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What Is the FOREX?

If everyone in the world used the same currency, there would be no need for a foreign currency exchange market or foreign exchange rates. However, our world consists of several national currencies and as individuals or companies from one country trade across borders, the need for foreign currency arises. For example, when a U.S. importer buys French wine, either the importer needs Euros to pay the French merchant or the French merchant must accept US Dollars and then convert them to Euros. The (spot) FOREX, a global market where trades are transacted immediately at current market price, plays a key role in transferring financial payments across borders and moving funds and purchasing power from one currency to another. This international market has played an extensive and direct role in national economies and has a major impact that affects our lives and our prosperity. The movement of different currencies between countries determines a very important price: the exchange rate. It is the exchange rate that allows the currencies to be traded for profit. The Foreign Exchange is not traded on a physical exchange like the stock market. It is traded via the telephone or through the Internet. This electronic structure has contributed to making the FOREX the largest marketplace in the world. With over $1.5 trillion dollars traded per day versus $25 billion per day traded on the New York Stock Exchange (NYSE), the Foreign Exchange market offers many trading opportunities due to the low cost of executing the transactions and the speed at which the execution occurs. The (spot) FOREX market is open 24 hours a day, six days a week, Sunday evening through Friday afternoon. Virtually all large institutions and professional traders conduct most of their Foreign Exchange dealing in the (spot) FOREX market. The (spot) FOREX market pairs together currencies from different countries and quotes them according to the values of the respective currency. The (spot) FOREX market has extremely low margin rates as compared to those of the NYSE. FOREX market brokers offer margin rates anywhere from as low as 1% to 2%. At a 2% margin rate, you can trade $2,000 in a margin account and control $100,000 in currency exchange trading capacity. But you must be careful, the leverage can be a double-edged sword and without proper risk management and tools, the market can move against you resulting in the loss of your trading capital. Most brokers in the (spot) FOREX do not charge a commission. Instead, they are compensated by the difference between the bid and the ask: Bid what the trader sells at and what the market buys at Ask what the trader buys at and what the market sells at The difference between the bid and the ask is called the spread. Be sure to read the brokers disclosure statement; some of them charge transaction fees or ticket charges.

Market Hours
The spot FX market is unique to any other market in the world, as trading is available 24-hours a day. Somewhere around the world, a financial center is open for business, and banks and other institutions exchange currencies, every hour of the day and night with generally only minor gaps on the weekend. Essentially foreign exchange markets follow the sun around the world, giving traders the flexibility of determining their trading day. How market hours work:

Time Zone
Tokyo Open Tokyo Close

New York
7:00 PM 4:00 AM

GMT
0:00 9:00

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London Open London Close NY Open NY Close

3:00 AM 12:00 PM 8:00 AM 5:00 PM

8:00 17:00 13:00 22:00

Market Participants
Until recently, the Forex market wasn't accessible to the retail trader or individual speculator. With the large minimum transaction sizes and often-stringent financial requirements, banks, hedge funds, major currency dealers and the occasional high net-worth individual speculator were the principal participants. These large traders were able to take advantage of the many benefits offered by the Forex market versus other markets - including vast liquidity, 24-hour market access, and the strong trending nature of the world's primary currency exchange rates.

Trade with the 'Big Boys'

Forex United - with its extensive network of relationships in the FX market, is now able to offer smaller transactional sizes (as small as 1000 units) and allow investors of almost any size, including individual speculators or smaller companies, the opportunity to invest and take advantage of the same rates and price movements as the large players who once dominated the Forex market.

Ancient Times
Money has been around in one form or another since the time of Pharaohs. Middle Eastern moneychangers were the first currency traders who exchanged coins from one culture to another. However, during the middle ages, the need for another form of currency besides coins emerged as the method of choice. The Babylonians are credited with the first use of paper bills and receipts. These paper bills represented transferable third-party payments of funds, making foreign currency exchange trading (also referred to as Forex or FX) much easier for merchants and traders. From the infantile stages of foreign currency exchange during the Middle Ages to WWI, the Forex markets were relatively stable and without much speculative activity. After WWI, the Forex markets became very volatile and speculative activity increased tenfold. From 1931 until 1973, the Forex market went through a series of changes many of which have paved the way for the road ahead. The Forex market, as we know it today, originated in 1973.

A Transitional Era
The Bretton Woods Accord The first major transformation, the Bretton Woods Accord, took place toward the end of World War II. The United States, Great Britain and France met at the United Nations Monetary and Financial Conference in Bretton Woods, New Hampshire to design a new global economic order. The location was chosen because, at the time, the U.S. was the only country unscathed by war; most of the major European countries were in shambles. The Bretton Woods Accord was established to create a stable environment by which global economies could restore themselves. The Bretton Woods Accord established the pegging of currencies and the International Monetary Fund (IMF) in hopes of stabilizing the global economic situation. Up until WWII, Great Britain 's currency, the Great British Pound, was the major currency by which most currencies were compared. This changed when the Nazi campaign against Britain included a major counterfeiting effort against its currency. In fact, WWII vaulted the U.S. dollar from a failed

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currency after the stock market crash of 1929 to a benchmark currency by which most other international currencies were compared. Now, major currencies were pegged to the U.S. dollar. These currencies were allowed to fluctuate by one percent on either side of the set standard. When a currency's exchange rate would approach the limit on either side of this standard, the respective central bank would intervene to bring the exchange rate back into the accepted range. At the same time, the US dollar was pegged to gold at a price of $35 per ounce further bringing stability to other currencies and the world Forex situation. The Bretton Woods Accord lasted until 1971. Ultimately, it failed, but did accomplish what its charter set out to do, which was to re-establish economic stability in Europe and Japan. The Beginning of the Free-Floating System After the Bretton Woods Accord came the Smithsonian Agreement in December of 1971. This agreement was similar to the Bretton Woods Accord, but allowed for a greater fluctuation band for the currencies. In 1972, the European community tried to move away from its dependency on the dollar. The European Joint Float was established by West Germany, France, Italy, the Netherlands, Belgium and Luxemburg. The agreement was similar to the Bretton Woods Accord, but allowed a greater range of fluctuation in the currency values. Both agreements made mistakes similar to the Bretton Woods Accord and in 1973 collapsed. The collapse of the Smithsonian agreement and the European Joint Float in 1973 signified the official switch to the free-floating system. This occurred by default, as there were no new agreements to take their place. Governments were now free to peg their currencies, semi-peg or allow them to freely float. In 1978, the free-floating system was officially mandated. In a final effort to gain independence from the dollar, Europe created the European Monetary System in July of 1978. Like all of the previous agreements, it failed in 1993.

The Foreign Exchange Market Today

The major currencies today move independently from other currencies. The currencies are traded by anyone who wishes. This has caused a recent influx of speculation by banks, hedge funds, brokerage houses and individuals. Central banks intervene on occasion to move or attempt to move currencies to their desired levels. The underlying factor that drives today's Forex markets, however, is supply and demand. The free-floating system is ideal for today's Forex markets.

Quoting Conventions
In the Foreign Exchange market, currencies are traded in pairs. For instance, a speculator may trade the Euro versus the US Dollar, EUR/USD, or the US Dollar versus the Japanese Yen, USD/JPY. The base currency is the term for the first currency in the pair. The counter currency is the term for the second currency in the pair. The exchange rate represents the number of units of the counter currency that one unit of the base currency can purchase. Traders in the Foreign Exchange market are speculating on the exchange rate between two currencies. Exchange rate s measure the relative strength of one currency to another. Speculators make buy and sell decisions on currency pairs based on fundamental and technical analysis, with the intention of the exchange rate moving in their favor. EUR/USD In this example euro is the base currency and thus the basis for the buy/sell. If you believe that the US economy will continue to weaken and this will hurt the US dollar, you

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would execute a BUY EUR/USD order. By doing so you have bought euros in the expectation that they will appreciate versus the US dollar. If you believe that the US economy is strong and the euro will weaken against the US dollar you would execute a SELL EUR/USD order. By doing so you have sold euros in the expectation that they will depreciate versus the US dollar. USD/JPY In this example the US dollar is the base currency and thus the basis for the buy/sell. If you think that the Japanese government is going to weaken the yen in order to help its export industry, you would execute a BUY USD/JPY order. By doing so you have bought U.S dollars in the expectation that they will appreciate versus the Japanese yen. If you believe that Japanese investors are pulling money out of U.S. financial markets and repatriating funds back to Japan, and this will hurt the US dollar, you would execute a SELL USD/JPY order. By doing so you have sold U.S dollars in the expectation that they will depreciate against the Japanese yen. GBP/USD In this example the GBP is the base currency and thus the basis for the buy/sell. If you think the British economy will continue to be the leading economy among the G7 nations in terms of growth, thus buying the pound, you would execute a BUY GBP/USD order. By doing so you have bought pounds in the expectation that they will appreciate versus the US dollar. If you believe the British are going to adopt the euro and this will weaken pounds as they devalue their currency in anticipation of the merge, you would execute a SELL GBP/USD order. By doing so you have sold pounds in the expecta tion that they will depreciate against the US dollar. USD/CHF In this example the USD is the base currency and thus the basis for the buy/sell. If you think the Swiss franc is overvalued, you would execute a BUY USD/CHF order. By doing so you have bought US dollars in the expectation that they will appreciate versus the Swiss Franc. If you believe that due to instability in the Middle East and in U.S. financial markets the dollar will continue to weaken, you would execute a SELL USD/CHF order. By doing so you have sold US dollars in the expectation that they will depreciate against the Swiss franc.

Sample Trade
A trader wishes to speculate on EUR/USD. Believing that the EUR will rise against the USD, or that the exchange rate will move upwards, the trader places an order to buy EUR/USD at a market rate of 1.3050. Let us also assume that the trader is speculating on 100,000 units of the base currency, which is the standard lot size, or trading increment, used in the Foreign Exchange market. Since the base currency is the first currency in the pair, the trader is speculating on the value of 100,000 Euros with respect to the US Dollar. In this example, the trader is buying Euros, since he believes the Euro will rise in value with respect to the US Dollar. Accordingly, he finances the transaction of buying 100,000 Euros by borrowing an equivalent amount of US Dollars. For the trader, the value of the amount borrowed is a function of the exchange rate. Since the exchange rate at the time of the transaction was 1.3050, the market cost for 1 Euro was 1.3050 US Dollars. Hence, 100,000 Euros cost $130,500 (1.3050 * 100,000). This borrowed amount of 130,500 USD must be paid back when the transaction is closed. Lets assume that the trader is correct in assuming that the Euro would rise in value with respect to the USD, and that the exchange rate moved to 1.3150, 100 pips above the rate at which the trader entered. If the trader were to close his position now, the 100,000 Euros he purchased at the onset of the transaction would be sold, and his debt of 130,500 US Dollars would be paid off.

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At an exchange rate of 1.3150, the traders 100,000 Euros are now worth 131,500 US Dollars (100,000 * 1.3150). After repaying the borrowed amount of 130,500, this leaves him with a profit of $1,000. Traders have equal opportunities to profit regardless of whether the exchange rate is rising or falling.

Spreads & Bid/Ask

When viewing quotes, you will notice that there are two prices for each currency pair. Similar to all financial products, FX quotes include a "bid' and "ask". The bid is the price at which a dealer is willing to buy and clients can sell the base currency in exchange for the counter currency. The ask is the price at which a dealer is willing to sell and a client can buy. Bid = The Price at which the Trader (You) Can Sell Ask = The Price at which the Trader (You) Can Buy For example, say the EUR/USD is trading at 1.3050 x 1.3053. In this case, the bid is 1.3050 and the ask is 1.3053. The difference between the bid and ask constitutes the spread. In the above example, the spread is 3 pips, or points. This differential reflects the cost of the trade. Essentially, the market would have to move 3 pips in your favor for you to break even, and 4 pips for you to be in your profit zone.

Structure of the Market

The FX market is an over-the-counter market with no centralized exchange. Traders have a choice between firms that offer trade-clearing services. Unlike many major equities and futures markets, the structure of the FX market is highly decentralized. In other words, there is no central location where trades occur. The New York Stock Exchange, for example, is a totally centralized exchange. All orders pertaining to the purchase or sale of a stock listed on the NYSE are routed to the same dealer and pass through the hands of a single clearing firm. This structure requires buyers and sellers to meet at the NYSE in order to trade a stock that is listed on this exchange. It is for this reason that there is one universally quoted price for a stock at any given time. In the FX market there are multiple dealers whose business is to unite buyers and sellers. Each dealer has the ability and the authority to execute trades independently of each other. This structure is inherently competitive as traders are faced with a choice between a variety of firms with an equal ability to execute their trades. The firm that offers the best services and execution will capitalize on this market efficiency by attracting the most traders. In the equities markets, the execution of trades is monopolized and there is no incentive for a clearing firm to offer competitive prices, to innovate, or to improve the quality of their service.

Margin
In standard cash stock accounts, money should be deposited for the full amount of the position you are trading, or if you have a margin account, for at least half of the position. This is in contrast to the FX market, where only a small percentage of the actual position value needs to be deposited prior to taking on the trade. This small deposit, known as the margin, is not a down payment, but rather a performance bond or good faith deposit to ensure against trading losses. The margin requirement allows traders to hold positions much larger than their account value (up to 200x the size). Margin requirements are as low as .5% meaning for every standard lot size of 100,000 units, you must commit $500. However, if you wanted to control a $100,000 in the stock market, you would have to deposit at the very least, $50,000. Even in the futures market you would have to deposit at least $5,000 to control a $100,000 position.

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Bank of England Collapse

The above illustration shows a classic example of a 5000-pip collapse of the GBP/DEM in 1992 from 2.9000 to 2.4000 in a matter of weeks. George Soros, in fact made $1 billion overnight buying GBP to convert them into DEM.

Currency Abbreviations
Below is a list of the abbreviations for various currencies that are commonly traded in the FX market: EUR = Euro GBP = British Pound (Sterling, Cable) JPY = Japanese Yen CHF = Swiss Franc (Swissie) USD = United States Dollar NZD = New Zealand Dollar (Kiwi) AUD = Australian Dollar (Aussie) CAD = Canadian Dollar

WHAT DRIVES THE CURRENCY MARKETS

Currency markets move based on countries economic data or different world events, which may affect a particular countrys economy. Market Sentiment Market sentiment can defy logic; market psychology often contradicts business reality. But in the real world, perception can become reality, at least for a time. Therefore, you must at times be prepared to make moves that are against your better judgment. The flip side is that at other times, your investor intuition can prove to be more valuable than painstaking analysis.

CURRENCY BROKERAGE FIRMS

Currency Brokers are firms or agents of large banks that take orders from different clients, companies or countries for an amount of currency that needs to be bought or sold and converted from one to another. Brokerage firms also allow clients to speculate on the values that a currency will move to in the future. Brokers in the U.S. are required to be licensed and are regulated by the NFA or National Futures Association. Most brokerage firms clear their currency purchases through large InterBank Clearing Desks run by the worlds largest banks.