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The Basics

Getting Started Trading Forex

Terminology and Market Conventions

If you are going to trade forex you need to understand the terms and quoting conventions used, especially in regards to the spot market.

Notational Conventions
The forex market uses 3-letter codes for all currencies.  These are commonly known as SWIFT or ISO codes.  For example, USD is the code for the US Dollar. Here are the codes for the other primary currencies:

AUD: Australian Dollar
CAD: Canadian Dollar
CHF: Swiss Franc
EUR: European Euro
GBP: British Pound
JPY: Japanese Yen
( For a complete listing of all currency SWIFT codes, click here. )

Expressing a relational value between two currencies is done by combining two currency abbreviations in the fashion of XXX/YYY. This indicates the amount of YYY currency (the “quote” currency) equivalent to one unit of XXX (“base” currency).  For example if the exchange rate for USD/JPY – the US Dollar to Japanese Yen rate – was 100 it would mean that each USD is worth 100 JPY.

Using this convention, changes up or down in the quoted exchange rate indicate changes up or down in the value of the base currency. Using the USD/JPY example again, if the rate went from 100 to 101 it would mean a 1% increase in the value of the USD against the JPY.  Similarly, a decline from 100 to 99 would represent a 1% fall in the USD value vs. the JPY.

In theory, one could quote the exchange rates either way around – meaning if USD/JPY is 100 it is the same as saying JPY/USD is 0.01 (one JPY is worth $0.01). In practice, however, the forex market has specific conventions for the traded pairs.  In most cases, USD is the base currency, with the other currency in question being the quote currency. USD/JPY is an example.

There are a few exceptions, though. When it was introduced in 1999, the market authorities decided the Euro would always be the base currency in all traded pairs. Before that, the Pound (GBP) held that distinction. Thus, when traded against either of those, the USD is the quote currency (EUR/USD, GBP/USD). The same also holds for former British Commonwealth currencies the Australian Dollar (AUD/USD) and the New Zealand Dollar (NZD/USD).

It is worth noting that forex futures contracts involving currencies as quoted against the US Dollar do not hold to the spot market convention.  Instead they all use the USD as the quote currency.

Majors and Crosses
In the forex you will here the terms “majors” and “crosses” when traders refer to different categories of currency pairs.  In general terms, the “majors” are the pairs which include the USD quoted against the other primary industrialized currencies. Those include the ones listed above. So the majors are as follows:

AUD/USD
EUR/USD
GBP/USD
USD/CAD
USD/CHF
USD/JPY

While technically every currency pairing is a cross-rate, the term “cross” is most commonly used to refer to currency pairings which do not include the USD. For example, EUR/JPY is the Euro-Yen exchange rate. That would be considered a cross.

Forex Price Quotes
With an understanding of what we are looking at, now we can turn out focus to the actual price quotes.  The graphic shows a sample table of quotes for an array of currency pairs – majors and crosses.

One thing you will notice in the table is that some pairs are quoted to four decimal places, while others only go out two places.  In general terms, those pairs with values of about 10 or less will go out to four places, while those with higher values will be quoted only at two places.

Regardless of how many decimal places a currency pair is quote to, though, the term “pip” is used to define a single price movement value. So, for a two decimal place pair, a pip would be .01, while for a four decimal place pair a pip would be .0001.

We can see this in the quotes on the chart, especially when looking at the bid/offer spreads.  AUD/JPY is quoted at 79.60-79.64, which is a 4 pip spread, while AUD/USD is quoted 0.7648-0.7650 for a 2 pip spread.

In recent times there has been introduced the “pipette”, which is a fraction of a pip. In essence, some of the more popular pairs like EUR/USD are trading at five decimal places now, which is why you can see a spread of 1.5 listed on the chart (column to the right of the price quote itself).  That means the bid-offer spread is 1 and 5/10 pips.

One will sometimes here the term “figure” in spot forex trading. That is used to refer to a price level which is a round 100 pip figure.  In USD/JPY that would be a multiple of 1 full JPY (such as 104), while in GBP/USD the figure would be a $0.01 multiple (like 1.8800).

The term “yard” sometimes comes up as well.  That is used to refer to a one billion base currency transaction.  So a yard of USD/JPY would be $1 billion.

Getting in to the Trading

Opening an Account
It is quite easy to start trading forex. There are a great many forex brokers available and opening an account is pretty straightforward. Some things you should consider as you look to identify the one best suited to you are:

  • Account minimum deposit (if any)
  • Transaction size flexibility
  • Spreads
  • Execution
  • Commissions (if any)
  • Security of deposited funds
  • Allowable leverage
  • Currency pairs available for trading
  • Usability of the trading platform

The great thing is that nowadays the vast majority of brokers have available demo trading platforms you can use to evaluate their system. Be sure, though, to make note of any differences there are between the real platform and the demo one.  Some brokers’ platforms are both the same across the board, but some have noticeable differences in things like execution speeds. It wouldn’t hurt to check around the discussion boards to see what others are saying.

Actually, if you are new to forex trading it is well worth it to spend a while trading via a demo platform first.  It will help you develop and understanding of how it all works.  That way, when you do go live, you will be more confident and ready for action.

Making Trades
Forex market trading is really little different from an execution perspective than most other markets. You can buy or sell. In most cases, the same types of orders (stops, limits, etc.) are available.  The trading platforms are very modern and trades can be done very quickly.  Anyone who has ever used an online trading platform for any other market will have no trouble making the move to forex and executing trades with ease.  For that matter, even those new to trading will find entering and exiting forex positions a breeze.

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The Basics

Understanding Forex Positions & Profits

Understanding the Trades

The best way to understand what happens in a forex trade is to demonstrate by way of example.  In this case we will outline a trade in which we buy EUR/USD at 1.2100. 

Remember, when buying or selling in the forex market you are doing so in regards to the base currency (the first one listed in the pair).  That means for EUR/USD we are long the Euro, and by extension, short the USD.

This diagram shows the way the transaction runs it’s course:

Simple Spot Forex Trade
Buy 100,000 EUR/USD at 1.2100
Borrow 121,000 USD (100,000 x $1.21)
<Pay USD Overnight Rate>
||
Convert USD to EUR at 1.2100
||
Deposit 100,000 EUR
<Earn EUR Overnight Rate>

When we close out this trade, it is a simple reversal process. The EUR position is converted back in to USD and we pay-off the USD loan we took out.  If the exchange rate increased, then we would have Dollars left over, which would be our profit.  For example, if the rate went to 1.25 we would have $4000 left over after paying back our loan (100,000 x $1.25 = $125,000 – $121,000 = $4000)  If the rate had dropped, we would have a shortfall on our loan repayment, and thus a loss on the trade.

For a trader whose account is denominated in US Dollars, the above example is pretty straightforward.  There is only one exchange happening each way. When one is trading cross-rates, however, things get more complex.

Everything remains essentially the same when we enter the trade. If, for example, we were buying 100,000 EUR/JPY at 131.00 we would borrow 13,100,000 JPY (100,000 x 131), exchange that in to EUR, and deposit it. We would pay interest on the JPY loan and earn it on the EUR deposit, just like we did in the EUR/USD example.

The complexity of a cross trade comes when unwinding the trade. Assume EUR/JPY rises to 132.00, and see how the long position unwind would look:

Cross-Rate Trade
Unwind 100,000 EUR/JPY long
(Entered trade at 131.00)
100,000 EUR
||
Convert EUR back to JPY at 132.00
(100,000 x 132 = 13,200,000 JPY)
||
Repay 13,100,000 JPY
(13,200,000 – 13,100,000 = 100,000 JPY remains)

You will note that there are 100,000 JPY remaining after the original JPY loan is repaid.  That is our profit, but as USD-based traders we need to convert that back in to USD for our accounting purposes.  That happens by exchanging the JPY for USD at the current USD/JPY rate.  If that rate is 107.00, then we have a gain of $934.58 on the trade (100,000/107.00).  Of course, we must also take in to account the interest carry when determining our net profit.

Calculating Profits & Losses

The above outlines of forex trades may seem complicated, but as an individual trader, you don’t see all that stuff. When it comes down to determining your profit or loss (P&L), it’s pretty simple. The essence of determining one’s P&L boils down to starting value and ending value (as set by the market).

Here are the formulas for calculating your profit or loss on a forex trade: 

Non-USD Base (i.e. EUR/USD): 
Long:  (Units x R2) – (Units x R1)  or Units x (R2—R1)
Short:  (Units x R1) – (Units x R2)  or Units x (R1—R2)
Where R1 is the starting rate and R2 is the ending one.

Ex: Buy 100,000 EUR/USD at 1.3000 and sell at 1.3100:
(100,000 x 1.31 = $131,000)—(100,000 x 1.30 = $130,000) = $1000

USD Base (i.e. USD/JPY): 
Long:  ((R2/R1) – 1) x Units
Short:  ((R1/R2)  – 1) x Units

Long Ex: Buy 100,000 USD/JPY at 110.00 and sell at 111.00:
(( 111.00 / 110.00 ) – 1) x $100,000 = $909.09
 
Short Ex: Short 100,000 USD/JPY at 110.00 and cover at 109.00:
(( 110.00 / 109.00 ) – 1) x $100,000 = $917.43

As we know from the EUR/JPY example, cross trades require an additional step.  The same calculation can be used as above (the non-USD base is probably the easiest, though either could be used), but the Profit/Loss figure would then have to be converted using one of the currencies involved to get it back to the account currency as demonstrated earlier.

Remember, forex trades have an interest rate carry based on the interest rate differentials.  This can be either positive or negative. For longer-term trades, this can be a significant influence on the final P&L.

Multiple Open Positions

A common piece of advice offered by experienced forex traders to novices is to focus on one currency pair and stick to that.  There are two reasons.  One is to develop a good understanding of one forex relationship and not spreading things too thin.  The other reason is to avoid some of the issues which can crop up when a trader has positions open in multiple currency pairs.

The first of those issues is creating excessive exposure to one currency.  This is done by going long or short the same currency in different pairs.  For example, I you were to sell EUR/USD and at the same time buy USD/JPY you would have two USD long positions.  In shorting EUR/USD you are going long USD, and obviously in buying USD/JPY you are doing the same thing.  This is a very quick way to put your trading account at serious risk if you are not aware of your total exposure.  If the USD were to suffer a decline you would likely lose on both those positions.

The other issue in holding positions in multiple currency pairs is that you can accidentally create a position completely different than what you intended.  For example, if you were to buy EUR/USD and buy USD/JPY the USD exposure in those trades would at least partially offset each other (you are selling USD in the first trade and buying it in the second), depending on the values of the two trades in question.  What you are left with is a long EUR/JPY position, which has very different trading characteristics than either EUR/USD or USD/JPY.

The combination of the risk factor and the offsets that can happen is why even experienced traders often will only carry one open forex position at a time.  It just keeps things simpler.

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The Basics

What Influences Forex Prices?

Foreign exchange rates are both a market unto themselves and an influence on the fundamental situation of other markets.  They reflect the strength or weakness of an economy and are a factor in it.  This kind of duality can create a truly mind-spinning situation at times.  There are a few things, however, which directly influence forex prices.

Interest Rates

Most people will think first of interest rates when the idea of evaluating one currency against another comes in to play.  They are indeed a major part of the forex market equation.  Interest rates on the one side determine the “yield” of a currency, while on the other side can be viewed as a barometer of the position of a country’s  economy (or of an economic region like the European Union).

To that end, the same sorts of things which impact interest rates also play a part in forex prices.  Inflation, or rather the expectations for inflation, is the single largest influence on interest rates.  But even there it is not a clean scenario. If interest rates are rising because of strong economic growth leading to mild concerns about inflation, that tends to be a positive for a currency.  On the other hand, if rates are rising because signs of inflation are starting to show (or significant inflation already exists), that can be a negative.

Keep in mind that the value of a currency is a reflection of its buying power. Inflation erodes that, so a country seeing high rates of inflation will generally have a weaker currency.  This can easily be seen in the emerging markets where interest rates are often quite high, but the the currencies remain weak because of issues with inflation.

Trade

The forex market exists first and foremost to facilitate trade, and trade is a huge determinant in the value of a currency.  The more a country’s goods are in demand, therefore requiring buyers to convert their currencies in to the exporter’s currency, the stronger it will be.  It is a simple supply and demand equation.  More demand means higher values.

Because of this influence, forex traders keep a keen eye on trade data.  These figures, of course, are historical by the time the market sees them, meaning the trade transactions have already happened and their push or pull on a currency’s value have taken place.  What traders want to know, however, is if money is flowing in to or out of a country.

Capital Flows

Capital flows are a parallel to trade.  Rather than representing the value of goods and services being exchanged, they indicate the investment of capital in to a country.  Investment works the same way as trade.  A country receiving a lot of investment money is similar to a country selling a lot of goods on the trade market. It’s currency is in demand.
What creates capital inflows? Higher relative real interest rates (rates adjusted for inflation) is one thing.  Opportunities for investment profits in a country’s stock market is another.  Capital seeks returns.  It will go where it thinks it is going to get the highest one for a given level of perceived risk.

Capital flows are seen in the balance of payments information released by the government. Traders look at it the same way they do the trade data.  Is money coming in or going out of the economy?

Reserve Currency

You may have heard that the US Dollar is a reserve currency, which means other country’s keep a supply of Dollars on hand as a safety measure against adverse conditions.  This helps provide demand for the Dollar, even when the items noted above would suggest a negative scenario.

A similar situation can be found in the fact that global commodities like oil and gold are denominated in US Dollars.  Anyone buying them must exchange their own currency for Dollars in order to make a purchase, providing an added layer of demand for the US currency.

Comparison

The thing which makes the forex market so complex is the fact that when one is trying to perform the kind of fundamental analysis we have discussed here, it is a multisided equation.  Looking at one country is not enough because a currency is valued and traded against an array of others, all of which have their own sets of considerations.

The comparison for a stock trader would be a spread trade in which one is going to buy one company’s shares and sell those of another related one in a bet that the former outperforms the latter.  Obviously, you would buy the stock of the firm with the better fundamental outlook and sell the one which looks weaker.

This multiple analysis is enjoyable to some, but is probably the biggest factor behind the extreme popularity of technical analysis among forex traders. 

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The Basics

Why Should I Trade Forex?

Advantages of Forex

Trade on Your Schedule
The single biggest advantage the forex market has over other markets is its 24-hour nature. A trader can put on or take off positions literally any time of day or night, regardless of their base of operations. That opens the game up to a great many individuals who might not otherwise have the time available to trade.

Consider, for example, the working person with a 9 to 5 type of job.  Most folks like that cannot be expected to operate effectively as day traders in a market such as stocks.  They just can’t spend the requisite time watching the market during trading hours.  With forex, though, one could theoretically day trade in the evenings after work, or in the mornings beforehand.  The forex market is never really closed (yes, in some cases you can even trade on the weekend!).

No (or low) Transaction Costs
For most traders, the forex market also offers the benefit of no transaction costs.  For the most part, forex brokers do not charge commissions (if they do, they are relatively small). There is, of course, the bid/offer spread, which can be viewed as a transaction cost, but the reality of the situation is that most traders buy at the offer and sell at the bid in whatever other market they trade, so that’s really no different.  Actually, the forex spreads can be quite small in the major currency pairs.

Low (or no) Account Minimums
Forex trading is also open to a wider trading demographic in that there are many opportunities to open smaller accounts than is the case in other markets. In fact, there is at least one broker which has no minimum account size.  What’s more, they also have no minimum trade size.  That sort of flexibility opens the door to essentially anyone who wants to explore forex trading.  This isn’t to say that all brokers are that flexible.  There are, however, a great many which offer so-called mini-contracts.

Multiple Trading Vehicles
Additionally, forex trading can be done in a number of fashions.  Many folks tend to think strictly of the spot market.  While that is certainly the largest of the components, it is not the only one.  The futures market has become a bit more attractive with the expansion of e-mini currency contracts.  There are  futures options as well.  What’s more, an array of other option trading alternatives have been popping up, providing traders even more ways to take positions in the forex market.

Always Moving
One of the biggest attractions to forex trading is that there’s just about always something moving. There are a number of primary currencies involved, each of which is continuously interacting with all the others. Chances are, at any given time, there is movement in at least one of those exchange rates based simply on the sheer volume of trading and the number of global news events providing impetus to action. 

Easily Trade Long or Short
In the stock market there are restrictions imposed on selling short. In forex there is nothing of the sort.  It is just as easy to taking a short position as it is to take a long one.

Disadvantages of Forex

No Exchange
The disadvantage to forex, some would say, is in the lack of an exchange system in forex trading.  Some traders find comfort in knowing that there is a regulated mechanism backing their market participation.  What’s more, the lack of a centralized data point means the spot forex market does not have all the great add-on information stock and futures are used to seeing (volume, for example).

Complex Nature
In terms of market analysis techniques, technical analysis is just as useful in forex trading as in any other market – some might say more so. The thing that gives some traders concern. however, is the complexity of the fundamental side of the forex market. Currency exchange rates are influenced by a wide variety of factors, which can fluctuate over time.

Two-Sides to Every Position
By it’s very nature, there are always two sides to the forex market, because currencies are quoted in terms of their value against each other. That means for any given exchange rate there are two countries (or region’s) to take in to consideration.  Sometimes issues related to one of the countries will dominate, while sometimes the other will.  It can be quite fluid in that regard, which can sometimes lead to quite confusing reactions to news and events.

While these issues may seem like significant barriers to trading forex for some, the fact of the matter is that for most folks they are easily overcome. Just like any market, forex requires some getting used to.  Once you do, though, it provides a wide array of opportunity.

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Deep Posts Trading Tips

Behind the Trade

Excerpt from The Essentials of Trading

OK. So we’ve done a trade, but what does that mean? The financial markets bring together buyers and sellers. Some transactions are very straightforward, as in the stock market. The buyer pays the seller money and receives shares in return. Even when using leverage and margin, the basics of the transaction remain very simple. This is not always the case.

The stock market is what can be referred to as a cash market. That means the buyer gives the seller cash now to receive an asset immediately. It may take a period of time for the actual exchange of the assets to take place (three days in the U. S. stock market), which is referred to as settlement, but the buyer is considered to have taken ownership at the time of the trade.

The forward market is a kind of deferred cash market in that the traders agree to exchange assets at some future time, generally with a set of specific terms (price, date, transaction size, asset quality). An example could be a gold transaction. The agreement could be that Trader A commits to buy 100 ounces of certified gold bullion from Trader B at a price of $400/oz for delivery in three months. Note that when the agreement is made, no exchange of assets takes place. Trader A does not own the gold yet. That will not happen for three months when he gives Trader B $40,000 and takes delivery.

The buyer of stock is considered to be long because ownership generates benefits through price appreciation. When entering in to a forward or futures trade, however, no asset changes hands until some future time. Even so, the party who agrees to be the buyer takes on a long position. In the above example, Trader A will be the buyer. He is therefore considered to be long due to the fact that he will benefit from a rise in the price of gold. If gold were to rise to $410 by the time he has to buy those 100 ounces from Trader B, he could take possession and immediately turn around and sell for a $1000 profit ( 100 x $10 ). Trader B, on the other hand, would be short. Were gold to fall in price to $380, she would benefit in that she could buy the gold in the market and turn right around to deliver it to Trader A under the contract terms and make $2000 ( 100 x $20 ).

In most cases (all for the individual trader) forward/futures agreements require margin. This is to protect the counter-party against default of the agreement (for futures the exchange is the counter-party)

The options market differs from the forward/futures market in one very meaningful way. Like a forward contract, an option is an agreement to exchange assets at some future time. The difference, however, is that in options one of the parties – the buyer of the option – does not have to fulfill the contract – hence the “option”. The option market, however, is a cash market in its own right. Options are bought and sold in the same manner as stocks, with the buyer paying the seller for the right to conclude a future transaction or force the seller in to a future agreement (forward/futures for example).

Excerpted from <>The Essentials of Trading

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Deep Posts Trading Tips

Analysis Pitfalls

(Excerpt from The Essentials of Trading)

Back in the chapter on market analysis methods we mentioned the representation bias, which is the tendency to view the portrayal of something as the thing itself. The example we used was a map, which shows the terrain, but is not the terrain itself. As such, it presents a limitation on one’s ability to use it in the decision-making process.

There are other biases as well.

The Lotto Bias relates to control. Its name comes from those who play the lottery and their belief that picking numbers somehow improves their chances of winning. If the odds of winning are 1 in a million for a given set of numbers to come up, it does not matter a bit whether those numbers are picked at random or by some kind of system.

Lotto bias relates to trading in regards to entry signals. Traders often spend enormous amounts of time trying to find the perfect system for getting in to the market when the fact of the matter is that for any given trade the likelihood of profiting is essentially dictated by chance. That is why we have said a few times that at least as much effort must go in to determining the exit strategy, to include money management. It is also why the trader must listen to the markets and not succumb to the idea that imposing one’s will on them is possible.

Closely tied to the lotto bias is something known as the Gambler’s Fallacy, which is the belief that a string of losses increases the chance of experiencing a winner. If one were to roll a standard six-sided die, the chance of getting a five is 1/6, or about 17%. It does not matter how many times in a row the die comes up with something other than five, the odds of the next roll being a five are 1/6.

The problem many people have is in thinking of the odds of a specific run happening and then extrapolating that in to some kind of odds for a single event. For example, there is about a 1/3 chance of getting 20 non-five rolls in a row on our six-sided die if we roll it 100 times. Does that mean that if we see 19 non-five rolls in a row that there is a 2/3 chance of getting a five on the next roll? No! Why? Because each roll is an independent event. The 1/3 odds were for seeing a run of 20 consecutive non-five rolls, not the odds of getting a non-five if there had already been 19 non-fives in a row.

This discussion is all based on discrete, independent events assuming no memory and a fair die. One is likely to find that a trading system operates in the same fashion. Even if it does not, however, the point still stands. One must ask the right question of the statistics, and avoid using them to prove something, to get useful results.

Shifting back to biases, the Conservatism Bias essentially means being hard-headed. It is when one refuses to consider elements which do not mesh with one’s existing opinion or belief, or to change one’s position as circumstances dictate (or to do so only slowly). We have all seen this sort of thing happen, such as the case where someone refuses to accept a fact contrary to their belief until the evidence is incontrovertible. This kind of bias is particularly problematic when someone has expressed a view publicly, meaning they have to admit to being wrong. The point is to not to trade with a set notion, and to be ready, willing, and able to make adjustments to one’s view quickly.

Biases such as the ones we have mentioned are serious pitfalls for those trading the markets. It is hard to accept that one is going to be wrong a lot and that one has no control over the markets, but both are the case. The trader that can overcome these hurdles is moving in the right direction.

Another thing to worry about in one’s analysis, especially as it relates to system design and testing is postdictive error. This occurs when one uses information which would not have been available at the time to make decisions. Clearly, this is not something generally done on purpose. It can happen, however, as the result of incorrect referencing when doing calculations in spreadsheets and charting packages. Attention to detail is all that is required to avoid postdictive error creeping in to one’s work.

Excerpted from John Forman’s book The Essentials of Trading.

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The Basics

What is the Forex Market and How is it Different?

What is Forex?

The foreign exchange market, often referred to as forex, is the market for the various currencies of the world. It is a market which, at its core, is rooted in global trade.  Goods and services are exchanged 24 hours a day all over the world. Those transactions done across national borders require payments in non-domestic currencies.

For example, a US company purchases widgets from a Mexican company. To do the transaction, one of two things is going to happen. The US firm may, depending on the contract terms, make payment in Mexican Pesos. That would require a conversion of Dollars in to Pesos to make payment. Alternately, the payment could be made in Dollars, in which case the Mexican company would then exchange the Dollars for Pesos on their end. Either way, there is going to be some transaction which takes Dollars and swaps them for Pesos.

That is where the forex market comes in. Transactions like that take place all the time. The market maintains a rate of exchange between the US Dollar and the Mexican Peso (and between and amongst all other world currencies) to facilitate that activity. Consider the amount of global trade which takes place and you can see why the forex market is the biggest in the world, dwarfing all others. Literally trillions of dollars worth of forex transactions take place each and every day.

How is the Forex Market Different?

There are some significant differences between the forex market and others like the stock market.  While it may be the feeling that a good trader should be able to handle any market, the fact of the matter is that some structural differences in forex can require a different trading approach.

Time
For most stock traders, the first difference they will notice between the forex market and equities is time frame. Although the hours of stock trading have been expanding in recent years, the forex market is still the only one which can truly be viewed as 24-hour. There is ready forex trading activity in all time zones during the week, and sometimes even on the weekends as well. Other markets may in fact transact 24-hours, but the volume outside their primary trading day is thin and inconsistent.

No Exchanges
The lack of an exchange is probably the next big thing that sticks out as being different in forex. While it is true that there is exchange-based forex trading in the form of futures, the primary trading takes place over-the-counter via the spot market. There is no NYSE of forex.

On the largest scale, forex transactions are done in what is referred to as the inter-bank market. That literally means banks trading with each other on behalf of their customers. Larger speculators also operate in the inter-bank market where they can execute multimillion dollar trades with ease. Individual traders, who generally trade in much smaller sizes, primarily do so through brokers and dealers.

This is something which can trouble stock traders. There is no central location for price data, and no real volume information is attainable. Since volume is an often reported figure in the stock market, the lack of it in spot forex trading is something which takes a bit of getting used to for those making the switch.

Transaction Processing
Also, the lack of an exchange means a difference in how trading is actually done. In the stock market an order is submitted to a broker who facilitates the trade with another broker/dealer (over-the-counter) or through an exchange. In spot forex much of the trading done by individuals is actually executed directly with their broker/dealer. That means the broker takes the other side of the trade. This is not always the case, but is the most common approach.

Transaction Costs
The lack of an exchange and the direct trade with the broker creates another difference between stock and forex trading. In the stock market brokers will generally charge a commission for each buy and sell transaction you do. In forex, though, most brokers do not charge any commissions. Since they are taking the other side of all the customer trades, they profit by making the spread between the bid and offer prices.

Some traders do not like the structure of the spot forex market. They are not comfortable with their broker being on the other side of their trades as they feel it presents a type of conflict of interest. They also question the safety of their funds and the lack of overall regulation. There are some worthwhile concerns, certainly, but the fact of the matter is that the majority of forex brokers are very reliable and ethical. Those that are not don’t stay in business very long.

Margin Trading
The forex market is a 100% margin-based market. This is a familiar thing for those used to trading futures.

In fact, spot forex trading is essentially trading a 2-day forward (futures) contract. You do not take actual possession of any currency, but rather have a theoretical agreement to do so in the future. That puts you in a position of benefiting from prices changes. For that your broker requires a deposit on your trades to provide surety against any losses you may incur. How much of a deposit can vary. Some brokers will asked for as little as 1/2%. That is fairly aggressive, though. Expect 1%-2% on the value of the position in most cases.

Now, unlike the stock market, margin trading does not mean margin loans. Your broker will not be lending you money to buy securities (at least not the way a stock broker does). As such, there is no margin interest charged. In fact, since you are the one putting money on deposit with your broker, you may earn interest in your margin funds.

Interest Rate Carry (Rollover)
When trading forex, one is essentially borrowing one currency, converting it in to another, and depositing it. This is all done on an overnight basis, so the trader is paying the overnight interest rate on the borrowed currency and at the same time earning the overnight rate on the currency being held. This means the trader is either paying out or receiving interest on their position, depending on whether the interest rate differential is for or against them.

This is commonly handled is what is referred to as a rollover. Spot forex trades are done on a trading day basis, and as such are technically closed out at the end of each day. If you are holding your position longer than that, your broker rolls you forward in to a new position for the next trading day. This is generally done transparently, but it does mean that at the end of each day you will either pay or receive the interest differential on your position.

The type of trader you are and the way your broker handles rollover will be the deciding factors in determining whether the interest rate differentials are an important concern for you. Some brokers will not apply the day’s interest differential value on positions closed out during the trading day. By that I mean if you were to enter a position at 10am and exit at 2pm, no interest would come in to play. If you were to open a position on Monday and close it on Tuesday, though, you would have the interest for Monday applied (the full day regardless of when you entered the position), but nothing for Tuesday. (Note: There is at least one broker who calculates interest on a continuous basis, so you will always make or pay the interest differential on all positions, no matter when you put them on or took them off).

It should also be noted that although some folks will claim there is no rollover in forex futures, the interest rate spread is definitely factored in. You can see this when comparing the futures prices with the spot market rates. As the futures contracts approach their delivery date their prices will converge with the spot rate so that the holders will pay or receive the differential just as if they had been in a spot position.

Intervention
Fixed income traders know that central bankers, like the Federal Reserve, are active in the markets, buying and selling securities to influence prices, and thereby interest rates. This is not something which happens in stocks, but it does in the forex markets. This is known as intervention. It happens when a central bank or other national monetary authority buys or sells currency in the market with the objective of influencing exchange rates.

Intervention is most often seen at times when exchange rates get a bit out of hand, either falling or rising too rapidly.  At those times, central banks may step in to try to nullify the trend. Sometimes it works. Sometimes not.

The US has traditionally taken a hands-off approach when it comes to the value of the Dollar, preferring to allow the markets to do their thing.  Others are not quite so willing to let speculators determine their currency’s value. The Bank of Japan has the most active track record in that regard.