Part 1:  A Beginner’s Guide to Understanding the Currency Trading Market

Provided by guest contributor Jennifer Gorton from Forex Traders

The world of foreign exchange, or forex as it is commonly called, is the largest and most liquid market on the planet.  Over $3.2 trillion is exchanged on every business day, “24/5”, starting with New Zealand in the morning and then moving on to Tokyo, London, New York and beyond.  Since global trade only amounts to $12 trillion on an annual basis, there is obviously something else going on in the market to create the other 98.5% in volume. 

The movement of global capital searching for the highest return is part of the reason.  Major global banks are also in a position to take advantage of arbitrage opportunities when interest rates and exchange rates do not correlate properly.  The “Interbank” market, the volume exchanged between banks alone, makes up 50% of the trading, but the remaining volume consists of hedge fund speculators attempting to replicate what big banks are doing, corporations and others using risk management techniques to mitigate adverse movements in the market, and investors investing in the retail forex market.

The diagram above helps to put all of this into perspective.  It is also important to note that the forex market is not centralized on any exchange.  EBS and Reuters provide an electronic communication network for trade notifications between partners in a trade, but there is no central recording or volume statistics maintained by an independent body.  Actual access entry points and the market forces impacting your banking partners down the line are what influence individual exchange rates.

The high volume of trading ensures that liquidity is always present for major trading pairs and that pricing is fair and appropriate.  However, currencies always come in pairs, and there is no notion of “intrinsic” value.  Exchange rates represent the “relative” value that the market assigns to the economic health comparison between the two nations comprising the currency pair.  The global consensus of trader and investor psychology evaluates fundamental economic data and produces a current valuation that constantly changes based on new information, whether fact or rumor, that enters the public domain.

An international standards board establishes a three-digit code for every currency that is officially recognized in global trade.  The symbol for the Malaysian Ringgit is “MYR”, as opposed to the Singapore Dollar that is “SGD”.  Presently, trading volume for the Ringgit is outside the top twenty traded currencies due primarily to investor concerns over political and country risk.  However, if Malaysia can emulate the economic success story of its neighbor, Singapore, capital could surely flow to the country and bolster the strength of its currency.

Currency trading has gained enormous popularity over the past decade as brokers offered smaller trading lots and the Internet provided easy access to sophisticated trading platforms and software.  Forex trading is not about gambling, nor is it the latest adult video game on the market.  As in any other actively traded investment medium, such as commodities or options, a high-risk profile exists and specialized training is a prerequisite for anyone wishing to trade in this market.  Every forex site page carries with it a “disclaimer” that strongly suggests that you review your objectives and discuss them with an accredited financial advisor before entering this field of endeavor.

Forex trading should be approached as if it were a business, with a disciplined approach for every action contemplated that always includes risk management techniques.  Using the same view, forex trading is not suitable for everyone. Part 2 of this series will provide guidelines on what steps are necessary to develop these disciplines and obtain consistency in your trading over time.  Stay tuned.

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