What is Forex and how it differs from other markets
Welcome to a new section, this one is about why we are all here, FOREX. We will start with basics first, but as we progress, we will go much more in-depth, so after we will finish this series, you will know everything about forex trading. This lesson will look at what forex is and compare it to the other markets.
What is forex?
Forex, short for FOReign EXchange, is a decentralized global market where all world currencies trade. It is an over-the-counter (OTC) market, which means that there is not one centralized place. In other words, forex is a decentralized market. As the market is open twenty-four hours a day, five days a week, it becomes extremely liquid over time. It is the biggest market in the world, with over $6.6 trillion in daily volume (in 2019).
For comparison, the US stock market has an average daily trading volume of around $480 billion USD. Due to the size of the forex market, even players such as banks cannot easily manipulate the prices. Banks and large institutions are the big players in the forex game. Retail traders make up only around 2-3% of that daily volume. Each forex trade involves two currencies because we are betting on the value of one currency against another.
In the EURUSD, which is the most traded currency pair in the world, the euro is the base currency, and the US dollar is the quoted currency. If the EURUSD pair’s price is 1.12, it means that one euro is equal to one US dollar and twelve cents. If, for example, the number increases, this means the euro is getting stronger than the US dollar and vice versa. Trades can be closed within minutes of opening, but can also be held for months.
Forex vs other markets
So why should we trade forex? We already described all the different markets in previous videos, so now let’s compare them to forex. There are pretty much three major markets that are traded, forex, stocks, and futures.
Forex compared to stocks
Fees
Fees are the first great advantage of forex trading. Because most brokers make money due to the spreads, which are usually very tight anyway, we can trade forex with very low commissions and fees. We are not mentioning swaps which can add additional costs for holding positions overnight, but swaps can also be positive, where a trader is actually paid for holding a trade.
Trading hours
Forex is traded 24 hours a day, five days a week. This is different from stocks which are only active during the trading hours of stock exchanges. Of course, this applies not only to US stocks, which are the most liquid and popular but also to other markets.
Immediate execution
With forex, in most cases, we are getting executed at prices we see at our broker’s trade window. In trading stocks, this is the case only at the big blue-chip stocks. If we decide to trade less liquid companies, we will have a hard time getting in and out of a trade once we start trading with a more significant account.
Market restrictions
In the stock market, several rules prohibit traders from trading freely. From 1938 to 2007, an Uptick Rule required short sales to be conducted at a higher price than the previous trade. Several other rules and regulations often happen in the stock and futures markets, such as limit up and limit down, which we could see during the Covid-19 crash in March 2020.
Market manipulation
All markets are manipulated. Even in forex, we could see a lot of headlines where major banks were fined by the SEC for manipulating their client’s orders. But in general, the forex market is much harder to manipulate due to the huge daily volume of over $6.6 trillion. In the stock market, many penny stocks that are very popular amongst traders are very often manipulated with pump and dump schemes or insider trading.
Number of products
On the New York Stock Exchange, there are around 2,600 listed companies and another 3,800 listed on Nasdaq. If we add Asian and European stocks to the mix, we look at a very long list of products. But it is not realistic to trade all of them. We would likely lose focus because of trying to find new opportunities constantly. Compared to that, we have 28 majors and crosses in forex. Of course, forex brokers offer exotics and CFDs, but it’s still much less than stocks.
Forex compared to futures
Higher liquidity, 24-hour trading, low fees, no expiration and over $6.6 trillion daily volume is something we won’t find in the futures market. Also, if we are interested in trading popular futures products such as S&P 500, crude oil or gold, we can still participate in those markets through CFDs that are offered by forex brokers. One of the significant advantages that futures markets have over forex is transparency due to futures markets’ centralized nature. This gives us access to real trading volume data that we can’t see on Forex. An account at a forex broker can be opened with as little as $100. For trading futures we can start with $100 too, but then we can open much smaller positions because of bigger margin requirements.
