Retail forex
From Wikipedia, the free encyclopedia
 |
This article or section is missing citations or needs footnotes. Using inline citations helps guard against copyright violations and factual inaccuracies. (May 2007) |
| Foreign Exchange | |
 |
|
|
Exchange Rates |
|
|
Markets |
|
|
Products |
|
|
See also |
|
In financial markets, the retail forex (retail currency trading or retail FX) market is a subset of the larger foreign exchange market. This "market has long been plagued by swindlers preying on the gullible," according to The New York Times[1]. It's commonly thought that about 90% of all retail FX traders lose money. [2] [3]
Contents |
[edit] History
| Rank | Currency | ISO 4217 Code |
Symbol |
|---|---|---|---|
| 1 |  United States dollar |
USD | $ |
| 2 |  euro |
EUR | € |
| 3 |  Japanese yen |
JPY | ¥ |
| 4 |  British pound sterling |
GBP | £ |
| 5/6 |  Swiss franc |
CHF | - |
 Australian dollar |
AUD | $ |
While forex has been traded since the beginning of financial markets, on-line retail trading has only been active since about 1996 . From the 1970s, larger retail traders could trade FX contracts at the Chicago Mercantile Exchange.[1]
By 1996 on-line retail forex trading became practical. Internet-based market makers would take the opposite side of retail trader’s trades. These companies also created online trading platforms that provided a quick way for individuals to buy and sell on the forex spot market.
In online currency exchange, few or no transactions actually lead to physical delivery to the client; all positions will eventually be closed. The market makers offer high amounts of leverage. While up to 4:1 leverage is available in equities and 20:1 in Futures, it is common to have 100:1 leverage in currencies.]].[1] In the typical 100:1 scenario, the client absorbs all risks associated with controlling a position worth 100 times his capital.
Currencies are quoted in pairs i.e. EURUSD (euro vs. United States dollar). These are often incorrectly quoted with a "/" between them. In fact if the "/" is present the currency order should be reversed - the "/" signifying arithmetic division. The pair should be quoted EURUSD or USD/EUR. This then gives the correct exchange rate. e.g. if you had to pay $135,000 for €100,000 135000/100000 = 1.35 (the exchange rate).
[edit] Key Concepts Behind a Retail Forex Trade
[edit] Currency Pairs
Currency prices can only fluctuate relative to another currency, so they are traded in pairs. Take two of the most common currency pairs, the EURUSD (the price for euros in US dollars) and the GBPUSD (the price for the British pound in US dollars).
[edit] High Leverage
The idea of margin (leverage) and floating loss is another important trading concept and is perhaps best understood using an example. Most retail Forex market makers permit 100:1 leverage, but also, crucially, require you to have a certain amount of money in your account to protect against a critical loss point. For example, if a $100,000 position is held in EURUSD on 100:1 leverage, the trader has to put up $1,000 to control the position. However, in the event of a declining value of your positions, Forex market makers, mindful of the fast nature of forex price swings and the amplifying effect of leverage, typically do not allow their traders to go negative and make up the difference at a later date. In order to make sure the trader does not lose more money than is held in the account, forex market makers typically employ automatic systems to close out positions when clients run out of margin (the amount of money in their account not tied to a position). If the trader has $2,000 in his account, and he is buying a $100,000 lot of EURUSD, he has $1,000 of his $2,000 tied up in margin, with $1,000 left to allow his position to fluctuate downward without being closed out.
Typically a trader's trading platform will show him three important numbers associated with his account: his balance, his equity, and his margin remaining. If trader X has two positions: $100,000 long (buy) in EURUSD, and $100,000 short (sell) in GBPUSD, and he has $10,000 in his account, his positions would look as follows: Because of the 100:1 leverage, it took him $1,000 to control each position. This means that he has used up $2,000 in his margin, out of a $10,000 account, and thus he has $8,000 of margin still available. With this margin, he can either take more positions or keep the margin relatively high to allow his current positions to be maintained in the event of downturns. If the client chooses to open a new position of $100,000, this will again take another $1,000 of his margin, leaving $7,000. He will have used up $3,000 in margin among the three positions. The other way margin will decrease is if the positions he currently has open lose money. If his 3 positions of $100,000 decrease by $5,000 in value (which is fairly common), he now has, of his original $7,000 in margin, only $2,000 left.
If you have a $10,000 account and only open one $100,000 position, this has committed only $1,000 of your money plus you must maintain $1,000 in margin. While this leaves $9,000 free in your account, it is possible to lose almost all of it if the speculation loses money.
[edit] Transaction Costs and Market Makers
Market makers are well compensated for allowing retail clients to enter the forex market. They take part or all of the spread in all currency pairs traded. In a common example, EURUSD, the spread is typically 3 pips (3/100 of a percent). Thus prices are quoted with both bid and offer prices (e.g., Buy EURUSD 1.2000, Sell EURUSD 1.2003). That difference of 3 pips is the spread and can amount to a significant amount of money. Because the typical standard lot is 100,000 units of the base currency, those 3 pips on EURUSD translate to $30 paid by the client to the market maker. However, a pip is not always $10. A pip is 1/100th of a percent, and the currency pairs are always purchased by buying 100,000 of the quote currency, which is also known as the counter currency. For the pair EURUSD, the base currency is USD; thus, 1/100th of a percent on a pair with USD as the base currency will always have a pip of $10. If, on the other hand, your currency has Swiss Franc (CHF) as a base instead of USD, then 1/100th of a percent is now worth around $8, because you are buying 100,000 worth of Swiss Francs.
[edit] Financial Instruments
There are several types of financial instruments commonly used.
- Forwards
- One way to deal with the Forex risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be a few days, months or years.
- Futures
- Foreign currency futures are forward transactions with standard contract sizes and maturity dates — for example, 500,000 British pounds for next November at an agreed rate. Futures are standardized and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts.
- Swaps
- The most common type of forward transaction is the currency swap. In a swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not contracts and are not traded through an exchange.
- Spot
- A spot transaction is a two-day delivery transaction, as opposed to the futures contracts, which are usually three months. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction. The data for this study come from the Spot market.
[edit] The Difference Between Spot and Futures in Forex
 |
This section does not cite any references or sources. (April 2008) Please help improve this article by adding citations to reliable sources. Unverifiable material may be challenged and removed. |
|
|
This section may contain original research or unverified claims. Please improve the article by adding references. See the talk page for details. (April 2008) |
Before a description of retail trading, it is important to understand the difference between the Spot and Futures markets. Futures are generally based on contracts, with typical durations of 3 months. Spot, on the other hand, is a two-day cash delivery. While the Futures markets was created to hedge out risks and speculate on future market conditions, Spot was created to allow actual cash deliveries. Spot developed a two-day delivery date in order to give those transporting the actual cash a window of time to receive it. While in theory there still is a two-day delivery date imposed after a Forex transaction, this is effectively no longer used. Every day, at 5 pm EST (the predetermined end of the trading day) Spot positions are closed and then reopened. This is done in order to guarantee an unlimited timeline for delivery. For example, if a Spot transaction occurs on a Monday, the delivery date is Wednesday. At 5 pm on Monday, the position is closed and then immediately re-opened; now this is a new position with the close date of Thursday. This daily process allows an investor to hold open a position indefinitely.
Another important difference between Futures and Spot is how interest is credited. Each currency in a Forex transaction has an inherent interest rate attached to it. In the case of the US dollar, this is the Federal Funds Rate. This interest is added every single day whether the market is trading or not. Interest cannot take a vacation; money and its loaning value are still important even if the financial world has stopped dealing. In Futures, the interest is built into the price of the contract. In Spot, however, interest is not taken into account in the offering price because the Spot market is a cash market, not a contract market. There must be some mechanism for crediting interest, and various institutions have developed ways to do it. The most common method is to credit that day’s worth of interest at the same time they “flip” the position, or carry it over to the next day. This is important for later discussions and analysis because the transactions examined in this study had interest credited at the end of the business day at exactly 5 pm EST. If a position was held from 5:01 pm on Tuesday and closed at 4:59 pm on Wednesday, no interest would be credited for that day. If, on the other hand, a position was opened Tuesday at 4:59 pm and closed Tuesday 5:01 pm, a full day’s interest would be credited. This has interesting ramifications; traders who work intra-day, or “day traders,” often do not use interest for either gain or loss.
[edit] References
- ^ a b c Egan, Jack. "Check the Currency Risk. Then Multiply by 100", The New York Times, June 19, 2005. Retrieved on 2007-10-30.
- ^ Tajitsu, Naomi. "Japan's retail forex punters trade round the clock", Reuters, July 11, 2007. Retrieved on 2007-10-31.
- ^ Karmin, Craig. "Currency Markets Draw Speculation, Fraud", The Wall Street Journal, Dow Jones and Company, July 26, 2005. Retrieved on 2007-10-31.
[edit] See also
[edit] External links
- Online foreign exchange trading - 3 December 2007 – Finance Week introduction online forex for small and medium businesses in the UK
