When people ask what is forex (the common name for foreign exchange), they are surprised to learn that its market is the largest financial marketplace in the world. When asked, most casual investors tend to be under the impression that the stock market is where the bulk of financial activity takes place every day. In fact, the average daily turnover at the New York Stock Exchange hovers around $50 billion.
To put it into perspective, the average daily turnover in the foreign exchange market is around $3 trillion per day. That means the daily turnover in the forex market is more than 50 times greater than the New York Stock Exchange. Furthermore, if you add up the daily turnover at every major stock exchange in the world, including London, Tokyo, Frankfurt, and Sidney, the total is still far less than the daily turnover in the forex market.
Now, this begs the question: If the forex market is the largest financial market in the world, why are so many people unaware of its existence, much less how to actually trade it? Well, the simple answer is that the forex market was accessible to only very wealthy investors until the early 2000’s. The minimum position size typically ranged from $1 million to $10 million, so only investment banks, hedge funds, family offices, and wealthy private investors were able to buy even minimum-sized contracts.
The Internet Changed It All
The internet boom in the late 90’s changed our world forever, and it completely revolutionized the forex market. In the early 2000’s, retail online brokerages began opening up shop and allowing small traders to trade position sizes as small as $10,000 on 100:1 leverage. These retail brokerages were able to negotiate with clearing firms such as Bank of America and Morgan Stanley, and consolidate all of these small retail trades and pass them through to the clearing firms so that the daily turnover and volume would be worth it for the larger clearinghouses.
Today, traders can open up small accounts at retail forex brokers with as little as a few hundred dollars. With the power of leverage, traders can control positions at a 50:1 leverage ratio.
What is Forex and How Do You Trade It?
So what is forex exactly? Forex trading is simply the exchange of one currency for another. If you have ever travelled internationally, then you have traded in the forex market. For example, if you go on holiday to Cancun, you exchange U.S. dollars for Mexican pesos. In effect, you are selling U.S. dollars and buying Mexican pesos. Thus, you are buying the USD/MXN currency pair.
As a retail trader, individuals make bets on the relative movements of one currency against another. Traders do this by analyzing macroeconomic indicators and by analyzing technical charts. By utilizing both types of analysis, traders can gain insight into probable future movements of a currency pair and make active bets.
The incredibly high leverage available in the forex market makes it very attractive for traders because it means that a much smaller amount of capital is needed on deposit with a broker in order to control rather large positions in the marketplace.
Many traders are also attracted to the forex space because of the tendency for currency pairs to trend over a longer time horizon. In our current economic climate, finding trending stocks can be quite a challenge as the stock market has been virtually sideways over a 10 year period. Currencies, on the other hand, rise and fall in relation to a country’s macroeconomic conditions, and these trends can last for years.
To get started trading foreign exchange, simply visit one of the many online retail brokerages and download a simulated account in order to get used to trading with fake money. Oftentimes these retail brokerages also have free educational resources to help a person get started.
Readers – Have you ever looked into trading forex? Does anyone use it as part of their investment strategy?
* This material was written and contributed by Sara Mackey.
Photo Credit: Microsoft Clip Art