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What is FOREX?

FOREX = FOREIGN EXCHANGE

Every country has a currency; a country IS their currency. If you want to buy Maple Syrup from Canada, you need to pay in Canadian dollars, so the Maple Syrup maker can go buy the things he needs in Canada.

When a country sells it's goods and services, payment is eventually received in their local currency. If their goods are in high demand, there will be a short supply of their currency, as people will be willing to pay more and more, as it goes. Thus we have a free-floating currency system where countries trade their currencies based on trade value and also interest. Each holder of any dollars receives interest on that money, and the higher the interest the more attractive that currency is. Now think about the US - during the 90's everyone in the world wanted to invest in the DOW, the NASDAQ, in small US based businesses, and properties. Every single investor, before purchasing the above, needs to purchase US Dollars! Money flowing into the states can explain the strength of the dollar in part.

The growth of the post World War 2 economy can be largely credited with the stable financial system put in place by F.D.R. called The Bretton Woods Treaty. This laid out an economic policy for currency and exchange rates which were fixed, and that the U.S. would act as a world banker (all foreign central banks would hold U.S. dollars as a reserve currency), and the U.S. dollar would be backed by Gold and Silver (See Bretton Woods) . In 1971 U.S. President Richard Nixon abandoned this agreement, and soon currencies began freely floating against each other based on market demands.

Now, it is possible for anyone with a computer to trade in the currency market. In a world of Globalization, where the largest U.S. retail distributor (Wal-Mart) imports its' goods from countries like China, currency investment combines all world financial markets. Americans, for example, may not understand that by NOT investing in currency they actually lost 50% since 2002, but they understand that gas is more expensive, along with many other imported products. Therefore an investment in forex is not a traditional 'investment' with the hope of potential return, it is a hedge against inflation caused by your local currency fluctuations.

Currency Hedging

Hedge v.

- To hem in, hinder, or restrict with or as if with a hedge
- To minimize or protect against the loss of by counterbalancing one transaction, such as a bet, against another.
- A securities transaction that reduces the risk on an existing investment position

If your business does regular international business, you may implement a "hedging" strategy. This can be done in many ways, typically a business will buy a year's worth of foreign currency at a set rate. Whatever is the rate, it prevents fluctuations in a currency to affect the budget of the business.

A hedge is simply a strategy to safen your investment. Buying gold is a hedge if you hold US Dollars, because they have an inverse relationship.

See more about Currency Hedging

 Why Forex

An investment in the currency market is a hedge against other investments. A recommended forex investment should comprise 10% to 20% of your overall portfolio, if your investments are all domestic.

If you have foreign investments, 38% should be put into forex, as your investment can be risked by a fluctuating currency market.

For example, if you live in New Zealand, and invest in the DOW, and your stocks increase by 28%, but the USD goes down by 26% against the NZD, after repatriating the money into NZ you have actually only made 2%, or even less after transaction costs!

 Deliverable

Deliverables are "real deals" or banks actually sending currencies to other countries. A commercial bank may pack thousands of orders together to form a large wire of say a billion dollars to another bank, where that currency is exchanged for the local one. This is what actually drives the forex market.

This does NOT mean PHYSICAL NOTES. Electronic signals are just as legitimate as paper cash.

 

Currency Trading

A forex dealer can buy and sell currencies speculating that they will go up or down in value. While owning a currency you bear the interest of that currency, so if you buy New Zealand Dollars, you get 5% while you own it. If you hold Hungarian Dollars, you get 12%.

The main difference between FOREX TRADING and EQUITY TRADING is that you are not investing in an instrument, or a derivative, but in MONEY ITSELF. When you purchase shares, you are buying the belief that they will go up, and investing in the experience and quality of the company management. When buying USD, you are essentially investing in the entire economy of the US, as if you are investing in all US shares at once. While single companies may rise and fall, the entire US economy will not be wiped out in one day.

While you could argue that buying a countries currency is like investing in that country, in today's world it doesn't quite work like that. American companies have more factories outside the US than inside. 65% of US assets are owned by foreigners. It is more complicated than saying okay, I'm investing in Europe when I buy Euros.

 Central Bank

Central banks play a major role in the forex market, as they are responsible for keeping their own trade balance, currency value, and stable economy. If the currency market became as volatile as the stock market, you would see chaos everywhere, as companies would either be out of business or very rich in a matter of hours, ALL AROUND THE WORLD. Central banks will intervene in the markets to ensure stability, or for example print money and inject it into the economy to increase money supply.

However central banks do not speculate in the forex market, their business is real or 'deliverable'. They may print money or buy a foreign currency to keep in their 'reserves'. Since World War 2 the primary reserve currency has been the US Dollar, although now the Euro is competing for this position.

 Online Platforms

To increase market liquidity even further, many banks have offered software that investment professionals can gain access to the currency markets that banks have.  Your funds are held at that bank, which is usually a major bank, but instead of sitting in one position you may switch to a different currency.  Sometimes this is done by third parties, such as the case with FXCM.  FXCM is a software company essentially, that provides data to you as the user from their banks; they get their prices from the interbank forex market.

There is little difference between a trading platform and your online banking platform.  Online banking is designed to allow multiple daily transfers of funds in between different accounts, usually to pay bills.  In a forex account, this is done to switch dollar positions as the markets move.

 Banking Vs. Forex Managed Account

Why keep money with a forex trader vs. keeping it in a bank? Cash is the most liquid instrument, but imagine having a bank that could constantly switch currencies to the strongest one? Your monthly bank statement might include forex trades, that on a certain day, your deposit of $129,002 was switched to Euros. Forex trading involves a substantial risk of loss.

All money in forex trading platforms are held with the largest investment banks in the world. They are the ones that have access to the currency markets. Your money is still in a bank, but it is managed by a group of people who have it in their best interest for you to profit, and avoid losses. They are constantly watching the market, like 'account watchdogs'.

The money is just as liquid, or "on call", as you can request a full withdrawal and receive the money within at least 24 hours, possibly within the hour if all involved happen to be awake at the same time.

  Forex Vs. Stocks, Bonds, Options

The stock market can crash, the currency market cannot. If the forex market for some reason collapsed, we would be back in the stone age, trading cows for gold, and banks would not exist. Unless you are willing to accept this abstract reality, you can be safe and sound knowing that the forex market will never crash. Anyhow in a scenario like that, only investments in raw materials will be of value (sugar, coffee, alcohol, gasoline, tobacco)

For a detailed description, click here for our forex vs. stocks comparison

To find out more beyond this page, here are some good forex learning resources:

Trading Terms Glossary  Yahoo Forex Dictionary  Cilforex  Elite Trader's Toolbox

FOREX FAQ'S

Where's The Money

Funds are held at a number of international institutions such as Saxo Bank in Copenhagen, National Bank of Australia, Citibank of NY, and other large investment banks. This is to ensure access and liquidity in the event of a major global catastrophic event, where certain local markets may be closed. All banks have secured deposits insured up to millions of dollars, unlike the commercial US FDIC which is up to $100,000.

All banks are connected by the EBS system (Electronic Banking System), through the Interbank Forex Market (price feed) managed by the BIS (Bank of International Settlements) in Switzerland.

But I Buy Everything In Dollars!

As your currency becomes weaker, those goods you need will become increasingly expensive. Take this example:

You make 100$USD a week from your pension. It costs you 80$USD to purchase the food you need that week.

The USD goes down by 25%. It costs suppliers 25% more to buy the same materials they need to produce the food you eat, so they increase the price by 25%. Now your food costs $105 a week, you are still making $100 a week, YOU STARVE TO DEATH.

Click here for a full article explaining how currency and the 'weak' or 'strong' dollar affects YOU.

Why Isn't Everyone Doing This?

If someone knows how to make a million in the markets, why would they tour around giving seminars and selling books?  If a trader is that good, why is he working for a bank for a low-salary?

If you don't understand currency, all the more reason to get into it. It truly affects everyone in business, and the livelihood of every investor on the planet, because all investments are dollar based (in some Fiat dollars). So if it sounds like a bunch of magic to you, find someone who knows what they're doing to work with. Forex trading may not be suitable for all customers.

Forex Articles

Trade.net.nz - New to trading. Full explanation of forex trading

Foreign Exchange Terms Glossary

The Bretton Woods Agreement

From Wikipedia, the free encyclopedia (written by Elite E Services)

The only real currency market is the 'deliverable' orders for individuals and businesses who need to buy and sell x currency at any rate. If you are buying a house in New Zealand, or a farm in Ireland, you will exchange your dollars regardless of the rate. This deliverable business drives the prices up and down unless rates are pegged (see below) like China's Yuan is pegged to the US dollar 8.23 YUAN to 1 USD.

It is possible for investors to speculate on currency fluctuations and realize profits by parking funds in one currency, and after it appreciates in value, switching to another. Of course, that position can just as easily depreciate in value, thus creating a loss.

In our floating point system actually every investment in the world is calculated in some domestic currency. So when you are making 20% on your investment in the US Dollar by investing in the DOW, realize that if the dollar has gone down by 40% you have actually lost! This will not be reflected in your bank statements of course, but it will be reflected in the purchasing power of your dollars when you go to spend them. This is tied to inflation. Let's say you turn a $10,000 investment into $15,000 - you are very happy! But because the US dollar is down by 50%, it now costs 2$ for a gallon of gas than 1$ - so you may have a nice fuzzy feeling about making 50% but in fact you have lost.

Like any market there is a bid and an ask (buying price and selling price). The REAL spread between currencies is actually 1 or 2 pips. In the EURO/USDOLLAR price of 1.4238 a pip would be the '8' at the end. So the bid/ask quote of EUR/USD might be 1.4238/1.4239 - however a bank will mark up the difference to say 1.41 / 1.43 . To most travelers exchanging 10 or 100 or even 1,000 dollars this is only a few dollars, but if you are a business exchanging millions, this can be a huge risk. To mitigate this risk a business will HEDGE a currency, for example buying a contract to buy 6 month worth of EURO at a set price. He will never make money on the currency, but he will never lose, and he can make a budget for selling his products.

People say 'but I buy everything in dollars' - there are several instances where you should consider currency: when you are INVESTING (in anything), when you are traveling, when you are conducting business (other than mom and pop shop). The only airline who is not filing bankruptcy is the one who hedged the price of oil by buying 2 years worth of fuel. Currency is not something to be passed aside.