While online Equities and Futures Trading have enjoyed exponential growth and widespread notoriety over the past few years, online Foreign Exchange Trading or otherwise known as the Forex, FX, or 4X Market is now gaining popularity among seasoned active Traders, Commodity Trading Advisors (CTAs), and other professional money managers.

So what are the benefits of trading the Forex Market? (1) 24 hour a day trading: Traders benefit from the ability to respond to breaking news immediately, day and night. (2) Superior market liquidity: More than 1.8 trillion dollars are traded every day in the 4X Market. The sheer volume of this market helps ensure price stability, as well as less gapping and price slippage. (3) Narrower dealing spreads: Normal bid/ask spreads are five pips or less, much tighter than a typical stock transaction. (4) No uptick rule: Making it easy to establish both short and long positions. (5) Increased leverage: Firms offer Traders a 2% margin, compared to a 50% margin for the Equity Markets. (6) No commissions or fees: Overall, FX has much lower transaction costs than Equities or Futures, an important point for active Traders.

Until recently, large international Banks dominated the Foreign Exchange Market, only allowing access via telephone trading to a select few such as Fortune 1000 Companies, large funds, high net worth individuals, and so on. But now, the tide has turned and finally there are established online trading firms that provide individual Investors with direct access to the largest, most liquid financial market in the World.

In addition to the market’s trading opportunities, Foreign Exchange can be a solid diversification component in your financial portfolio. Most diversification strategies involve a combination of sector allocation, foreign and domestic equities, and fixed income. Some participants have branched out into precious metals and/or energy products. However, trading opportunities in the Forex Market deserve serious consideration as a diversification strategy for your portfolio. Few Traders consider expanding into Forex. Why? The reason may be in the simple fact that in the US, investors tend to be under exposed to foreign exchange. Unfamiliarity typically breeds misconceptions, and Foreign Exchange in the US is no exception.

Is Forex as risky as everyone thinks? One way to measure risk is to compare a financial product’s risk relative to its return. If you take the time to compare an investment in Forex to common investments such as equities and fixed income, you will find that from a risk/reward standpoint, Forex investments provide respectable returns and should be considered viable portfolio diversification tools. An investment in a basket of major currencies last year was comparable to 30-year bond futures, and clearly outpaced the negative returns generated by the DJIA. Although Forex trading can lead to very profitable results, there are risks involved. When it comes to trading Forex, you’ll need to worry about exchange rate risks, interest rate risks, credit risks, and Country risks, things you may not consider when trading stocks.

Approximately 80% of all currency transactions last a period of seven days or less, while more than 40% last fewer than two days. Given the extremely short life span of the typical trade, technical indicators heavily influence entry, exit, and order placement decisions. Further, approximately 85% of all daily Forex transactions involve the majors, which include the US dollar, Yen, Euro, British Pound, Swiss Franc, Canadian Dollar, and Australian Dollar. The depth and concentration of the market in just seven currencies provides a statistically significant dataset for trend analysis. Technical indicators work the same way on the Currency Market as they do on the Equity Markets.

The Foreign Exchange Market is also unique in that central Banks intervene from time to time to affect the price movements of their respective currencies. This may disturb some Traders who use fundamentals to make investment decisions, but Banks can only influence currency values for short periods, over time, the markets adjust to the changes and leads to the formation of trends, which trend following strategies will help you trade. Since most currency trading is short term in nature, speculators can also cause erratic fluctuations in the exchange rates.

Of the more than 1.8 trillion dollars a day transacted in the foreign exchange markets, an estimated 95% comes from speculative trading (trading for profit). While the large international Banks are responsible for the majority of this volume, there are retail investors all over the globe trading Forex on a daily basis. Without a doubt, investors in the US are behind the curve with regard to learning about and participating in this market. Active Equity and Futures Traders who appreciate liquidity, strong technical indicators, and a multitude of short term trading opportunities will find the Forex Market especially appealing. In conclusion, trading the Foreign Exchange Market deserves serious consideration as a diversification strategy in anyone’s portfolio.

Courtesy Stocks and Commodities Magazine, 2002