Currency Trading For Dummies - Kathleen Brooks

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capabilities and functionalities. In addition, different brokers have different trading policies, charting packages, and research offerings. Also, try to get a feel for the level of customer support you’ll receive as a client. (You can find more information on choosing a forex broker on the Cheat Sheet. Visit www.dummies.com and type “Currency Trading For Dummies Cheat Sheet” in the search box.)

      Trading in a practice account is the 21st-century form of paper trading. Paper trading is writing down trades on paper based on real-time market prices but not having any real money at risk. Practice accounts are a souped-up version of paper trading — you only have to click and deal, and the trading platform does all the recording for you.

      Whether you’re trading in an online forex practice account or paper trading on stock quotes from the morning newspaper, be sure to keep in mind that your results aren’t real because you never had any real money at stake.

      Think of it this way: If you make a handshake bet with a friend on a sports game, you’re probably not going to be too concerned with whether you win or lose. You may not even watch the game. But if you bet $50 or $100 on the game, you’re probably going to watch the whole game and cheer and yell while you do. The difference: Your emotions come alive when real money is on the line.

      Practice accounts are a great way to experience the forex market up close and personal. They’re also an excellent way to test-drive all the features and functionality of a broker’s platform. However, the one thing you can’t simulate is the emotions of trading with real money. To get the most out of your practice-account experience, you have to treat your practice account as if it were real money as much as you can.

      Who Trades Currencies? Meet the Players

      IN THIS CHAPTER

      

Understanding where currency rates come from

      

Hedging and investing through the forex market

      

Understanding that speculating is the name of the game

      

Managing foreign currency reserves

      The forex market is regularly referred to as the largest financial market in the world based on trading volumes. But this massive market was unknown and unavailable to most individual traders and investors until the early 2000s.

      That leaves a lot of people in the dark when it comes to exactly what the currency market is: how it’s organized, who’s trading it, and why. In this chapter, we take a look at how the FX market is structured and who the major players are. Along the way, we clue you in to how they go about their business and what it means for the market overall.

      If you believe that information is the lifeblood of financial market trading, which we certainly do, we think you’ll appreciate this guide to the movers and shakers of the currency market. When you have a better understanding of who’s active in the FX market, you’ll be able to make better sense of what you see and hear in the market.

      When people talk about the “currency market,” they’re referring to the interbank market, whether they realize it or not. The interbank market is where the really big money changes hands. Minimum trade sizes are one million of the base currency, such as €1 million of EUR/USD or $1 million of USD/JPY. Much larger trades (in the hundreds of millions) are routine and can go through the market in a matter of seconds. Even larger trades and orders are a regular feature of the market.

      For the individual trading FX online, the prices you see on your trading platform are based on the prices being traded in the interbank market.

      The sheer size of the interbank market is what helps make it such a great trading market, because investors of every size are able to act in the market, usually without significantly affecting prices. It’s one market where we would say size really doesn’t matter. We’ve seen spot traders be right with million-dollar bets, and sophisticated hedge funds be wrong with half-billion-dollar bets.

      

Daily trading volumes are enormous by any measure, dwarfing global stock trading volumes many times over. The most recent Bank of International Settlement (BIS) report, released in 2019, estimated daily FX trading volumes of over $6.6 trillion. Find out more at www.bis.org.

      Getting inside the interbank market

      So what is the interbank market and where did it come from? The forex market originally evolved to facilitate trade and commerce between nations. The leading international commercial banks, which financed international trade through letters of credit and bankers’ acceptances, were the natural financial institutions to act as the currency exchange intermediary. They also had the foreign branch network on the ground in each country to facilitate the currency transfers needed to settle FX transactions.

      

The result over a number of years was the development of an informal interbank market for currency trading. As the prefix suggests, the interbank market is “between banks,” with each trade representing an agreement between the banks to exchange the agreed amounts of currency at the specified rate on a fixed date. The interbank market is alternately referred to as the cash market or the spot market to differentiate it from the currency futures market, which is the only other organized market for currency trading.

      The interbank market developed without any significant governmental oversight, and it remains largely unregulated to this day. In most cases, there is no regulatory authority for spot currency trading apart from local or national banking regulations. Interbank trading essentially evolved based on credit lines between international banks and trading conventions that developed over time.

      The big commercial banks used to rule the roost when it came to currency trading, as investment banks remained focused more on stocks and bonds. But the financial industry has undergone a tremendous consolidation over the last 25 to 30 years, as bank merger after bank merger has seen famous names subsumed into massive financial conglomerates. Just 20 years ago, there were over 200 banks with FX trading desks in New York City alone. Today that number is well below a hundred. But overall trading volumes have steadily increased, a testament to the power of electronic trading.

      Currency trading today is largely concentrated in the hands of about a dozen major global financial firms, such as UBS, Deutsche Bank, Citibank, JPMorgan Chase, Barclays, and Goldman Sachs, to name just a few. Hundreds of other international banks and financial institutions trade alongside the top banks, and all contribute liquidity and market interest.

      Bank to bank and beyond

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