This market has long held these benefits for market participants, so why now should this be the moment that Forex has come of age for the individual trader?
In fact, it is the coinciding of two key factors; firstly, rarely has there been so much focus on the foreign exchange markets as in the last 18 months, leading to continued and consistent trading opportunities. And secondly, the technology revolution that enables individuals to trade effectively on a 'level playing field' with the institutions is now a reality.
Hardly surprising then that the largest, most liquid market in the world, is drawing increased interest from both active and retail investors alike.
Market accessibility is the key component that enables individual traders the opportunity of participation, and now more than ever before, brokers, software providers and financial institutions have both the ability and presence of mind to offer effective market access.
But, it is active traders who are benefiting most from the aggressive rise in accessibility of the electronic foreign exchange markets. New software, providing lightning speed of execution, variable order-type, and improved software applications all go toward making daytrading more effective.
Couple this with increased Internet speed, the availability of timely market news and quality analysis and it is clear to see that the active trader can now access the very 'heart of the market'.
The trend is set to continue with an increased appetite amongst the brokerage community to offer global currency markets alongside their existing product offering. This is leading to the launch of successive products from specialist brokers, as well as spread-betting companies, all offering market access to everyone with an online trading account.
Dealing services like that of easy2forex (see figure 1) incorporate multi-screen capabilities, including real-time news, data, charting and dealing functionality, displayed in an intuitive format. The result is that a market once dominated solely by banking institutions has now truly become accessible to all. With more and more traders gravitating towards this compelling market place, whether in conjunction with an existing trade schedule or as an entire switch.
As an asset class, foreign exchange is probably the least understood by retail investors and active traders alike. Knowledge is still limited, especially when compared to products such as equities, bonds and futures. Indeed, European traders have some catching up to do compared with their US counterpart with regard to the widespread inclusion of Forex trading. However, the trend is in place and over the next few years the currency markets promise to become a widely used underlying instrument for daytraders, swing-traders, and even private investors.
The following paragraphs briefly examine market background, key information including contract terminology and specification, as well as outlining some of the most effective techniques used to trade the foreign exchange markets.
History and background
Looking back to the origins of currency trading, coins have been around since ancient Egyptian times and currency notes were introduced in the Middle Ages to make commercial trading an easier process. This use of bills as opposed to coins helped regional economies flourish. These currency markets, from their origins right through to the mid 1940's and the end of the Second World War, were relatively stable and were never perceived as instruments for speculation.
All this changed as the post-war economies became extremely volatile, resulting in a dramatic increase in currency volatility. Market volatility began to attract speculators and traders, whose numbers were few given the potential gains from such volatility. At this time, the British Pound was the benchmark for global currencies, however, the inevitable post war turmoil led to the US Dollar taking it's place and has remained the benchmark and safe haven ever since. The Bretton Woods Accord, formed in 1944 between the US, UK, and France as an attempt to stabilise the global economies, essentially limited currency movement to just 1% against the Dollar. This pegging of currencies to the US Dollar lasted until the early 1970's.
More recently, the European Monetary System, which was introduced in 1978 as an attempt to gain independence from the US Dollar, failed in a spectacular fashion in 1993, following the exit of the British Pound in 1992.
Since 1993, the major global currencies have been freely trading with no structured boundaries. This free movement of the major currencies catalysed an influx of mainly institutional speculators including banks, brokerage houses and hedge funds. The increase in speculative interest has now filtered down to private individuals who are also able to trade Forex.
Until relatively recently, Japan had long been a country with an interest rate differential to the rest of the world so large that made holding the Yen a punitive gamble. This world differential is now far smaller, meaning that even the Yen is on the table to traders with a broader appetite.
The largest and most recent impact to foreign exchange trading occurred with the incorporation of the Euro. The new single currency is no longer the fledgling underdog that it started life as. The Euro has risen in importance and increased its weighting in the global economy, gaining its current status as the second most liquid currency in the world. The result is that the major currencies now holding speculators interest are the US Dollar, the Japanese Yen and the Euro, with as much as 90% of all transactions involving the Dollar.
Volatility and change is something that the Forex market has become accustomed to, and with recent aggressive Dollar depreciation, once again the spotlight is firmly fixed on foreign exchange trading opportunities. This time however, it’s not just the banks who can take advantage of the market, as changes in market accessibility mean that everyone from day-traders to swing traders to long term portfolio hedgers, can access this global market place.
An efficient market place
Worldwide focus together with factors touched upon in previous paragraphs all contribute to the adoption of currency markets amongst private traders. However, there are additional and important market characteristics that also enhance trading opportunities and explain why Forex is rapidly gaining popularity.
24/7
Forex markets are open for business every hour of every day. They in effect "follow the sun" around the globe in a market that rarely experiences periods of illiquidity. The market for major currencies never closes; in fact at every moment someone somewhere is trading the principal markets.
This means that any trader in any time zone can trade Forex day and night. In contrast to just about every other asset class, a Forex trader never has to wait for the market to open when perhaps news has already hit newswires. The result is the virtual eradication of' overnight risk,' as a stop-loss order can be executed at any time. It also allows Forex traders the added flexibility and continuous market opportunities that just aren't available in most other markets.
The three main economic world zones ensure continuous execution availability. For instance, when the Pacific Rim markets such as Japan and Singapore begin to slow, the European markets of England, Switzerland and Germany take over, followed by the North American markets of the United States, Canada and Mexico. As the North American markets begin to slow down for the evening, the Pacific Rim starts their trading day and so on.
Super-liquidity
A perpetual trading environment attracts volume, in turn attracting additional volume, creating a market with super-liquidity. This makes it extremely difficult for large 'players' to manipulate the market during periods of low volume, thus resulting in an even more attractive market place. The true 24-hour nature of the Forex markets, mean that traders enjoy unparalleled liquidity. With liquidity comes tight spreads, reducing trade slippage as well as improving price fills on both entry and exit orders.
In contrast to many futures markets where overnight access is to a large extent "window dressing," currency markets offer full-time genuine liquidity, allowing greater control over position management.
Minimal execution fees and high leverage
Whether trading currency futures or SPOT, Forex execution typically offers some of the lowest commission levels available in any market place. Instead, brokers are compensated by the spread between the bid and ask prices.
However, the high degree of leverage can work both for or against a trader. Increasing leverage increases both potential gains or losses
Forex markets provide some of the smoothest trends available in any market. Whereas equity and futures markets often trade with gaps and spikes, currency markets may offer smoother and less erratic trading conditions, better for traders who dislike trading 'choppy markets.'
In fact, foreign exchange markets are widely accepted as the best trending markets in the world. Proof, if needed of this fact, is that Forex is traded technically and systematically by all major hedge funds. ManFinacial, the FTSE100 Company, has over recent years grown assets under management to over $30 billion, trading, to a great extent, systematically.
This last and important feature is the premise on which a vast majority of traders build their trading strategy. Trending markets offer traders incredible opportunities, allowing price data analysis to form the foundation to a trading system over many varying time frames.
Strategy - fundamental or technical?
As with any other market in the world, there are two high-level trading strategies used to identify trading opportunities in the Forex market. The first strategy is technical or systematic analysis using charts, mathematical analysis, support and resistance and so on. The second is fundamental analysis which uses financial, political and economic information to make trading decisions.
Beneath these primary headings lie hundreds of different strategies to choose from. Add this to the fact that many of the most successful traders use a combined approach, and it becomes clear that there are numerous valid Forex strategies.
The strategy that traders adopt as their own must be dependent on what works best in the traders’ experience and is most comfortable for them. If choosing fundamental analysis exclusively, a trader must follow current breaking news, indicators, as well as current political trends in order to increase the chances of making money. Using fundamental analysis for trading decisions requires deep understanding of how the markets work and of how the markets will react to news.
Econometric tools can aid the analysis of fundamental information, some of which are provided by brokers and financial web sites. A trader choosing to use technical analysis will also have to learn techniques that best suit their individual trading style. There are hundreds of technical trading techniques to choose from, encompassing the use of standard charts, mathematical formulae and quantitative methodology.
In fact, this vast range of technical techniques often overwhelms traders, effectively negating any potential opportunities with 'analysis paralysis,' or analysis overload. The result is that too many traders feel cornered into a strategy that they have either read about or been lectured about. Trader should use studies that work for them, remembering that within any given market, at any given time, a vast array of traders using hugely varying trading strategies can all simultaneously profit or lose.
Technical analysis
For a trader entering the forex market for the first time, technical analysis has major advantages when compared to fundamental methods, not least the fact that it is a directly transferable skill-set. Techniques learned and fine tuned over many years of trading are just as valid when trading foreign exchange contracts as they were with previously traded instruments. From an active trader's perspective, this effectively means that existing expertise may be directly transferable to the currency markets.
Technical analysis also has the advantage of assisting short term intra-day trading, as opposed to fundamental techniques, which are largely applied to mid- and long-term position taking. In addition to this, trading using technical analysis has the benefit of being rule-based or systematical. This makes strategy testing using historical data comparably easy. By mastering any degree of systematic approach, traders are able to measure both current and past performance, enabling them to tweak their system-criteria attempting to maximize their performance. It also provides the benefit of helping eliminate stress, reducing individual trade anxiety and improving overall time management.
The following paragraphs examine the utilization of these techniques when constructing an initial Forex trading strategy.
A trader undertaking foreign exchange trading while continuing to trade in other markets must determine two important factors. Firstly, how much time can productively be spent trading the Forex markets, and secondly, which time frame to trade within.
Clearly, for a trader who is unable to focus entire attention on one market, a sensible approach is to trade from a medium-term perspective, perhaps initially trading only several times per week or even less. Forex markets are ideally suited to this approach to trading as they typically trend extremely well.
So, when considering which technical trading strategy to implement, the most reasonable starting point is to utilise trend following and continuation techniques.
Supporting this theory is the fact that one of the most common causes of losing trades is from trying to pick the top or bottom of the market. Often, as a result of a 'gut feeling', the exchange rate is overdone and traders attempt to pre-empt the trend reversal.
Foreign exchange trends are typically long and often overshoot perceived value areas; there is no better example of this than that of the Euro since launch. It was, and still is widely considered by most institutional analysts that "fair-value" for the Dollar versus Euro is between 1.20 and 1.22 Dollars to the Euro.
However, following launch it traded as low as 0.80, overshooting within the long-term trend. Now the reverse is true, and markets are witnessing considerable Dollar weakness. In Forex, the trend is your friend.
Clear trend patterns can be identified using simple but effective continuation and breakout techniques, once again emphasising just how valuable technical analysis is for traders.
A trading strategy
An initial trading strategy for a trader entering the Forex markets, in addition to his existing trade activities should include the following attributes:
• Trend following technical analysis - use existing techniques that work for you
• Medium-term position trading - initially just a few trades per week
• Monitoring system - traders must have the ability to evaluate precisely where they are making and losing money
• Start small - test performance with inconsequential trade size
• Keep it simple! - Start with basics and then add one system constituent at a time
• Stick to your rules: discipline, discipline, discipline
Traders should utilise existing techniques that have been well-tested, however the most widely used technical analysis techniques in the Forex markets are:
• Support and resistance
• Channel trends
• Moving average
• Fibonacci
• Relative Strength Index
An initial trading strategy should aim to trade with the long or medium term trend, from the position of the trend. So if the Dollar is in a long- or medium-term depreciation trend as is currently the case, opening trades even if relatively short-term, should be from the short Dollar side. This is particularly important if a trader's attention is divided between several markets.
Traders often suffer losses when they feel under pressure to trade, forcing trade decisions that perhaps do not meet all trade entry or exit criteria. By trading less frequently as outlined above, traders might be more successful than anticipated due to their ability to follow a newly developed trading strategy with reduced trade pressure.
Currency trading patterns are apparent over a whole range of different time frames, from yearly to monthly, to daily and intra-day trends. With this in mind, a trader has the ability to scale-in trade frequency and activity. The fact that Forex markets consistently trend is the crucial reason why many independent currency traders choose to utilise technical analysis. Indeed, even when combined with some broad fundamental studies, technical analysis can form the cornerstone of an active traders rule set.
Conclusion
Catalysed by world events and then fuelled by the incredible appreciation of the fledgling European currency, interest in Forex trading is now penetrating even the retail investor market. Headline grabbing news of the Dollar's decline to levels not seen for over a decade, coupled with global market volatility, has turned the spotlight on the emerging opportunities available to market participants.
From an active trader's perspective, identifiable trading patterns as well as comparatively low margin requirements and cheap execution costs have created potentially favourable trading conditions. Whether in conjunction with an existing trading approach or as an entirely new undertaking, Forex markets may lend themselves to traders following price data using technical analysis. Indeed, many traders previously trading futures on bonds or even equities have switched entirely to the currency markets.
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