The forex market is the world’s biggest and most liquid market, averaging trillions of dollars’ trade per day. It’s not therefore surprising that forex trading is a highly in-demand venture for investors.
In forex trading, you trade currencies. So it’s like trading money for bigger money. The liquidity, size of the market, and the unregulated nature makes it a very attractive market for those who want to make it big.
However, just like any lucrative endeavor, forex trading has its own good and bad sides. And we’re going to tackle those things one by one.
Let’s start with the currencies.
Forex Trading: The Currencies
The first step to gain a firmer footing in forex trading is to be familiar with the currencies you can trade. While there are hundreds of currencies you can choose from, here are the major ones you should focus on.
1. The US Dollar a.k.a. the Greenback
The US dollar easily takes the title of being the most in-demand currency in the forex world. You can find the USD in pair with all the other major currencies. it can also serve as the middle currency in transactions where three currencies participate.
Why is that so?
This is because the USD is the world’s (unofficial) reserve currency. Nearly all central banks and institutional investment entity in the world hold this currency.
Moreover, many countries also use the dollar as their official currency instead of a local currency. You can call this practice dollarization.
Foreign Exchange Rates and the Dollar
The dollar is also key factor in the foreign exchange rate market for other currencies. It can act as a benchmark or target rate for countries that peg their local currencies to the greenback’s value.
For example, China has long pegged the Chinese yuan to the dollar, much to the annoyance of economists and bankers.
The pegging serves a purpose: it stabilizes the exchange rate of the other currency. This is the opposite of allowing the local currency to be free-floating.
The US Dollar’s role in Commodities
The dollar also serves as the standard currency for most commodities like oil and precious metals. In other words, the US dollar’s value fluctuation also affects the price those commodities.
2. The Euro
The world witnessed the birth of the euro on January 1, 1999, and circulation started three years later. Even if this currency is still relatively new, it’s already become the second most in-demand currency.
The euro serves as the official currency of most of the countries in the Eurozone. Aside from that, many countries in Europe and Africa peg their currencies to the euro. It’s pretty much the same case with the dollar: they peg to stabilize their exchange rates.
Traders of the Euro
Since a lot of traders trust the euro and trade it, it also adds liquidity to any currency it trades with. For speculators, the euro helps them play with the general health of the Eurozone.
The political happenings within the Eurozone can result to large trading volumes for the euro. This is especially true for countries with local interest rates falling rapidly.
Overall, you can think of the euro as the most “politicized” major currency in the forex market.
3. The Japanese Yen
Out of Asia, the Japanese yen easily takes the crown as the most traded currency. Many market participants view the yen as proxy for the underlying strength of Japan’s manufacturing-export economy.
In other words, the performance of the country’s economy dictates the yen’s performance to some extent. Many participants also use the yen to gauge the overall condition of the Pan-Pacific region.
The Yen and Carry Trading
The yen is also popular in forex trading because of carry trading. With carry trading, you try to profit from the difference in interest rates between two currencies.
Basically, Japan has zero-interest rate policy for more than a couple of decades. You can borrow the yen at almost zero cost and use it to invest in other higher-yielding currency. You can practically take home the differentials in the process.
As a result, it’s difficult for the yen to appreciate in value. The yen still trades with the same fundamentals as any other currency, though. The thing is its ties with interest rates (particularly with the greenback and the euro) are a huge factor for its value.
4. The British Pound
You can also call the British pound as the pound sterling. It’s the fourth most in-demand currency in the market.
Even though the UK is an official member of the European Union until the Brexit, it opted not to use the euro as its official currency. There are many reasons behind that, but mostly it’s the historic pride in the pound. It also helps them retain control of domestic interest rates.
As such, you can say that the pound is pure play on the United Kingdom. When forex trading, you can base the pound’s value on the overall strength of the British economy. You can also take into account the political stability of its government.
5. The Canadian Dollar
You can probably say the Canadian dollar is the world’s primary commodity currency. This means that it follows the commodities markets, especially crude oil and precious metals.
Canada is such a heavy exporter of commodities. Because of this, it’s very sensitive to movements in their underlying prices.
See also: Myths of Investing in Commodities
Forex trading-enthusiasts trade the Canadian dollar to speculate on the movements of these commodities. They also use it as a hedge to their holdings of commodities derivatives.
Also, since Canada is very near to the United States, which is the world’s largest consumer base, the Canadian economy and Canadian dollar, is highly sensitive to the strength of the US economy and movements in the US dollar as well.
6. The Swiss Franc
You can look at the Swiss franc and decide that it’s a “neutral” currency. This is because it’s considered a safe-haven within the forex market. The fact is that the franc tends to move in the opposite direction to more volatile commodity currencies.
The Swiss National Bank is famous for being active in the forex market. It makes sure that the franc trades within a tight range to lower volatility, keeping interest rates in line.
Now that you know the major currencies in forex trading, let’s look at the good and bad side of the career.
Forex Trading: The Good
Forex trading costs cheap—just brokerage and commissions. In fact, you can say there’s no real commission. This is because most forex brokers earn from the spreads between currencies. You don’t have to worry about including separate charges.
Different Trading Styles
The forex market can run all day which means you can trade anytime you want. This is very beneficial for short-term traders who usually trade for short periods of time.
Other financial markets cannot rival with the forex market’s liquidity, thanks to the number of its market participants. There are retail traders and banks and other financial institutions.
You can easily fill your orders even if they very large orders without any price deviations. This gets rid of the likelihood of price manipulation and price anomalies.
No Central Exchange
When forex trading, you don’t have to deal with a central exchange. It’s an over-the-counter market running across the world. Central banks do interfere in rare occasions, but participants already anticipate such actions.
Lack of transparency
Because of the deregulation of the forex market, you are practically trading with professionals. Forex trading in a market that brokers drive may not give you the transparency you’d like.
Complicated Price Determination
Several factors affect forex rates, such as politics or economics. They can be difficult to analyze and so it’s difficult to draw solid conclusions.
High risk due to high leverage
You can perform forex trading with high leverage. That means you can gain multiple times bigger than your trading capital—which also means you can lose massive amounts.
In the stock market, you can get help from portfolio managers, trade advisors, and relationship managers. In the forex market, you’re practically on your own with minimal to zero help.
Since you have no control over macro-economic and geopolitical events, you can easily suffer huge losses.
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