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Foreign Exchange Market (FOREX) & FAQ for Begginers

 

FOREX market

THE FOREX MARKET & FAQ FOR BEGINNERS


The Foreign Exchange Market (FOREX) was introduced in the 70's when the global currency trading system was changed from a system of fixed currency value to a variable rate system. Fixed exchange rate system started in 1944 based on the agreement of “Bretton Woods”. Today, huge amounts are traded in the FOREX market  -the FOREX market has a daily turnover of about four (4) trillion US dollars. Forex market has no specific geographic location -transactions are made through the electronic network of banks. Anyone with a computer and internet access can buy and sell currencies through the FOREX market. 

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Size of The FOREX Market 

In 1977, the average daily turnover of the FOREX market amounted just 6 billion US dollars. In 1987, daily turnover reached 600 billion dollars and in 1997 daily turnover reached 1.2 trillion dollars. In 2007, daily turnover reached 3.2 trillion dollars and nowadays the daily turnover of the FOREX market is estimated to about 4 trillion dollars in a daily basis. Most of the FOREX daily market activity takes place in the UK (36%), followed by U.S. (17%) and Japan (6%). The FOREX market operates 24 hours and 5 days a week, from Monday through Friday. 

Chart: Forex Market Activity 
                             FOREX Market Activity


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Why to Participate in the Forex Market? 

The are two reasons to participate in the international FOREX market: 
1) Hedging against Currency Risk 
FOREX market offers the chance of covering against the abnormal fluctuations of a particular currency. Currency risk is a market-risk that is incorporated in international activities. For example an US importer who imports goods from Europe may hedge against his exposure on Eurodollar exchange rate. Learn about Investment Risk

2) Market Speculation 
Speculation on the FOREX market is a common practice in US, Europe and Asia. Thousands companies and individual traders speculate on the FOREX market in a daily basis. 
 

How to Trade the Forex Market?

Here are four different ways to participate in the Forex market. 

1) FX SPOT TRADING 
Market Size: 1.5 trillion US dollars daily transactions 
The spot market represents a direct transaction between a buyer and a seller. This type of transactions consist cash and are delivered after a two-day period (T +2). Note that in exception, some rates applies a single delivery day (T +1). FX Spot Trading activity is the largest of the Forex market and it is carried out  through the banks electronic network. 

2) FORWARD CONTRACTS  
Market Size: 480 billion US dollars daily transactions  
A currency transaction through a Forward Contract is a 'closed' agreement between two parties -that is delivered in the future. The buyer and the seller agree today to the terms of the delivery –but the delivery itself takes place at a pre-specified future date. The duration of a Forward Contract can be from one day to several years. Forward-type contracts are similar to Futures contracts (discussed below) with the difference that a forward contract is not traded to any market. Usually, a Forward agreement consist a bank in one side and a large company or a large private investor in the other side. 

3) SWAPs CONTRACTS (FOREIGN EXCHANGE SWAP & CURRENCY SWAP) 
Market Size: 1.8 trillion US dollars daily transactions 
In a SWAP like transaction, a sale order of a currency and a purchase-order of a currency are placed in the same time. At a specified date in the future the two sides (buyer and seller) are forced to reverse the transaction. This method is mainly used for hedging against periodic currency risk.  

4) CURRENCY FUTURES & OPTIONS CONTRACTS 
Market Size: 210 billion US dollars daily transactions (futures and options)
-CURRENCY FUTURES CONTRACTS 
Futures contracts can be bought nowadays in most international markets. Futures contracts are standardized contracts that are traded as any common financial securities. Futures are delivered in the future after a period of usually some months. Futures assume the existence of a percentage of the total transaction as a collateral (margin). Usually margin counts 5-15% of the total value of the transaction. Margin can be raised depending on future market movements, what is called as Marginal Call. Futures can be used for hedging or speculation.
-CURRENCY OPTIONS CONTRACTS 
Options unlike futures contracts expose its holders to a fixed risk. An Option buyer has the right but not the obligation to carry out a transaction in the future. That means that no Marginal calls are applied. An option contract will be delivered at a specified price and a specified future date. Options are used for hedging risk but mainly for speculation.  

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Why World Currencies Fluctuate? 

In order to analyze the Forex market investors are using both fundamental and technical analysis. 

1) FUNDAMENTAL ANALYSIS OF A CURRENCY
Fundamental analysis investigate facts and macroeconomic figures related to the reference economy but also analyze the global economic and political content. Analysis consist variables such are : interest rates, inflation unemployment rate, GDP growth, industrial production, public and private debt and many others. Central banks worldwide influence hugely the fluctuations of the international exchange rates. 

2) TECHNICAL ANALYSIS OF A PAIR OF CURRENCIES
Technical analysis in the FOREX market is the process of analyzing the movements of currencies exchange rate in order to identify similarities with past patterns. Technical analysis is actually measuring the psychology of the market. Many automated systems are used to trade the FOREX market using technical analysis without human interference which are called FOREX robots.

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Capital Leverage in the Forex Market 

High capital leverage characterizes the FOREX market. An investor can leverage his capital from 2 to 50 times.  An investor holding $10,000 can buy or sell currencies worth up to $500,000. Leverage of capital is attractive but it also masks enormous risks for investors -especially for those who are not familiar with portfolio risk management. 

Currency Symbols

The table below shows the symbols of the major international currencies.

Table: Major Currency symbols 

Currency

Symbol

Euro

EUR

US Dollar

USD

British Pound

GBP

Japanese Yen

JPY

Swiss franc

CHF

Australian dollar

AUD

Canadian Dollar

CAD

New Zealand dollar

NZD

Swedish krone

SEK

Danish krone

DKK

Norwegian krone

NOK

Singapore Dollar

SGD

Major Pairs of Currencies  

Many currency pairs are offered in the Forex market. The major currency pairs include: 


1) EUR / USD and EUR / USD 
2) USD / JPY and USD / JPY 
3) GBP / USD and GBP / USD 

The above pairs of currencies are characterized:

i) Βy high volume activity in the FOREX market  
ii) By small market spreads (spread is the difference between the highest buying price and the lowest selling price). 

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