One particular market that is becoming more popular with retail investors and day traders is foreign exchange, which is the biggest and most liquid market in the world – in particular spread betting the foreign exchange markets or forex spread betting for short. As with other kinds of spread betting, you can gain just as much from a falling market as from a rising one, as long as you have backed the movement.
While the movement between currencies was once only available to traders for large investment banks, there are now hundreds of brokers that use online platforms which allow anyone with a bank account to speculate on the movements within the forex markets.
The global foreign exchange (forex) market is the largest of the financial trading markets in the world. According to the Bank for International Settlements, which acts as central bank to the world’s central banks, more than $4 trillion (£2.5 trillion) of currencies are traded every day. In comparison, the value of shares traded on the London Stock Exchange for the whole of June 2011 was a mere £107 billion. As an over-the-counter (OTC) market, it offers continual, unbroken pricing and trading 24 hours a day from Sunday evening until Friday night GMT.
However, what is particularly attractive is that the forex markets run throughout the day and night which means that they are always available to trade. The huge flows of exchange mean that currency is always available to buy and sell. Foreign exchange also offers traders the lure of making a lot of money from a comparitively small position. Margin requirements are usually 1% of the overall value of the position. When you trade forex, you are speculating on the value of two different currencies, otherwise known as a currency pair/cross.
A number of indicators and data points drive the main currency pairs, most of them macroeconomic. These include a country’s current account, which records trade
flow into and out of a country; its capital account, which records money flow into and out of a country; economic reports, interest rates, growth rates, inflation and unemployment; and actions or statements by a government, central bank or bodies like the International Monetary Fund (IMF) and World Bank. Although currency pairs can be sensitive to almost any data and event, interest rates are commonly cited as the most important drivers. Commodity prices are another major force. The Canadian dollar for instance is very closely correlated to oil prices because Canada is such a big exporter of oil, particularly to the USA. Australia is meanwhile a major exporter of industrial and precious metals, creating a correlation between prices of these and its currency.
With currencies, you choose a pair and bet on the movement between them. For instance, if you believe that sterling will strengthen against the US dollar, you can buy the £/$ pair and your profits will rise in line with any increase in price of the £/$ pair. Similarly, if you believe that sterling will weaken against the USA dollar, you can sell the £/$ pair, and your profits will increase in line with any fall in the price of £/$.
All spread betting brokers will allow you to speculate on a wide range of currencies and you could buy or sell currency at a click of a button so that you quickly take advantage of market movements. Note that for currencies in particular, technical analysis is incredibly important. With so many forex traders basing their strategies on what they see in the charts, technical analysis has a self-fulfilling edge that is stronger than in other markets.
Trend analysis provides traders and investors with a hint on whether a currency is rising or falling in relation to another but this analysis needs to be complemented by the use of support and resistance tools. Support refers to point that a foreign exchange pair tends to drop to but not breach, while resistance refers to points where a currency rises to but not break. Spread traders can use these tools to identify just how far a foreign exchange pair might rise or fall in the medium-term.
Ten points of advice for those bent on trading:
- Demo trade first. Don’t jump straight into it. If you believe you will make a successful currency trader, use a demo account first or trade on paper for a number of months while you are on the costly learning curve. Keeping track of all gains and losses will also help you to identify if you are successful or not over the longer term.
- Ensure you avail yourself all the education tools and read as much as you can on the subject; you need to learn about position management and risk management.
- When you do open a live trading account, you keep your leverage extremely low. Only open an account with funds you can afford to lose so that you don’t want to be trading with funds that you need for something else;
- Use stop-losses to limit losses. A stop-loss will automatically close the trade if it exceeds the determined loss level. Be sure to identify how much you are happy to loose on each trade and use a stop-loss contain it. Make sure that you put your stop-loss at a realistic level however as often the price will go just beyond your stop-loss and then turn back leaving you with crystallised loss in a trade which could shortly turn profitable.
- Keep a diary of all your trades. It is way too easy to forget about your past losses and just remember the winning ones. Be sure to keep a spread sheet of all performance and review regularly whether you are actually making money overall, and if it is worth the intensive time required.
- Focus on one or two “pairs” first. Rather than trying to do everything at once, try to focus and learn the characteristics of one or two pairs (e.g. £/$ or $/¤). You will soon discover how news affects the pricing of these pairs as well as learning their typical trading ranges.
- Have a strong strategy of when to deposit more money into forex and when to withdraw profits. If you have lost the money you put in, it is tempting to put more money in to try and win it back but ask yourself if you really want to throw good money after bad. Similarly, if you have built up a good profit, ensure that you withdraw it on a regular basis rather than getting too confident and losing it through larger trade sizes.
- Allow ample time to trade and follow the markets. If you are going to spread trade you need to allocate some time during the day to do that. Those who are very careful and allow a time frame during the day when they sit with the platform and figure out some trading strategy, they tend to be the most successful.
- Choosing a time zone is very important. If you are going to trade in the European time zone, you are going to be up at a certain time of the day and look at the time zone in its entirety and decide how you are going to attack it; In Asia some currency pairs will be less liquid than others. You have to be acutely aware of what moves markets during certain time zones and keep your eye on major news events as to how they will affect volatility.
- View forex trading as part of your overall investment exposure – not all of it.