Trading Rules and Procedures
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Forex (a contraction of “foreign exchange,” often abbreviated as FX) is the market in which currencies are traded. The forex market is the largest, most liquid market in the world in terms of the total amount of cash traded, with average daily sums measured in the trillions of dollars. It includes all of the currencies in the world.
Forex is an example of a contract for difference (CFD). In any CFD, a seller agrees to pay to a buyer the difference between the current value of an asset and its value at a specified contract time. In the event the difference will turn out to be negative, the buyer pays the seller. People, businesses and governments can all be sellers or buyers.
There is no single central forex market. Trade is conducted over the counter in all major financial centers, including Frankfurt, Hong Kong, London, New York, Paris, Singapore, Sydney, Tel Aviv, Tokyo, and Zurich.
Not surprisingly, the U.S. dollar is the most actively traded currency, and it is most frequently traded for euros, followed by the yen, the pound sterling, and the Swiss franc. The profit or loss in forex is due to market fluctuations that typically result from a combination of short-term speculation, major economic indicators and interest rate differentials.
Spot vs. Forward Trading
Forex transactions take place on either a “spot” (immediate) or a “forward” (later) basis. Spot is defined as two business days for most currency pairs, not counting weekends or legal holidays in the countries whose currencies are being traded. A forward trade can be scheduled by agreement at any time in the future other than a weekend or holiday, and takes into consideration the interest rate differential between the two traded currencies. Transactions that will mature more than a year later are relatively unusual, but possible. In both cases, funds are exchanged not on the day of the transaction but rather on the settlement date.
A "future" is similar to a forward, but is only traded on an exchange and can only be executed for specific amounts and on specific dates. The buyer pays a portion of the value of the contract up front and either pays or receives money based on the change in value. Futures are most commonly used by speculators, and the contracts are usually closed out before maturity.
- Forex provides an option for every budget and every investor with a different appetite for risk taking, and transaction costs are extremely low compared to other types of trading
- The forex market operates 24 hours a day, seven days a week, closing only for major national holidays
- Information regarding forex markets is easily available and simple to understand
- The global forex market is huge, so no country, central bank or single investor can corner the market or rig prices for an extended period of time
- Time differences between major financial centers around the world can affect exchange rates
- Individual traders, therefore, are advised to use algorithms to protect the value of their investments when they are sleeping, in transit or otherwise indisposed
- A relatively small adjustment in the price of a contract may yield immediate and substantial losses in excess of the amount invested
- Changes in the forex market are usually small, unless they are “leveraged” through low margin deposits or trade collateral
- The other party to the transaction may not have the intention or the ability to honor a contract
- Sudden unexpected news (catastrophic weather or earthquakes, for example) can significantly affect the market
- There is almost no government regulation, so investors have few, if any, protections
- Traders may lose all of their investment in a matter of minutes, even before deducting brokerage commissions, if they place highly leveraged bets
Caveat Emptor: Buyer Beware
In the United States, there are no registered exchanges that offer CFDs to retail investors. If your retail brokerage claims to be registered in the U.S., it’s a scam. Other countries and jurisdictions that have banned or severely restricted retail forex trading are:
- Bosnia & Herzegovina
- Canada (in British Columbia and Quebec)
- Ivory Coast
- North Korea
- South Korea
- Sri Lanka
- St. Helena