Category: Forex for Beginners

Effective long and medium-term trading strategies in all markets typically involve identifying the major underlying trend and then trading with the trend’s overall direction.

This tends to hold true regardless of whether the trend consists of an upward trend or bull market, or a downward trend that is otherwise known as a bear market.

Bear Markets and Stock Trading Regulations

Because of the regulation which many traders consider to be excessive, stock traders are often limited in their ability to take short positions in stocks. This can significantly affect the scope of their trading opportunities, especially in bear markets.

The reason for these numerous rule changes involves the stock market’s various crashes which have occurred historically. These regulations have the overall effect of making the shorting of stocks increasingly difficult in declining markets.

Basically, traders are only permitted to short a stock on an uptick in its price. This so-called short sale rule has even been expanded recently to prohibit the shorting of financial stocks altogether when the market has declined by a certain percentage.

In addition, because of the fact that currencies trade in pairs, all currencies cannot decline simultaneously in the forex market. This differs from stocks, which can all move down simultaneously in a typical bear market crash scenario. This is the primary reason that the short selling regulations were instituted in the first place.

Trade Bear Markets in Forex Easily

Unlike the stock market, the forex market is comparatively unregulated. This allows traders to sell short regardless of the direction of the last sale, which is how this regulation works in the stock market. In essence, the forex market allows traders to go short any currency pair as long as a bid price can be found in the amount they wish to deal.

Because of the lack of restrictions in the forex market, bull and bear markets remain equally easy to trade. Also, because of its unregulated nature, moves in the forex market are usually dictated by the levels of supply and demand in the market, although at times central banks may intervene to stabilize their currency.

Basically, the forex market allows traders a more equitable and efficient marketplace in which to operate. This makes trading just as easy in a bear market as in a bull market.

The U.S. Dollar’s Trend Creates Bull and Bear Forex Markets

In the stock market, individual stocks will tend to trend according to the company’s prospects and for the market generally.

Nevertheless, stocks which perform poorly will still rise in a bull market, while high performing stocks with strong earnings will still decline in a bull market, although perhaps to a lesser degree than the overall market.

The rough equivalent of the overall stock market for forex traders is the performance of the U.S. Dollar. Because of the Dollar’s status as the world’s premier reserve currency since the end of the Second World War, the majority of large moves seen in the forex market will either be in favor of or against the U.S. Dollar.

Basically, since the U.S. Dollar often plays the role of market leader, its value will rise and fall against a number of other currencies simultaneously depending on economic conditions in the United States in relation to the rest of the world.

This tends to give the impression of bull or bear markets for all currency pairs which include the U.S. Dollar as the fortunes of the United States rise or fall respectively.

The forex market has often been the choice for many professional traders who had previously traded in the stock and commodity markets. Some reasons for their switch are rather simple: the forex market offers greater liquidity, longer trading hours and more trading opportunities.

Furthermore, with the advent of forex electronic trading available by connecting to the Internet, in combination with the recently available online forex retail accounts, small investors can now access and trade the multi-trillion dollar forex market that was previously only available to banks and large corporations.

Before the Internet, small traders were largely restricted to trading stocks or commodity futures and options, where retail accounts have, for the most part, always been available.

Also, currency futures were not made available until just after exchange rates began to float in 1972. For many years, currency futures were the only way that retail traders could participate in the foreign exchange market.

The forex market has some clear advantages for traders which cannot be found in other markets such as the stock market. Some of these features that the forex market offers traders compared to the stock market include:

Liquidity

The forex market makes up the deepest and most liquid market on the planet.

Currency trading occurs around the clock by the world’s largest banks and financial institutions and helps ensure that a market maker or dealer will always be available to take either side of a trade.

Conversely, trading in the stock market is limited to certain hours of the day, and liquidity can become almost nonexistent in some of the smaller stocks.

Trading Hours

The forex market remains open continuously from Sunday afternoon until Friday afternoon EST. This means that currency traders enjoy the longest continuous trading hours of any financial instrument.

Stock trading is limited to certain hours of the day, with some highly capitalized stocks which may be traded on overseas markets.

Expense

Trading stocks can be quite costly, especially for active traders since commissions can build up significantly.

Trading currencies is considerably less expensive in comparison since most forex dealers only charge a part of the spread instead of charging a straight commission.

This means the cost savings in trading forex over trading in stocks can be considerable.

Leverage

One of the best reasons to trade in the forex market consists of the amount of leverage a trader can use. Trading in stocks requires 50% of the purchase price, or a 2:1 leverage ratio, while forex trades can be leveraged by as much as a 500:1 ratio.

Because a trade in the forex market represents an exchange of equivalent assets, there is no initial cost in establishing a position. This differs from the stock market where one is actually purchasing an asset.

Fewer Choices for a Trading Vehicle

In contrast to the stock market, where thousands of stocks exist, the lion’s share of trading in the forex market occurs in just eight major and minor currency pairs quoted against the U.S. Dollar and several active cross rates pairs.

This makes choosing a currency pair to trade substantially easier than picking from among the thousands of choices in the stock market.

Not only is the forex market the largest financial market worldwide, but it also includes a high number of participants.

One of the primary benefits of having more active participants in a market is that it usually contributes to greater liquidity in that market.

Advantages of Liquidity

The basic idea behind liquidity involves how quickly you can convert an asset into cash. Of course, with currency trading, you can turn your spot trade into cash within just a couple of business days.

When a market is highly liquid, that implies that it operates in a very efficient manner. Usually dealing spreads would also be quite competitive, with relatively low transaction costs.

Read our previous article: Winning Forex Trade with Major Currencies

Another advantage of high liquidity is the ability of a market to handle large transactions without the price moving too far as a result. Liquidity also generally means that orders will tend to be executed well, with minimal slippage on stop losses.

When it comes to liquidity, the huge forex market easily comes out on top when compared to other financial markets like those for stocks, bonds, and commodities. It also offers 24-hour trading during the business week.

Forex Participants That Help Provide Liquidity

The main participants in the forex market that assist in providing liquidity generally fall into one of the following basic types:

• Major Commercial and Investment Banks

  These are the big professional players in the forex market. By acting as both speculative traders and as market makers to clients and one another, their activities provide substantial liquidity to the forex market.

• Governments and Central Banks

  These institutions can have a major impact on the forex market as they intervene to manage the exchange rate of their nation’s currency or shift currency reserves. At especially volatile times, central banks will often provide liquidity to help stabilize the forex market.

• Large Corporations

  Many companies engage in business in other countries and this often requires that they participate in the forex market. Their hedging activities of foreign currency exposures often help provide considerable liquidity in the forex market, and they generally participate by acting as a large bank’s customer.

• Hedge Funds

  These players largely act as speculative trades in the forex market to enhance their funds’ profits. Their large transactions can significantly increase trading volume and hence liquidity in the forex market.

• Investment Funds

  When the managers of these funds invest internationally or shift investments from one nation’s market to another’s, they need to use the forex market to convert currencies. Usually acting as customers of large banks, their often large forex transactions, and orders, as they enter, exit and protect their foreign investments, can add significant market liquidity.

• Individual Traders

  Such participants can range from wealthy individuals, who can often trade forex using credit lines that banks extend to them, to retail traders who participate on margin via online forex brokers. This group of participants provides an increasing amount of liquidity in the forex market.

• Interbank and Retail Forex Brokers

  These firms act as intermediaries in forex transactions. Interbank brokers will generally only handle sizeable transactions between large banking counterparties, while retail forex brokers tend to provide access to the forex market for much smaller individual accounts. This access has made the forex market available to a much larger segment of the population and has significantly increased both the breadth and liquidity of the forex market.

One of the reasons that many savvy traders consider forex the best market to trade is the little effort required to assimilate the knowledge required for trading.

Also, the fact that most currency trading activity is limited to a handful of key currencies and currency pairs, commonly referred to as the majors, is a distinct advantage relative to other markets.

This makes trading currencies a much simpler trading process, with only eight major and minor currencies to follow. The following sections provide a list of these primary currencies and descriptions of their most active pairs traded in the forex market.

Check our previous article: How to get Forex latest market Information

The Major and Minor Currencies

The so-called major and minor currencies are listed below after their standard ISO 4217 three letter code. They are listed in order of importance as determined by their average daily trading volume seen in the forex market.

• Majors

1. USD – United States Dollar
2. EUR – European Union Euro
3. JPY –  Japanese Yen
4. GBP – Great Britain Pound Sterling
5. CHF – Switzerland Franc

 

• Minors

1. AUD – Australian Dollar
2. CAD – Canadian Dollar
3. NZD – New Zealand Dollar

 

According to a 2017 survey by the Bank of International Settlements or BIS, the major and minor currencies listed above account for over 87% of all daily currency trading volume.

In addition, the U.S. Dollar acts as either the base currency or counter currency in over 85% of all forex trades and so clearly dominates forex trading activity.

The Primary Currency Pairs

Below find a brief description of all the currency pairs which make up the main currency pairs traded in the forex market:

 

• EUR/USD – The European Union’s Euro quoted in U.S. Dollar terms. The E.U. has the largest economy in the world by GDP, followed by the United States. This currency pair accounts for 27% of all forex transaction by trading volume.
• USD/JPY – The second most active currency pair, the USD/JPY currency pair accounts for 13% of daily forex trading volume. The USD/JPY pair is one of the most liquid, and the dealing spread can be as low as one pip.
• GBP/USD – Number three on the list is Cable or GBP/USD. The pair received its nickname at the end of the 1800’s from the Trans-Atlantic cable used to transmit the rate between New York and London. Cable makes up 12% of overall daily trading volume.
• USD/CHF – The U.S. Dollar against the Swiss Franc. While not the most liquid currency pair, it still accounts for over 5% of total daily forex volume.
• AUD/USD – The Australian Dollar versus the U.S. Dollar and nicknamed the Aussie. This pair reacts to commodities prices primarily because Australia is a major mining goods producer. China is one of the main markets for Australian exports.
• USD/CAD – The Canadian Dollar versus the U.S. Dollar. Nicknamed the Loonie after Canada’s national bird that appears on its one dollar coin, the Canadian Dollar also acts as a commodity currency and so reacts to movements in both crude oil and gold.
• NZD/USD – The New Zealand Dollar versus the U.S. Dollar and nicknamed the Kiwi. Not as actively traded as other commodity currencies, this particular currency pair accounts for less than 4% of forex trading volume. Nevertheless, it is a popular currency to trade among speculators.

Conclusion

Basically, a trader has a whole lot less to watch and hence less to worry about when trading in the forex market versus other capital markets. Having a limited number of currencies is clearly an asset that forex traders can use to their benefit.