Did you know that forex exchange market is the largest financial market in the world and it is many times larger than of stock market?
It is no surprise that forex trading has taken off in Singapore over the past couple years. In this article we will share with you what forex trading is about.
What is Forex Trading?
As the business industry moves to being global, people and entities need negotiable tools to effectuate transactions.
Currencies have different values in different countries.
This dilemma is recognized by Bretton Woods and thus pushed for a system that allows a free flow of trading between nations after the World War during the United Nations Monetary and Financial Conference.
The structure that we have at present was a result of this action. Hence, we have foreign exchange trading.
There are two views on why forex trading is vital and considered the largest and liquid in the financial market.
One, companies, the government, and even individuals earn or has acquired foreign currencies through buy and sell transactions.
The second is the conversion of profits from foreign countries. Thus, on a daily basis millions, billions and even trillion of money flow through the trade.
If you haven't caught up with the picture just yet, forex trading, also known as foreign exchange trading or FX trading is a process by which currencies are sold and bought.
Although it is referred to as an exchange, currencies are actually traded. Hence, there is physical office or ‘products’ being exchange.
There is only a computer network that connects dealers, entities or institutions for the transaction. It is even available for 24 hours a day.
#1 Who can participate in Forex Trading?
Forex trading is open to anyone. When traveling to a foreign country and you exchange your currency to that of the foreign country is already participating in the forex trading.
That simple transaction already allows you to be part of the market. However, there are other ways that you can join and participate. You can be a dealer or an investor.
Being a dealer will require you license as a broker or dealer to be able to enter the market. There are several brokers in Singapore that you can connect with when you want to be an investor.
The investor in forex trading can be individuals, who are called the retail forex traders or large organizations, which are institutional traders.
Banks serve as the facilitators of trading for their clients, while hedge funds and investment managers have pension accounts and the likes involve in the market.
A portion of the player's pie consists of individual traders or the retail forex traders. They are relatively smaller compared to large institutions. But, more and more individuals are attracted to forex trading.
#2 How Can I Make Money From It?
Your aim in forex exchange trading is to buy currency with another currency in the hope that the currency you bought will increase in value than the currency you used to buy the former.
As an investor, you can take the short or long position in the buy and sell process. The short position pertains to the selling of the currency.
In this position, you will be selling the base currency with the quote currency. When the base currency falls in price, you will buy it back and get your earnings.
You can also have the long position. The long position will require you to sell the base and buy the quote currency. It is opposite the short position as you will now buy back the base currency when it increases in value and sells it.
#3 What are the basics concepts?
When visiting a foreign exchange (also money changer), you might have observed a list of paired currencies. This listing reflects the relationship or the equivalent value of one against the other.
The first listing is called the base currency, and other is the quote currency. What happens here is that you use the quote currency to buy or purchase the base currency.
In the forex trading, the widely traded pairing is the EURO-USD. But, in Singapore, there are a lot of pairings to cater to different currency trades.
Pips — If you are new to the forex trading, one of the important terms and concepts you need to know and understand is the pip or pips or percentage in point. The pip in forex trading as defined by Investopedia is related to the currency value (from the previous point of discussion), which is the smallest unit measure when you trade the currencies.
This unit of measure, is however, more than just to calculate. It can be a beneficial concept to integrate into to your trading strategies.
The pip also represents the movement or change in the value of the paired currencies. You can observe the pip on the last decimal of the currency value.
An initial look at the pip seems like an insignificant change in value. However, forex traders know that this can affect investors because it can increase or decrease the value of quote currency when buying base currency.
Some traders even have the concept of ‘pipettes’ for traders or dealers that used a different decimal system from the standard two or four decimals.
A pip can also be powerful when incorporated into your planning and strategy because, despite the changes in the value, you can still earn or minimize loss as an investor.
Thus, when talking to a dealer, you can also ask about the pip and determine how they managed it.
Spread — Aside from the currency and pip/ pipette, the spread i is another concept that traders have to master.Simply put, a spread pertains to the relationship between the ask and bid principle in forex trading. The ask refers to the amount or price that the dealer is asking for the selling of the currency.Meanwhile, the bid is the amount or price that dealer is willing to bid for the currency that is being sold.
There are three (3) basic spread types:
#1 The fixed spread is the type of spread that has a fixed ask and bid price regardless of the market backdrop. The amount does not change and mostly done by automatic trading.
#2 There is also a fixed spread with extension, which is a spread having a part fixed, and a part that is set and the other part is dependent on market changes.
#3 The variable spread is the opposite of the fixed spread, which changes as the market conditions also change.Through understanding the spread and its efficient use, whether it be fixed, with an extension or a variable one will lead to success.
That is why having a trustworthy dealer and platform is very important for investors especially if they are new to the industry.
#4 What is leveraged trading?
Leveraged trading is one of the known strategies that investors can do to manipulate the forex trading in their favor.
It is the when your dealer loans to you, the investor, money to increase your capital required, which the margin.
Using a leverage is a win-win for the investor and broker if done right. It can help deal with fluctuations in the rate of exchange.
In some way, leveraged trading can distribute the risk associated with the trading business although it is in the form of a load.
An example of this is when your broker lends you an amount of money for your forex trading account, and you earn a certain percentage. Your own capital and that of the loaned money will also increase.
Hence, you have the capital plus the loan money and then the profits based on the amount of your original money and that of the money that the broker has loaned to you.
#5 What are the risks in forex trading?
Forex trading involves risks like all other financial investment activities. But, in forex trading, it is riskier because of the very dynamic conditions, where slight changes can also mean significant failures.
One of the risks in forex trading is the interest risk. This risk is related to the interest rates of the exchange rates. The decrease in the interest rates means that the currency is also weak.
Hence, the investors at a disadvantage when this happens. As mentioned, the market is very volatile that alterations may sometimes be expected.
Another risk is one that investors may be exposed to when you operate with leveraged trading. The other side of the coin is when there is loss due to the changes in the market.
As an effect, there is a margin call, requiring the investors to add their capital, which means investing more money.
The stability of the country’s forex trading structure can also play a big role in risk exposure in forex trading. A country with weak or poor structure can lead to a currency crisis that is a nightmare for investors.
It will decrease the value of the currency and a deficit to the investors.
There may be other risks involved in forex trading. When you talk to a dealer, make sure that you also cover risks. You need to understand how they can mitigate or handle the risks.
#6 Who are the forex brokers?
From the several points and concepts we have discussed, we also give emphasis to the broker or the dealer who or where investors entrust their financial investments.
The relationship between you and your broker is crucial to ensure that you will succeed in the trading business. When trading in foreign exchange, an investor like you, have dealers or brokers to serve as the intermediary.
They can give you access to the platform where the currencies are traded. Hence, now you can buy and sell different currencies.
Through the forex brokers and the advent of the Internet, small-scale investors or the individual investors can now participate in foreign exchange trading. The brokers or dealers will be your salesman and help you through the trading process.
They can even lend you finances for your margin (leverage trading). Therefore, they can help you in many ways.
The brokers can be compensated in different ways. They can have a transaction fee which may represent a percentage of your transaction.
They can also earn through the spread or the ask and bid process through selling the currency slightly higher than the original purchase price.
In Singapore, there are several brokers and dealers. In choosing your dealer, you need to keep in mind their legitimacy, reputation, and performance.
You need to partner with a dealer that you are comfortable with their set-up and strategies.
#7 What characteristics should successful brokers and platforms have?
The characteristics each dealer in forex trading are quite simple that what you might think.
The one important thing they should provide knowledge of the basics, allow you to experience and always update your information, and you can understand the strategies used by the dealers and platforms.
Provide knowledge — They say that knowledge is power. It is true and applicable in any endeavor but is one of the strongest foundation of forex trading success.
You may start from this post, but you need to expand your knowledge of the basics and the ins and outs of the industry.
One thing you can do is tap a dealer or broker who can transfer learning to you to enable you to start your trade. There are also platforms, where you can access the information that you need.
You just have to cross-check to examine the validity and accuracy of the information you have gathered.
Allows you to experience — Theoretical knowledge is a good way to start learning the forex trading business. It should be backed by relevant experiences. You can ask the dealer or broker to let you observe how the trading really works to give you a concrete understanding of the industry.
If you cannot tap a broker or dealer, a forex trading platform also works. You just have to make sure that it offers a demo program for beginners or learners like you. There are platforms that let you experience through simulated trading with the use of fake or play money.
Through this approach, your knowledge of the industry will be applied and put into test. It can also help you design your own strategy when you get to the real thing.
Provide reliable information — It is not enough to know fundamentals of forex trading because the business is very dynamic. The slight changes can influence your success. It is like reading your news to know what is happening around you. In forex trading, you also have to update your knowledge to keep up with the shifts.
It is not enough to know fundamentals of forex trading because the business is very dynamic. The slight changes can influence your success. It is like reading your news to know what is happening around you. In forex trading, you also have to update your knowledge to keep up with the shifts.
Information reliability also applies when choosing a dealer or platform.
That is, when you choose to tap with a dealer or use a certain platform, make sure that they are legitimate and that they offer valuable, updated, reliable and relevant information to you.
CEO of Dr Wealth. Built a business to empower DIY investors to make better investments. A believer of the Factor-based Investing approach and runs a Multi-Factor Portfolio that taps on the Value, Size, and Profitability Factors. Conducts the flagship Intelligent Investor Immersive program under Dr Wealth. An author of Secrets of Singapore Trading Gurus and Singapore Permanent Portfolio. Featured on various media such as MoneyFM 89.3, Kiss92, Straits Times and Lianhe Zaobao. Given talks at events organised by SGX, DBS, CPF and many others.