A Foreign Exchange (FOREX) Market Primer

Did you know the largest traded "market" in the world is not the U.S., Japanese or European stock markets? It's the foreign exchange market. It's also called FOREX for short, or called the cash currency or spot currency market. Speculators can and do trade this huge market, in which well over 1 trillion dollars (and other currencies) change hands every day.

The purpose of this feature is to introduce you to the FOREX market.  I will just scratch the surface here, and I suggest you read some books on FOREX trading if you want to learn more about the world's largest traded market.

Here's an example to help you better understand the FOREX market. If you have ever travelled to another country and needed to exchange your own currency for another country's currency, then you know why foreign exchange is a necessity. (Americans are spoiled when they travel to other countries because many retail merchants will accept U.S. dollars for payment.)

The "exchange rate" for your currency is usually posted at the institution at which you exchange your currency for another currency--for example, a bank branch at an airport.

Exchange rates fluctuate on a daily basis. Factors that impact an individual country's currency exchange rate are the health of its economy, political events, natural disasters and events around the world that could impact that particular country's economic or political well-being.

FOREX trading is done in "currency pairs." In other words, when you trade spot currencies you are trading in pairs. It has to be that way. Think about it: When you go to the airport to change out American dollars for Euros (the new European Union single currency), you are actually making a transaction in the "Euro-Dollar" currency pair. The first currency listed in every pair is known as the "base currency." The exchange rate refers to the amount of the second currency that can be exchanged for one unit of the base currency. 

Here are some major currency pairs that are traded by hedgers and speculators worldwide: Euro-Dollar, Dollar-Swiss Franc, Dollar-Canada Dollar, Dollar-Japanese Yen, Dollar-Australian Dollar and British Pound-Dollar. Notice that the U.S. dollar is the "base" currency for most major currency pairs.

There are currency futures and options that trade at the Chicago Mercantile Exchange (CME Group). You can trade the British pound, Swiss Franc, Australian Dollar, Canadian Dollar, as well as others. But again, even though the CME currencies are not labelled as "pairs," that is in fact what the futures are based upon. For example, Japanese yen futures prices are based upon the Dollar-Yen currency pair.

One big advantage to trading in the FOREX market is that it is a very liquid market (remember, it's the largest traded market in the world). The FOREX market trades from about 7:00 p.m. Eastern U.S. time on Sunday night, straight through until about 3:00 p.m. Central U.S. time on Friday afternoon.

There are some nuances in FOREX trading that futures and stock traders do not encounter. One is the fact that since FOREX trading occurs continuously for 24 hours per day, five days per week, there is a daily settlement period designated. FOREX traders must theoretically "settle up" or square their positions at the end of every day. There is usually a small fee charged for this daily settlement process.

The margin for trading the FOREX market is usually around 1%, meaning that a $10,000 account can trade about $1 million worth of currencies. Most FOREX brokers do require at least a $10,000 margin deposit to open a FOREX trading account.

U.S. traders wanting to explore more about trading the world foreign exchange market should be aware that in the Commodity Futures Modernization Act of 2000 (CFMA), the Commodity Exchange Act was amended to make clear that it is unlawful to offer FOREX products to retail customers unless the entity offering the service is a regulated financial entity as spelled out in the CFMA.  For more details regarding FOREX trading and the U.S. laws regulating it, check out the following Commodity Futures Trading Commission (CFTC) website www.cftc.gov.

Read more by Jim Wyckoff