During the 1980’s and 1990’s, if investors wanted to really leverage their capital, and take on greater risk in hopes of a greater return, the futures and commodity markets were the place to go. Leverage in these markets was much higher than equity markets, and the potential for huge profits, and also huge losses, was much greater.
However, in the early 2000’s, the Foreign-Exchange (FX) Market exploded. Until the late 90′s and early 2000’s, only banks, large funds, and wealthy individuals could trade in the FX Market due to the very large minimum account size and minimum contract sizes. The explosion of the FX Market into the retail consumer space has changed all of that, though.
Today, an investor can open an FX account with a broker for as little as a few hundred dollars. And they can use leverage that far dwarfs anything available in the futures or commodity markets. In fact, some brokers will actually allow customers to use leverage up to 400:1. This degree of leverage is extremely dangerous, which is why the National Futures Association (NFA) has cracked down with tough regulation, as they seek to cap leverage at 10:1. This has caused some investors to flock overseas where 200:1 leverage is still common.
Besides the high leverage available to traders, the FX Market possesses several key characteristics that set it apart from futures and commodity markets. First of all, the FX Market is not centralized—futures and commodity markets are. There are central exchanges located throughout the United States that make it fairly easy to track futures and commodity action. These exchanges are open 8 hours per day, 5 days per week. The FX Market does not have a centralized exchange. Instead, it is an Inter-Bank Market that is composed of banks and large financial institutions spread throughout the world. Due to this fact, the FX Market is a 24 Hour per day market.
For those who trade forex, the trading day begins in Asia, then moves to Europe, and finally ends in the United States of America. Then, just as the U.S. trading day comes to an end, Asia begins once again. This continual flow of currency transpires worldwide from Sunday evening until markets close in America late Friday afternoon. This can be very beneficial for traders as they are not subject to unexpected news events that can happen after market hours. The market is always open and order can always be opened, closed, or modified.
Another characteristic of the FX Market that differs from commodity and futures markets is the cost of doing business. In the FX Market, there is no commission charged to the trader. Since the marketplace is completely electronic the costs of business tend to be much lower. Instead of charging a commission, most FX retail brokers fix their cost into the bid/ask spread. For example, if the EUR/USD is showing a 1 pip spread at market, if a trader executes a trade at market, they will paying the broker 1 pip. There is no commission on top of this. This can be slightly misleading at times, especially if the broker widens the spread considerably during news times, which is common in the FX retail space. A trader may see a 1 pip trade most of the time, but during a volatile news announcement the spread may widen to 15 or 20 pips.
A final key characteristic of the FX Market is the liquidity. The estimated daily turnover in the FX Market eclipses $3 trillion. That number is so staggering that it is impossible for any one, or even a handful, of market participants to drive currency prices for any extended period of time.
author: Tom Cleveland of www.forextraders.com, photo from fundswide.com