Friday, October 20

Overview of Investment Product: Forex

The foreign exchange market (also known as forex or FX) may sound mysterious to you, but it is actually the largest financial market in the world, with daily average turnover of US1.9 trillion, or 30 times larger than the US equity markets.

What exactly is forex?

  • Forex is simply the trading of currencies, and they are always done in pairs, i.e. buying one and selling the other simultaneously. Examples: EUR/USD, USD/JPY.

What are the characteristics?

  • A “true” 24-hour market
  • Most sensitive to economic, social and political event
  • 85% of the transaction volume involves the “Majors”, i.e. US Dollar, Japanese Yen, Euro, British Pound, Swiss Franc, Canadian Dollar and Australian Dollar
  • Although forex trading is needed for normal running of multi-national business, the majority (95%) are trading for profits
  • Forex provides more leverage than stocks or futures, which makes forex trading attractive to many traders

What is leverage?

  • Leveraged trading (or trading on margin) means that you are not required to put up the full value of the position of the trade.
  • In forex, you can leverage up to 200 times. This is possible because the volatility of major currencies are usually within 1%. Without leverage the traders cannot capture higher returns on a the small market movement.
  • This is, however, risky business -- while you can have substantial gain with a small amount of capital, you can easily lose in the same magnitude. Afterall, the market is a zero-sum game.

Conclusion

  • Leave it to the advisors -- retail investors simply do not have the time to monitor the positions.
  • FX-linked structured products are available but are mostly for sophisticated investors.
  • However, if we are bullish on a particular currency, we can participate in forex indirectly by buying stocks and bonds. For example, if we like euro and we buy the shares of a retail business that have significant exposure in Europe, it would be a relatively safe and smart way to play the game.

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