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What is Forex ?
Forex (FOReign EXchange market) is an inter-bank market that took shape in 1971 when global trade shifted from fixed exchange rates to floating ones. This is a set of transactions among forex market agents involving exchange of specified sums of money in a currency unit of any given nation for currency of another nation at an agreed rate as of any specified date. During exchange, the exchange rate of one currency to another currency is determined simply: by supply and demand – exchange to which both parties agree.
The scope of transactions in the global currency market is constantly growing, which is due to development of international trade and abolition of currency restrictions in many nations. Global daily conversion transactions came to $1,982 billion in mid-1998 (the London market accounted for some 32% of daily turnover; the New York market exchanged approx. 18%, and the German market, 10%). Not only the scope of transactions but also the rates that mark the market development are impressive: in 1977, the daily turnover stood at five billion U.S. dollars; it grew to 600 billion U.S. dollars over ten years – to one trillion in 1992. Speculative transactions intended to derive profit from jobbing on the exchange rate differences make up nearly 80% of total transactions. Jobbing attracts numerous participants – both financial institutions and individual investors.

With the highest rates of information technology development in the last two decades, the market itself changed beyond recognition. Once surrounded with a halo of caste mystique, the foreign exchange dealer’s profession became almost grasroots. Forex transactions that used to be the privilege of the biggest monopolist banks not so long ago are now publicly accessible thanks to e-commerce systems. And the foremost banks themselves also often prefer trade in electronic systems over individual bilateral transactions. E-brokers now account for 11% of the forex market turnover. The daily scope of transactions of the biggest banks (Deutsche Bank, Barclays Bank, Union Bank of Switzerland, Citibank, Chase Manhattan Bank, Standard Chartered Bank) reaches billions of dollars.

The FOREX market as a place where to apply one’s personal financial, intellectual and psychic power is not designed for attempts at catching a bluebird there. Sometimes someone manages to do so but for a short time only. The key advantage of a forex market is that one can succeed there just by the strength of one’s intelligence.

Another essential feature of the FOREX market, no matter how strange it might seem, is its stability. Everybody knows that sudden falls are very typical of the financial market. However, unlike the stock market, the FOREX market never falls. If shares devalue it means a collapse. But if the dollar slumps, that only means that another currency gets stronger. For instance, the yen strengthened by a quarter against the dollar late in 1998. On some days dollar fell by dozens percentage points. However, the market did not collapse anywhere; trading continued in the usual manner. It is here that the market and the related business stability lie - currency is an absolutely liquid commodity and will be always traded in.

The FOREX market is a 24-hour market that does not depend on certain business hours of foreign exchanges; trade takes place among banks located in different corners of the globe. Exchange rates àre so flexible that significant changes happen quite frequently, which enables to make several transactions every day. If we have an elaborate and reliable trade technology we can make a business, which no other business can match by efficiency. It is not without reason that the pivotal banks buy expensive electronic equipment and maintain the staffs of hundreds of traders operating in different sectors of the FOREX market.

The starting costs of joining this business are very low now. Actually, it costs several thousands of dollars to take a course of initial training, to buy a computer, to purchase an information service and to create a deposit; no real business can be established with this money. With excessive offers of services, finding a reliable broker is also quite a real thing. The rest depends on the trader himself or herself. Everything depends on you personally, as in no other area of business now.
The main thing the market will require for successful operations is not the quantity of money you will enter it with – the main thing is the ability to constantly focus on studying the market, understanding its mechanisms and participants’ interests; this is constant improvement of one’s trade approaches and their disciplined implementation. Nobody has achieved success in that market by forcing one’s way with one’s capital atilt. The market is stronger than anything else; it is even stronger than central banks with their huge foreign exchange reserves. George Soros, a national hero of the FOREX market, did not win the Bank of England at all, as many of us believe – he made the right guess that, with existing contradictions inherent in the European financial system, there were plenty of problems and interests that would not allow to hold the pound. That’s exactly what happened. The Bank of England, having spent nearly $20 billion to maintain the pound rate, jacked it up, by giving it in to the market. The market settled this problem, and Soros got his billion.
The global monetary system has gone a long way during thousands of years of the human history, but it is surely experiencing the most exciting and earlier unthinkable changes. The two main changes determine a new image of the global monetary system:

the money is fully separated from any tangible media;
powerful information and telecommunications technologies made it possible to consolidate monetary systems of different nations into the single global financial system that has no boundaries.


Typical attractive features of the market:

liquidity: the market operates the enormous money supply and gives absolute freedom in opening or closing a position in the current market quotation. High liquidity is a powerful magnet for any investor, because it gives him or her the freedom to open or to close a position of any size whatever.

promptness: with a 24-hour work schedule, participants in the FOREX market need not wait to respond to any given event, as is the case in many markets.

availability: a possibility to trade round-the-clock; a market participant need not wait to respond to any given event;

flexible regulation of the trade arrangement system: a position may be opened for a pre-determined period of time in the FOREX market, at the investor’s discretion, which enables to plan the timing of one’s future activity in advance;

value: the Forex market has traditionally incurred no service charges, except for the natural bid/ask market spread between the supply and the demand price;

one-valued quotations: with high market liquidity, most sales may be carried out at the uniform market price, thus enabling to avoid the instability problem existing with futures and other forex investments where limited quantities of currency only can be sold concurrently and at a specified price;

market trend: currency moves in a quite specific direction that can be tracked for rather a long period of time. Each particular currency demonstrates its own typical temporary changes, which presents investment managers with the opportunities to manipulate in the FOREX market;

margin: the credit “leverage” (margin) in the FOREX market is only determined by an agreement between a customer and the bank or the brokerage house that pushes it to the market and is normally equal to 1:100. That means that, upon making a $1,000 pledge, a customer can enter into transactions for an amount equivalent to $100,000. It is such extensive credit “leverages”, in conjunction with highly variable currency quotations, which makes this market highly profitable but also highly risky.


Margin Trading System

A typical transaction amounts to $10 million in inter-bank trade. However, it is quite clear that such transaction values are not affordable for a private investor – well, at least to the overwhelming majority of them.

Involvement of small and medium investors in the Forex market was facilitated by intermediacy of dealing or brokerage companies. Medium and small investors have access to the global forex market in many nations, using the sums of money starting from $2,000 in their transactions. A dealing company provides its customers with a credit line – a so-called dealing leverage, or a credit leverage, that is several times as big as the deposit. Brokers providing margin trading services require that a pledge deposit should be contributed, and provide a customer with an opportunity of entering into forex sales and purchase transactions for amounts that are 50, 100 and sometimes even 200 times as large as the deposit made. The risk of losses is borne by the customer; the deposit serves as security hedging a broker. The system of operations through a dealing (brokerage) house, with a credit leverage, was called margin trading.

To put it simply, the essence of margin trading can be reduced to the following: by placing pledged capital, an investor becomes able to manage target loans provided against this pledge and to guarantee indemnification against any potential losses on open forex positions with the deposit.

As mentioned above, unlike with forex transactions with actual delivery or actual currency exchange, FOREX participants, especially those with little funds, make use of trading with an insurance deposit - margin trade, or leverage trade. In case of marginal trade, each transaction must consist of the two stages – purchase/sales of foreign exchange at one price, and then its compulsory sales/purchase at another (or at the same) price. The first action is called the opening of a position; the second is the closing of a position. Opening of a position is not accompanied with actual delivery of foreign exchange, and a participant that opened the position contributes an insurance deposit that serves as guarantee of indemnification against any possible losses. Upon closing of a position, the insurance deposit is returned, and profit or losses are calculated.

Any margin trading transaction must comprise two parts: opening of a position and closing of a position. For instance, when forecasting the euro goes up (looks up) vs the dollar, we want to buy a cheaper euro with dollars now and to sell it back when it rises in price. In this case, the transaction will look as follows: opening of a position – euro purchase; closing of a position – its sale. All the time until the position has been closed we have an “open euro position.” Just the same, when we believe that the euro will cheapen (look down) vs the dollar, our transaction will consist of the following steps: opening a position – sales of a more expensive euro; closing a position – purchase of a cheapened euro. Therefore, we are able to generate profit whether the exchange rate goes up or down.

You can enter FOREX through an intermediary only. A dealing center may act as such intermediary. This agency provides you with a (computer or telephone) communications channel with a broker who makes available forex quotations to you and through whom you can enter into transactions. You can also operate directly from your home PC through the Internet. The last option has been becoming increasingly more common recently. The prices you can see on your computer’s screen are prices of actual transactions at FOREX.

A customer concludes a contract with the company whereby the latter undertakes, at the customer’s order and in its own name, to enter into transactions. In this case, the company runs the risk of losses from entering into such transactions, so the customer deposits a certain sum of money with the bank as pledge. The amount of this deposit is determined based on the amount of transactions entered into by the bank and on the credit lever provided to the customer. If a dealing company makes losses from a concluded transaction, the investor becomes liable to it in the amount of this loss, and these liabilities are covered from the pledge deposit; if the company generates profit from a concluded transaction, it becomes liable to the investor in the amount of this profit. Generated profit is remitted to the customer’s pledge deposit. The customer’s order to the company to close an open position is a must; yet the company jobs with its own money. Otherwise the bank may close a long position with a short one, and the customer may sustain losses. The situations when cross rates change by more than two percentage points hardly ever happen in the global market, and losing his or her pledge is next to impossible if a customer jobs reasonably. If the bank’s dealer understands that potential losses, if the rate changes for the worse, might exceed the pledge deposit amount, the dealer can close a position independently, without waiting for the customer’s instructions, with losses not exceeding the pledge amount.

Margin trading appeals by its affordability. Investing funds into securities of the most developed foreign countries to generate any fixed income would hardly be interesting for our compatriots. U.S. Treasury bonds are surely the most reliable and stable, but, being very expensive, they have low yield (approx. 6% p.a.) and are the object of long-term investments. Shares generate higher yield; however, dividend amount is directly dependent on successful operations of any particular enterprise and its shareholders’ preferences. Share purchase for bull transactions seems more attractive but requires greater investments. Margin trading is free from the said limitations – you can sell and buy depending on your expectations, and 1%-3% of a transaction value will do to enter into the transaction.

 
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