide many advantages to the trader. One drawback with centralised exchanges is the involvement of middlemen. Parties located in between the trader, buyer or seller of the security add a layer of cost. The cost can be quantified either in time, fees or both. Spot currency trading is decentralised, quotes vary from different currency dealers and liquidity providers. Competition is so fierce that you are always assured that you get the best quotes. Forex traders get quicker access and cheaper costs. With the advancement of ECN, NDD and STP and as the liquid pools of quotes from banks is constantly changing you can be assured that the quote you obtain will be as close to the best the market can provide.
Read the full story.....

Source: FX Central Clearing Ltd, (FXCC BLOG)

  1,276 Views · 53 Replies ( Last reply by Bryan Robson )


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