MT5_2. Forex Markets Basics and Trading Examples

Lesson 2: Forex Markets Basics and Trading Examples

Unlike other financial markets like the New York Stock Exchange or the London
Stock Exchange, the forex market has neither a physical location nor a central
exchange.
The forex market is considered an Over-the-Counter (OTC), or “Interbank” market
due to the fact that the entire market is run electronically, within a network of banks,
continuously over a 24-hour period.
This means that the spot forex market is spread all over the globe with no central
location. Trades can take place anywhere.
The forex OTC market is by far the biggest and most popular financial market in the
world, traded globally by a large number of individuals and organizations.
In the OTC market, participants determine who they want to trade with depending on
trading conditions, the attractiveness of prices, and reputation of the trading
counterpart.
This chart shows the seven most actively traded currencies, which are also called
the major currencies.

The dollar is the most traded currency, taking up 84.9% of all transactions.
The euro’s share is second at 39.1%, while that of the yen is third at 19.0%.
One of the huge advantages of trading the forex market is the leverage. The concept
of leverage is used by both investors and companies. Investors use leverage to
significantly increase the returns that can be provided on an investment. They lever
their investments by using various instruments that include options, futures and
margin accounts.

In forex, investors use leverage to profit from the fluctuations in exchange rates
between two different countries. The leverage that is achievable in the forex market
is one of the highest that investors can obtain. Leverage is activated through a loan
that is provided to an investor by the broker that is handling the investor’s or trader’s
forex account.

When a trader decides to trade in the forex market, he or she must first open a
margin account with a forex broker. Usually, the amount of leverage provided is
either 50:1, 100:1 or 200:1, depending on the broker and the size of the position that
the investor is trading. What does this mean? A 50:1 leverage ratio means that the
minimum margin requirement for the trader is 2 percent. A 100:1 ratio means that the
trader is required to have at least 1% of the total value of trade available as cash in
the trading account, and so on. Standard trading is done on 100,000 units of
currency, so for a trade of this size, the leverage provided is usually 50:1 or 100:1.
Leverage of 200:1 is usually used for positions of $50,000 or less.

To trade $100,000 of currency, with a margin of 1%, an investor will only have to
deposit $1,000 into her or his margin account. The leverage provided on a trade like
this is 100:1. Leverage of this size is significantly larger than the 2:1 leverage
commonly provided on equities and the 15:1 leverage provided in the futures market.
Although 100:1 leverage may seem extremely risky, the risk is significantly less when
you consider that currency prices usually change by less than 1% during intraday
trading. If currencies fluctuated as much as equities, brokers would not be able to
provide as much leverage.

Although the ability to earn significant profits by using leverage is substantial,
leverage can also work against investors. For example, if the currency underlying
one of your trades moves in the opposite direction of what you believed would
happen, leverage will greatly amplify the potential losses. To avoid a catastrophe,
forex traders usually implement a strict trading style that includes the use of stop
orders and limit orders designed to control potential losses.

Forex exchange markets provide traders with a lot of flexibility. This is because there
is no restriction on the amount of money that can be used for trading. Also, there is
almost no regulation of the markets. This combined with the fact that the market
operates on a 24 by 7 basis creates a very flexible scenario for traders. People with
regular jobs can also indulge in Forex trading on the weekends or in the nights.
However, they cannot do the same if they are trading in the stock or bond markets or
their own countries. It is for this reason that Forex trading is the trading of choice for
part time traders since it provides a flexible schedule with least interference in their
full time jobs.

There’s a plethora of high quality knowledge and news, all free on the internet,
including charts, economic calendar and market analysis.

Unlike a stock market, the foreign exchange market is divided into levels of access.
At the top is the interbank foreign exchange market, which is made up of the largest
commercial banks and securities dealers. Within the interbank market, spreads,
which are the difference between the bid and ask prices, are razor sharp and not
known to players outside the inner circle. The difference between the bid and ask
prices widens as you go down the levels of access. This is due to volume. If a trader
can guarantee large numbers of transactions for large amounts, they can demand a
smaller difference between the bid and ask price, which is referred to as a better
spread. The levels of access that make up the foreign exchange market are
determined by the size of the "line", which is the amount of money with which they
are trading. The top-tier interbank market accounts for 51% of all transactions. From
there, smaller banks, followed by large multinational corporations, which need to
hedge risk and pay employees in different countries, large hedge funds, and even
some of the retail market makers.
Central banks also participate in the foreign exchange market to align currencies to
their economic needs.
The top 5 market participants are City Bank, JP Morgan, UBS, Deutsche Bank and
Merril Lynch.