Even though the foreign exchange market is the largest in the world it is still unfamiliar for many retail traders. Until internet trading became popular, Forex trading was mainly conducted by multinational corporations, hedge funds and large financial institutions. However, things are much different today, and individual traders can now easily access the financial markets. Before diving right into currency trading, you will first need to learn more about the foreign exchange market. There are many guides available that can assist you but the best foreign exchange trading guides will provide you with all the essential information of currency trading.
Forex Market vs. Other Financial Markets
The Foreign Currency market is different from the options, futures and stock markets because it is not conducted on a central regulated exchange. There is no central regulatory body, no clearing houses or panel to arbitrate disputes. Currency traders place trades that are based on credit agreements. Ultimately, the business conducted in the world’s largest and most liquid marketplace is based on nothing else except a symbolic handshake.
This idea can be quite frightening for new currency traders who are more familiar with structured exchange like the CME or NYSE. However, in practice the FX market runs flawlessly because the participants must cooperate and compete with each other. This market is based on self-regulation, and it effectively controls the market. In addition, reputable brokers are usually part of an organization that handles any arbitration if necessary. Therefore, you should only use a broker who is part of one of these organizations in your country.
If you have ever traded options, futures or stocks, you have probably used a broker who places these trades on your behalf. Your broker takes your order to the exchange and then carries your instructions. For this service, you are required to pay a commission fee when you purchase or trade a financial instrument. However, you are not likely to run into any commission fees when you trade Forex. Contrary to exchange-based markets, this market is principals-only. This means that firms are dealers rather than brokers. This is an important distinction that you must understand. Dealers, unlike brokers, assume the risk as the other party in your trade. Dealers will not charge you a commission but will charge you the difference between the bids and ask price.
What Are Pips?
Pip is an abbreviation for ‘percentage in point’ and it is the smallest increment used in forex trading. Prices are quoted to the 4th decimal point in currency trading. For instance, if a pack of gum at the store was priced at $2.05 then the Forex price of that same pack of gum would be quoted at 2.0500. A change in the 4th decimal point in that number is 1 pip and is equal to 1/100th of 1%. The Japanese yen is the only major currency that does not follow this rule.
What is Actually Purchased and Traded in the Forex Market?
The simple answer is that nothing is traded in the FX market. The best foreign exchange trading explanation is that the market is speculative. There is no actual physical exchange of currencies – all trades are simply entries in a computer based on the market price. The reason why the foreign exchange market exists is to allow multinational corporations to exchange one currency for another on a continual basis in order to pay foreign workers, mergers, acquisitions, etc. However, about 80% of the transactions carried out in the market are conducted by speculators rather than corporations.
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