Forex Investment - Delightful, But Have A Care!



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In an increasing variety of markets, ranging from spread-betting on stocks and shares to more exotic futures and derivative markets, internet technology has made it possible for a growing number of day traders situated around the globe to bet on the markets via online platforms from the comfort of their own home or office. Even the previously off-limits currency markets, which will be explored in this article, can now be traded online by the individual investor, and there is a growing list of banks, brokers and specialist firms offering these services.

Until relatively recently the foreign exchange market was strictly the preserve of institutional investors and hedge funds. Large minimum transaction sizes and stringent financial requirements dictated that only the largest and most capitalised investors could make bets on the direction of the world's currencies. However, in order to make any meaningful profits from these 'over the counter' currency bets, traders and money managers would frequently have to place positions the equivalent of millions of dollars, putting the world of forex trading way out of the reach of individual investors unless they invested through a currency fund.

But all that began to change when the internet revolution of the late 1990s swept through the financial markets and radically altered the way in which trades were executed in most markets. When placing a trade on a company's share or on a futures contract became as simple as a couple of clicks on the mouse, suddenly, the traditional broker/client relationship was no longer a pre-requisite and some of the barriers that prevented many investors from taking part in the financial markets began to tumble.

This has had something of a democratising effect on the financial markets, and in the years that have followed a plethora of banks and brokerages have extended the range of their services to a new market by packaging up their online trading systems for the retail market, enabling the more modest investor to trade from their own computer screen - even on the previously out-of-reach currency markets.

By offering clients high levels of leverage the banks and brokers give the small foreign exchange trader the opportunity to make some impressive gains for relatively little outlay. Of course, it also gives them a chance to make some pretty impressive losses. Therefore, any foreign exchange virgins who are considering making their next fortune via an online trading platform must understand the implications of leverage and the risks associated with these types of margin account.

Whilst leverage ratios can vary, typically brokers offer levels of anything up to 100:1, (far in excess of the leverage even the most experienced institutional investment managers are permitted) enabling traders to buy or sell foreign currencies in 'lots' of US$100,000, (or whatever the base currency of the trade happens to be). It means that the trader only has to put down $1,000 as margin to control $100,000 in the market place. The rest is effectively borrowed from the broker or market maker. Without this degree of leverage, it would be almost impossible for smaller traders to make any worthwhile gains in the currency markets.

So, by way of illustration, suppose a trader anticipates a rise in the US dollar against the Swiss Franc and buys 1 'lot' ($100,000) of USD/CHF at 1.2950 (thus controlling CHF129,500.) As expected, the USD/CHF rate rises to 1.3050, meaning the trader now controls CHF130,500 so the trade is closed out with a profit of CHF1,000. When converted back into dollars by dividing this profit with the rate at which the position is closed, the trader has realised a gain of $766.

Until recently many trading firms have required that clients maintain a minimum balance of $10,000 in their accounts to ensure adequate protection against sudden swings, putting forex trading out of the reach of those without HNWI status. However, it is now common for clients to open trading accounts with many firms for as little as $500, although minimum opening balances of $250 are not unheard of. For these 'mini' accounts, smaller lot sizes of $10,000 have been created, and leverage ratios are often as high as 200:1. Many firms consider such products are too risky to offer.

In spite of the inherent risks of the foreign exchange trading, one of the major bonuses of currency trading is the sheer volume and liquidity of the market place. It is estimated that the average daily volume of transactions in the global currency markets is in the order of $1.5 trillion. Therefore, in theory, traders should face little difficulty having their trades filled at their desired price. Also, the vast majority of online forex platforms offer commission-free trading, although bid/offer spreads may be somewhat wider than the big players are used to getting.

The trading interfaces themselves are not so different to those used by money managers, and the live prices displayed on the client's user interface are said to be the same as those shown on the terminals of professional currency traders. The systems also enable users to place a variety of different market orders that are standard in the industry, such as stop losses (advisable in the often volatile currency markets) and limit orders.

Most trading platforms are also packed with a variety of other features to help the trader formulate his or her strategy, including charts with basic technical analysis features, live news feeds and reporting tools permitting the user to analyse trading performance. Many firms have also incorporated chat rooms into their platforms enabling one to share tips and experiences with fellow traders or seek advice from a company broker or expert.

While the currency markets have the potential to make traders quick and substantial profits they can be a high risk financial instrument. An increasing level of regulatory supervision of the financial markets designed to prevent the mis-selling of unsuitable investment products means that opening an online trading account will require at least some degree of investment experience. This ranges from about six months upwards, although accounts aimed at the HNWI will often stipulate a minimum of two years' trading experience. Money laundering and fraud regulations also make it necessary for providers to ask for proof of identity, most commonly a passport.

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