Overview
We understand that not all investors are familiar with the foreign exchange market nor the concept of having an actively managed currency account. It is important to explain some of the basic inner workings of the FX market in order to clarify any questions he or she may have about the market itself, and what it means to become an investor.
The Currency Market At a Glance
The foreign exchange market is one of the largest and most liquid markets in the world. According to the Bank of International Settlements, the average daily turnover was reported to be over US$3.2 trillion in April, 2007(1). In contrast to the equity markets, where the number of investment options are vast, investment options in the currency market are typically not as numbered. Currencies are traded in pairs, meaning that when one currency is being purchased, an equivalent quantity of another is being sold, or vice versa. For example, if a trader were to buy the EUR/USD currency pair, he/she would be buying Euros and selling an equivalent amount of US Dollars. This is true for all currencies, and as the market has evolved, many different crosses have become available, adding to the investment options of individual traders.
The majority of traders focus only on the most active pairs, those being EUR/USD, USD/CHF, GBP/USD and USD/JPY. Other popular pairs to trade are NZD/USD USD/CAD, or AUD/USD. Over time, other synthetic crosses have become very popular as well, particularly those pegged to the Japanese Yen, such as EUR/JPY.
Speculative traders typically employ the use of technical or fundamental analysis in their trading in order to determine the future direction of any given pair. Technical analysis is the observance of historical price action in order to quantify future movement; whereas, fundamental analysis studies underlying fundamental trends/developments of economic or geopolitical data in order to forecast price.
In addition to speculators, other buyers and sellers of currencies include importers and exporters of goods and services, investors looking to hedge currency exposure of foreign-denominated portfolios, and travelers visiting foreign countries.
Other major features of currencies as an investment option include:
- Market open twenty-four hours, six days per week
- Flexibility and control over buying and selling various currencies, as one currency is always being purchased another is sold, or vice versa
- Accessible through a wide range of electronic mediums
- Brokers typically offer leverage incentives to trading entities, allowing them to control fairly sizeable positions without comparable amount of cash. This can be just as detrimental as beneficial, however, as losses incurred can be just as high as the degree of potential gains. Proper risk management is absolutely essential.
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(1) Bank for International Settlements (7)