How Forex Works
a smaller amount of money controls a much larger amount of money. With regards to Forex Trading for example, a leverage-factor of 100 can allow the trader to hold a 100,000 US Dollar position with a modest 1,000 US Dollar margin deposit. Online Forex day trading focuses its investment activity largely on Spot Forex because of the ‘risk manageability’ of in-and-out trading plus the potential to generate excellent and highly liquid profits.
Forex is not like traditional trading markets where buyers and sellers meet in a central location such as a trading floor. Forex trading has no need of this. The advent of the internet has changed the face of currency trading with the introduction of Interbank Foreign Currency Exchange via Forex Clearinghouses (also called Forex Brokerage Firms).
Because there is a constant trade in currencies going on around the world 24 hours a day, there is less randomness occurring in the currency market than does in the stocks.
Examples of fundamental predictability are demonstrated by the following: 83% of spot foreign exchange activity and 95% of swap activity involves US Dollars. The Euro is the second most active currency at 37%. The Japanese Yen (24%) and the British Pound Sterling (10%) are ranked third and fourth. The Swiss Franc is 7%, and the Canadian and Australian Dollars account for 3%.
A Spot Forex is a currency trade that has a settlement or liquidation period of within two working days after the close of trade. i.e. after the trade has closed payment must be effected within 2 days. Spot Forex allows a trader to have some liquidity therefore. A trader can buy a currency when it is weaker, and sell it when it is stronger, against another currency of course. It should be kept in mind, that with every trader that makes a profit, another trader must make a loss. Forex trading is not a case of everybody wins. It still follows the rules that one is betting that a specific currency will rise against another currency and that a currency will not fall against another currency.
“Few financial industries generate as much excitement and profit as currency exchange. Traders around the world enter trades for weeks, days or split seconds, generating explosive moves or steady flows, and money changes hands quickly at a staggering daily average of a trillion US dollars. Forex profitability is legendary. George Soros of Quantum Fund realized a profit in excess of 1 billion dollars for a couple of days work in September 1992. Hans Hufschmid of Soloman Brothers, Inc. netted $28 million for 1993. Even by Wall Street standards, these numbers are heartstoppers”.*
Despite its high trading volume and its fundamental role in the world, the Forex Market is rarely in the media limelight because its method of trading transaction is less visible than the Floor of a Stock Exchange. However, trading on the Foreign Currency Exchange Market is today surging into the public awareness, as flocks of internet traders are attracted by the market’s inherent profitability and risk manageability. Add to this the absence of geographic or temporal boundaries and a vibrantly active Forex market becomes open to all players.
* “Trading in the Global Currency Markets”, Cornelius Luca, 2000