The foreign exchange (or ‘forex’) market is by far the biggest financial market in the world, with an average daily turnover of $3trn. It’s also one of the fastest-growing, more than doubling in size in the last decade. And it’s open 24 hours a day.. But there’s quite a bit to master before taking the plunge.
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The trading basics
Currencies are a very different type of beast to equities and bonds. The first obvious difference is that they always trade in pairs. You don’t bet on the dollar rising or falling in isolation, you bet on it moving against a specific currency, such as the pound sterling. If you believe that rand is set to fall against the dollar, you ask your broker for a quote on the ZAR/USD exchange rate . This should come with a fairly tight bid/offer spread.
You short ZAR versus USD by selling ten contracts at your broker’s bid of 8.2245,. Hopefully you get the direction right and a few days later the rand is down.. You close your position at the offer price 7.8545, for a gain of 120% or R3,700.. Forex trades are always done on margin – you only put up part of the total value of the position – with most brokers requiring around 10%. In this case, the face value is R82,245, meaning you would have put up R3,100 as the margin per contract for the trade is R310.. This trade reveals one of the major features of forex. Because you’re using margin, there’s the potential to make major gains in a relatively short space of time and from a relatively small currency movement. Equally, it’s possible to lose quite a lot quickly too, so it’s important to manage your risks properly, as we’ll see below. The other thing to note is that currency trades are ‘zero sum’; one half of the pair must rise as the other falls. Contrast this to the equity market, where everything can fall together, and you can see why forex is a particularly attractive market for traders who like making relative value trades (bets that one asset will do better than another).
A world of choice
So what can you trade? There are six major world currencies that you can trade the rand agasint using Yield-X. They are:
• Dollar / Rand
• Euro / Rand
• Pound / Rand
• Australian Dollar / Rand
• Canadian Dollar / Rand
• Japanese Yen / Rand
Getting going
Beginners should focus on a single major pair and study it closely to get to grips with what makes a currency move. Because the market is so large and liquid it responds very quickly to economic news, such as central bank interest-rate decisions. A higher interest rate makes a currency more attractive because you can earn a higher return by converting your assets into that currency and investing at the prevailing interest rate. Thus a rate rise, or the expectation of one, should cause a currency to strengthen relative to currencies with lower rates, while a rate cut should make it weaken. But interest rates are only the start. A currency is a bellwether for its underlying economy. If that economy weakens, the currency will dip too. So statistics on growth, inflation, unemployment and so on are eagerly awaited by forex traders. But remember that sentiment is also important – news itself is often less important than how it is perceived. And because sentiment can settle very strongly for or against a currency, momentum is a key part of currency trading; pairs often trend in one direction for long periods before reversing sharply. Finally, don’t overlook the role of government action; while most Western currencies float freely, many other central banks frequently intervene to strengthen or weaken their currencies.
Managing risk
Forex is an exciting, fast-paced market, so it’s absolutely vital to keep your risk under control. The high leverage you’ll be using, and the likelihood of rapid swings, mean that inexperienced traders frequently run up serious losses before they’ve got to grips with the market. Good risk management dictates always having a stop-loss in place to close your position if it runs against you. Many traders also maintain a target exchange rate at which they will take profits; if you follow this approach, the distance between your entry price and the stoploss should always be significantly less than the distance to your profit target. This should help you cut your losers and run your winners, so that you come out with a profit overall. Finally, keeping a calendar of upcoming major economic announcements will help you anticipate which days are likely to be more volatile and help you to time your bets early enough to take advantage. Remember that if you don’t, someone else certainly will. Forex is no place for snails.
