Forex market tutorial investopedia
The market is open 24 hours a day, five and a half days a week, and currencies are traded worldwide in the major financial centers of London, New York, Tokyo, Zurich, Frankfurt, Hong Kong, Singapore, Paris and Sydney - across almost every time zone. This means that when the trading day in the U. As such, the forex market can be extremely active any time of the day, with price quotes changing constantly.
Spot Market and the Forwards and Futures Markets There are actually three ways that institutions, corporations and individuals trade forex: The forex trading in the spot market always has been the largest market because it is the "underlying" real asset that the forwards and futures markets are based on. In the past, the futures market was the most popular venue for traders because it was available to individual investors for a longer period of time.
However, with the advent of electronic trading and numerous forex brokers , the spot market has witnessed a huge surge in activity and now surpasses the futures market as the preferred trading market for individual investors and speculators.
When people refer to the forex market, they usually are referring to the spot market. The forwards and futures markets tend to be more popular with companies that need to hedge their foreign exchange risks out to a specific date in the future. What is the spot market? More specifically, the spot market is where currencies are bought and sold according to the current price. That price, determined by supply and demand, is a reflection of many things, including current interest rates, economic performance, sentiment towards ongoing political situations both locally and internationally , as well as the perception of the future performance of one currency against another.
When a deal is finalized, this is known as a "spot deal". It is a bilateral transaction by which one party delivers an agreed-upon currency amount to the counter party and receives a specified amount of another currency at the agreed-upon exchange rate value.
The ultra-high leverage of the forex market means that huge gains can quickly turn to damaging losses and can wipe out the majority of your account in a matter of minutes. This is important for all new traders to understand, because in the forex market - due to the large amount of money involved and the number of players - traders will react quickly to information released into the market, leading to sharp moves in the price of the currency pair. Though currencies don't tend to move as sharply as equities on a percentage basis where a company's stock can lose a large portion of its value in a matter of minutes after a bad announcement , it is the leverage in the spot market that creates the volatility.
For example, if you are using Therefore, it is important to take into account the risks involved in the forex market before diving in. Differences Between Forex and Equities A major difference between the forex and equities markets is the number of traded instruments: The majority of forex traders focus their efforts on seven different currency pairs: All other pairs are just different combinations of the same currencies, otherwise known as cross currencies. This makes currency trading easier to follow because rather than having to cherry-pick between 10, stocks to find the best value, all that FX traders need to do is "keep up" on the economic and political news of eight countries.
The equity markets often can hit a lull, resulting in shrinking volumes and activity. As a result, it may be hard to open and close positions when desired. When highly leveraging the trade, even a small difference between two rates can make the trade highly profitable. Along with capturing the rate difference, investors also will often see the value of the higher currency rise as money flows into the higher-yielding currency, which bids up its value.
Real-life examples of a yen carry trade can be found starting in , when Japan decreased its interest rates to almost zero. Investors would capitalize upon these lower interest rates and borrow a large sum of Japanese yen.
The borrowed yen is then converted into U. Treasury bonds with yields and coupons at around 4. Since the Japanese interest rate was essentially zero, the investor would be paying next to nothing to borrow the Japanese yen and earn almost all the yield on his or her U. But with leverage, you can greatly increase the return. However this strategy only works if the currency pair's value remains unchanged or appreciates.
Therefore, most forex carry traders look not only to earn the interest rate differential, but also capital appreciation. While we've greatly simplified this transaction, the key thing to remember here is that a small difference in interest rates can result in huge gains when leverage is applied.
Most currency brokers require a minimum margin to earn interest for carry trades.