Basics of Forex Market

The basic components of Forex

•  The currencies

 

 

The most important currencies are
• The American Dollar (USD)
• The Euro (EUR)
• The Japanese Yen (JPY)
• The Swiss Franc (CHF)
• The British Pound (GBP)
The lion’s share of the Forex market falls to these five currencies.
Listen to these figures:-
In 2001 the daily volume of conversion operations amounted to 1,798 trillion
Dollars. The London market dealt with about 32% of the turnover, the USA
markets 18% and Germany 10%. 70% of the operations involved USD. Internet
brokers processed 36% of the deals. An enormous river of money flows around our planet: An unstoppable, irresistible, ever dynamic force. Don’t you believe that it is possible to tap that force…?

•  The players

We have already made reference to the various players on the market. There are more than brokers (who you now have a passing acquaintance with) in this brave new world of ours. We need to understand who else is in the hunt.
First of all there are the large commercial banks. They often represent the interests of exporters and importers, investment institutes, insurance and pension funds, hedgers and private investors. To sum up, they serve a lot of people.
However, do not be misled into thinking that they are mere puppets, simple agents.
They were not born yesterday and they love to play on Forex a little for their own pleasure and profit. It goes without saying that giants like Deutsche Bank, Barclays Bank, Union Bank of Switzerland, Citibank, Chase Manhattan Bank and the Standard Charter Bank carry out transactions in their own interest and at their own
expense. The volumes of their daily operations reach hundreds of billions of Dollars. Very often the larger portion of their profit is made up of currency speculation.
Then there are the brokers. The voice of one broker is like a voice crying in the wilderness. For this reason they unite and form brokerage houses. They are also extremely active participants on the market; they are continually connecting buyers and sellers, handling a great number of funds and working with commission
houses, dealing centers etc.
One important fact which should always be kept in mind is that commercial banks and brokerage houses not only make deals on prices set by other active participants, they also propose their own prices, they advance their own agenda, they ensure there is always a market. In this way they influence the very formation
of prices and because of this they are known as market makers.
Finally, the central banks of various countries are also quick witted. From early in the morning to the dead of night, they go out onto the vast expanse of Forex to hunt. Pure profit is not their stated intent. Nor do they do it merely for the love of the chase, although it must pleasant to wave millions here and there…They look
after their currency and manage the existing rate. Otherwise things could get nasty and the blue skies of happiness could disappear in their country, if they ever existed at all of course.
Just because profit is not their priority does not mean to say that they carry out unprofitable operations. They are not stupid. Whenever the need arises, central banks, disguised as ‘ordinary people’ make their moves without issuing their intentions and other ‘ordinary people’ – the commercial banks – do their business too.
These then are the great movers and shakers on the market. There are also private individuals, for example me and you, who are not great at all, or, perhaps I should say, are less influential. People like us are forced to play by the rules and deal with the prices advanced by the market makers. It’s a fact and we should face up to it, but it’s not such a bleak prospect and it’s also not always plain sailing for the
market makers. I’ll talk more about this later. Of course, even among our group there is a hierarchy. Think about going to a bank and changing a hundred bucks for another currency and it will come as no surprise that you’ll exchange at the declared rate. Try the same place with say $20,000 and they will look at you
differently, I assure you, in a warmer manner. They will explain to you that the rate changes depending on the circumstances, especially for people like you.
You may be thinking: ‘Well, these big players deal in millions of Dollars. What can I do in the face of all
this?’
Ha! A lot! If you marshal your resources and potential and stop counting the money of other participants, you can succeed. Also, remember your leverage, a helping hand if ever there was one. Do you think the bank extends this credit for fun? You’ve also got the best tool of all, namely a keen mind.

•  Leverage

Let’s suppose that after a little time you save a nice round sum, say $1000. You take it down to your exchange office. A guard (such a charming fellow) closes the door behind you and takes your thousand away from you and puts it in a safe. Are you panicking? Listen to the end of my tale. While you are checking out the pictures of the new twenty dollar bill, the guard opens another safe, takes out a canvas bag, assumes an even more charming air and (surprise, surprise) gives it to you. It contains no less than $100000!!!
He tells you in a sweet confiding voice, ‘Go to the cashier’s window and buy currency X. You do so, sell the 100000 and get X. The cashier immediately sells the Dollars to the next client. You have just walked away from the window when the guard tells you to change again. You think for an hour or two, go to the
window and exchange X for Dollars. The rate hasn’t changed (I’m assuming the X is pegged) but because of the difference between the purchase price and the sale price, you make a loss. Let’s say about $100. The same procedure happens a number of times. Even an idiot will grasp that the guard (that defender of the bank’s interests) will only permit ten exchanges. You will only be allowed to make a deal while you hard earned 1000 is there to cover your losses. And then: game over. The guard will impassively take back the canvas bag (which now contains $99000) and resolutely show you the door. After adding your $1000 to the bag the bank is satisfied. $100000 remains in its vaults as before.
Oh, happy day? Yes, Oh happy day! The bank allowed you to manage an enormous sum in comparison to your outlay. But you… Calm down! It was not your fault. This was just a crude example. It illustrates how and what you lost but at least you did not fall into debt. Your risk was limited to what you had. If the rate at the exchange office had changed as dynamically as on the Forex market, then it is perfectly possible for you to have made $1000 rather than lost it. You can develop the story a bit. Your $1000 translates as $100000 after leverage. You bought and sold. You earned $100 and then another, the again $200 and another
$100. You then lost $200, then plus $100, minus $50, plus $200, plus $500 with a result of you earning $1050. When the guard takes away the bank’s money you are left with $2050 in hand.
This then is leverage. It strengthens your hand, it boosts your power and gives you the opportunity to capitalize on your price predictions. The income from the resale of $100000 will always be bigger than the income coming from $1000. However, losses will be equally magnified. So we have to work on ways of reducing losses to the minimum.

To summarize then, leverage is good on the whole. Working with leverage is more advantageous than working without: one hundred times more! We must remember the risks involved and of course leverage increases our risk factor. It’s a little like driving a Formula 1 car. If you immediately put your foot down without having any elementary driving experience, you will be killed for certain. If you approach instruction sensibly, you will be rewarded with the inexpressible feeling of the elation and freedom that you get from controlling such a powerful machine. One person may simply sit back and enjoy the contrast between this racing car and their usual family hatchback, whilst someone else will instinctively become Schumacher.