Introduction

Introduction Forex 

Forex is an abbreviation for foreign exchange. It refers to the act of trading one currency for another in the world financial market. The currencies change in their respective values over time and as a result the trader can theoretically profit through the act of buying and selling.

The period 1971-3 witnessed the crumbling of the Bretton Woods system of fixed exchange rates, leading to the floating of gold and currencies freely on the international financial market. Since then the amount of currencies exchanged internationally has grown significantly so that, according to the BIS (p.1), by 2007 the average daily turnover was $3.2 trillion. This leads to a highly liquid market where nobody, not even governments have a significant influence. That being said, Wikipedia, referring to the Wall street Journal Europe say that the ten most active traders, namely banks, account for almost 73% of trading volume. Other people involved in currency trading include central banks, brokers, companies involved in international trade, hedge funds, investors and speculators. The largest proportion of people trading currencies are speculators, they buy and sell currencies purely with the intention of profiting from the trade.

There is a debate whether speculators are positive contribution to the international currency market. Their trades tend to lead to the market overshooting it’s position. Countries blame speculators for distortions in their currency values. In July 1997, speculators sold the Malaysian ringgit heavily leading to a 50% decline in the currency. The Malaysian Prime Minister Mahathir Mohamad at that time accused speculators, a notable example being George Soros, of attacking the currency. The reality is, however, that speculators cannot afford to speculate in the wrong direction or they lose a lot of money. The only exception is where somebody has a monopoly over a currency, and this is why poorer countries tend to have fixed exchange rates to the dollar, to give them financial stability.

Advantages of Forex
Equity (buying shares etc) is a relatively stable form of investment and has many advantages, but forex has some advantages over equity. That being said, some trading companies mention advantages that are not really advantages at all. First, the advantages:
1. Liquidity – Due to the size of the forex market, there is always somebody willing to buy or sell a specific currency. In the our context that ‘person’ is a currency trading company who is not actually trading currencies but derivatives.
2. You can trade 24 hours a day – The forex is open 24 hours a day during the week (but not on the weekend) and you can trade any hour of the day or night.
3. You can make a profit on falling or rising currencies.
4. There is little chance that one person can dominate the international currency market so there is a relatively fair playing field.
5. In the UK at the moment, you do not pay tax on earnings from trading. The reason is because it is considered gambling.

Falsely Claimed Advantages of Forex
1. There is no commission – This is not actually much of an advantage because the currency trading companies make enough on the spread.
2. Currency Trading is ‘safe’. This is hardly true. There are ‘safe’ accounts, meaning that you can only lose all the money in your trading account rather than your house as well, but the reality is that in the ‘safe’ accounts, they double the size of the spread (that is, the profit that they take). See also later comments on gaps.
3. High Leverage. Currencies only change very slightly in any given day. Consequently, companies offer leverage on currencies so that even though their values change very slightly, their clients can gain or lose a lot of money quickly. This happens because the client does not buy an actual currency, only a proportion. For example, if there are two dollars to the pound and somebody believes that the dollar is going to become stronger, they can buy a hypothetical $100 000 for £50 000 with a leverage of 200:1 meaning that the client only pays 50 000/200 = £250 for the currency. If in a given time £1= $1.99, a person can then sell their $100 000 into pounds, 100 000/1.99 = 50 251. The client then finds that their initial investment of £250 has earnt them 50251 – 50 000 = £251… nice! The problem is that leverage can affect speculators the other way and they can equally lose the same amount of money and so leverage is not essentially an ‘advantage’.

Wikipedia has a good article on Forex scams that should be read prior to putting money up for trading. NEVER borrow money to do trading.