Why Trade FX: 7 Key Differences Between FX and Other Instruments
In the first part of this article, we looked at the relationships and investment themes that traders can access using FX. In the second part, we will look at the factors that differentiate FX from other asset classes and instruments and therefore, making FX a truly global product.
The Foreign Exchange or FX market is the largest and most actively traded market in the world. According to data from the most recent BIS triennial survey (the bible for FX turnover statistics) published in December 2016, global turnover in FX averaged just over $5.0 trillion per day. When you consider the market capitalisation of the entire US 500 index being just under 24 trillion dollars, you a get a real sense of the scale of the FX market.
“Every week the FX markets turns over a value greater than that of the US 500 Index constituents combined” and it does so “week in and week out”.
While the markets are open, thousands of individuals and businesses are participating in the FX markets around the world. They trade a common set of instruments, though it's fair to say there are regional biases, and that some instruments are more popular than others. For example, the value of US dollars traded on a daily basis has grown from US$ 1.114 trillion in 2001 to US$ 4.438 trillion as of 2016; an almost 400% increase. While turnover in the British Pound has grown by an even more impressive 435% over that same period.
It has been calculated that if you spent a dollar per second, 24 hours a day, it would take you more than 31,000 years to spend a trillion dollars.
A Truly Global Market
FX markets are truly global, and the currencies of both the world’s developed and developing economies are dealt by traders across the globe. It's estimated that approximately 170 currencies are regularly traded in the Forex markets, though the vast majority of FX trades are conducted in the seven FX pairs that comprise of the so-called "Majors".
These are :
EURUSD, USDJPY, GBPUSD, AUDUSD, NZDUSD, USDCAD and USDCHF
A 2014 report by US bankers, Citigroup, found that there were four million individual FX traders spread around the globe. The largest concentration of traders occurs in Europe and Asia and a relatively small number of FX traders emanating from the USA. These traders were attracted to the FX markets by what they saw as the potential for superior returns from FX trading when compared to other markets. However, that potential for excess returns is far from the only draw for FX trading.
Market Hours 24/5
FX markets operate from late Sunday afternoon East Coast time (early Monday morning in Asia) to the close of business in New York on the following Friday. Trading is conducted continuously, 24 hours per day, throughout this five day period. In fact, the FX markets are only closed on the weekends and on Christmas Day. FX trading is divided into three geographic sessions which overlap each other. The trading day starts in New Zealand and Australia before spreading across key Asian centres such as Tokyo, Hong Kong and Singapore. By the early afternoon in Asian time zones, it's early morning London time and the European FX session gets into full swing. London is the epicentre of global FX trading with around 48% of all FX trades being conducted in the UK capital. Just after midday London time, the trading desks on the US East Coast are waking up, and the US session starts to get into gear, picking the trading baton from London a few hours later, and carrying it into the evening before passing on the responsibility to Asian markets once more.
Of course, many other markets have limited trading hours and the availability of prices and trades can often be limited to the opening hours of the home market. For example, after the close of UK equity markets around 4.35 pm each day, it's not possible to trade the vast majority of UK shares. Even if you can trade them, you will often face limited liquidity and wide prices. Though FX traders face no such constraints. FX markets operate seamlessly and you will be offered tight spreads and plenty of liquidity in the most popular instruments or FX rates at any time of day.
No Centralised Exchange or Clearinghouse
Forex markets operate 24/5 and do so without a centralised exchange or clearing house (also known as OTC or Over The Counter trading). Under this methodology, traders or buyers and sellers effectively trade with and against each other, often through a specialist FX broker such as Pepperstone. You may be sitting at your desk in London trading the Eurodollar and transacting against a trader based in Shanghai, with an opposing viewpoint to yours. To be 100% correct about these matters, brokers such as Pepperstone becomes the counterparty to trades for both the buyer and seller. They ensure that both parties have sufficient funds/margin on the account to meet their liabilities. The broker settles the trade immediately when positions are closed or stopped out. In most other asset classes, the settlement of trades usually takes between one to two days.
Trade / Contract Flexibility
Trading FX on OTC basis means that there is a greater degree of flexibility around items such as trade size or trade duration; in FX, we tend to talk about lots traded. ‘A lot’ typically represents 100,000 units of currency. For example, if you trade ten lots of GBP USD, you are trading a million dollars worth of currency. In most other markets, you would need over a million dollars to make such a trade. Margin FX, on the other hand, is leveraged or geared, allowing traders to control a larger portion of the underlying assets than they could otherwise afford.
Effectively, your broker magnifies your deposit by lending you the difference between your initial margin and the value of your trade. The broker charges you interest on this loan if you hold open positions overnight. By the same token, the broker makes it possible for you to trade fractions of a standard lot. In fact, you can trade tenths or even hundredths of a standard lot in many of Pepperstone’s products; something that’s not possible with many exchange-traded products. That means FX traders can scale their trade sizes to suit themselves rather than be bound by rules which are often designed for other people.
Long, Short and Non-deliverable
Margin Forex trading is cash settled and non-deliverable. This means that positions can stay open indefinitely without the need for either side of a trade, buyer or seller to make or take delivery of Dollars, Yen, Reals or Rand. Though, don't forget that positions held for longer than a business day attract financing charges which can add up. That's one reason why day trading is popular in FX markets. In going home flat every night, you don't incur those financing charges or have to worry about overnight exposure and price movements. Although other traders take a longer-term view and factor in the financing or swap charges into their trading plan. The other benefit that cash-settled contracts offer is the ability to trade long or short with equal ease. In this way, FX traders can potentially benefit from falling as well as rising prices. When going short of an instrument, we are effectively selling something we don't own in the hopes or expectation of buying it back at a lower price at some point in the future.
DMA Trading From Multiple Devices and Locations
Modern FX markets allow traders to execute orders online with no outside intervention; a process known as DMA or Direct Market Access. Trading Platforms are available for desktop and mobile devices on Windows, iOS or Android.
Traders can move seamlessly from one device to another, for example, from a desktop to a tablet. In doing so, they effectively take the FX market with them wherever they go (as long they have a stable internet connection). Mobile versions of our trading software offer similar functionality to their desktop counterparts including streaming prices, charting tools and order management etc. Only a few other markets, if any, can offer such a flexible approach. You can find the full details of the trading platforms we offer here.
Over to You
I hope that's given you a flavour of what FX markets can offer traders. To recap, FX offers:
- Unrivalled scale and liquidity with literally trillions of Dollars traded every day.
- The ability to trade round the clock, throughout the week, between Sunday evening and the close on a Friday night.
- The ability to take long or short positions with equal ease and thus benefit from rising or falling prices and trends.
- Trade seamlessly from your desktop or on a mobile device, from anywhere you have a stable, fast internet connection.
- The ability to scale your trading to suit your style and circumstances.
If you haven't done so already, why don't you give it a try?