Why Forex

Vast, liquid and with just the right amount of volatility, FX is the world's biggest and fastest-growing market. The trading is 24 hour, the pricing is as tight as you will find and high leverage means that if you get it right, a little money can earn you a lot. No wonder retail investors are piling in.

'The access to the market has been blown right open,' says Russell LaScala, managing director – head of North American foreign exchange trading at Deutsche Bank.

Retail trade in FX has ballooned from $10 billion turnover six years ago to $110 billion today, he says. It is also the fastest growing segment of the foreign exchange market, currently accounting for 7% to 9% of total daily spot turnover.

FX is more 'democratic' than many other markets, and herein lies its appeal, says Marilyn McDonald, marketing manager at IBFX. 'It has low barriers to entry and most people, regardless of trading experience and disposable income, have the ability to trade in this market.'

Meanwhile, round-the-clock trading, five and a half days a week, 'means that you can work your full-time job, make dinner, take care of the kids and still have a few hours left over for trading,' she says. 'The forex market is not the exclusive club of bankers and brokers. Now the housewife in the suburbs can control a portion of the market from her home office.'

Starting small

Leverage also means that investors can start accessing the market from a relatively small margin account, McDonald continues. 'The standard lot size in forex is $100,000. Since most brokers offer 100-to-1 leverage that means that the average guy can control a standard contract with $1,000 in his margin account.'

Most brokers also offer 'mini contracts' or 'mini accounts' on $10,000 contracts, she adds. Since most mini accounts carry higher leverage – typically 200-to-1 – investors can control a mini contract for $50.And more are even offering 'micro mini contracts' – essentially 0.01% of a mini contract. 'This means that newer traders can learn by trading cents,' she says. 'It is much easier to be down a few pence on your first trade as opposed to £50.'

Technological innovations are driving FX's growth, says Kelly Quintanilla, spokesperson at GFT. 'Individuals can access the world's largest market from their home or from anywhere with an internet connection.

'GFT for example provides a secure mobile trading application, which lets investors trade from their mobile phone,' she adds. 'This kind of access would have been unimaginable a decade ago.'

And for the nervous novice, it is good to remember that retail investors often know more about FX than they think. 'Retail clients normally have a vague idea where certain FX rates are and certainly if they are going on vacation they tend to keep an eye on the rates – if only the tourist rates,' says Tom Nagle, senior manager, institutional sales at Saxo Bank.

'Most people also have some kind of a view on what they consider value – for example a UK resident will think that $2 to the pound is good value and Euro 1.25 to the pound is bad value, so by default they have a view on euro-dollar. Probably as a natural extension of this, retail investors find it less intimidating to trade in one of the four major currency pairs than in one of the thousands of share prices that are available globally,' Nagle adds.

Finely tuned

Ultimately, the best thing about FX is that it's a fine piece of machinery. As Sandy Jadeja, chief currency strategist at ODL Securities says: 'It is one of the best mechanical markets out there – it just works.'

FX markets are not, however, without their risks, with volatility at the top of the list. Even on a quiet day, they can move 60 to 100points, and on choppy days they can range400. This, though, is how traders like it.

In the first few weeks of March, cable traded in almost a 700-point range, creating juicy opportunities for ambitious investors, says David Jones, chief market strategist at IG Index. 'What traders want ultimately is not a market that just sits there dead in the water– they want a market that moves around.

'You have the opportunity to make more profits, and of course the opportunity to incur bigger losses,' he adds. 'It is a double edged sword.'

Currency markets are typically more volatile than other asset classes, and this is good news for FX investors, especially those using spread bets to trade, says James Hughes, market analyst at CMC Markets.

'If you are a spread bettor you tend to be a short-term trader, and if you're a short-term trader you tend to be looking for volatility,' he says. 'You need the volatility to hopefully make some money out of short-term moves.'

'A lot of the trading strategies that people use in FX really depend on volatility,' says Drew Niv, CEO at FXCM. And the good news is that unlike in commodities and fixed income, rising volatility has barely hiked FX spreads yet, he adds.

Access all areas

Transparency of price is one of the biggest drivers behind FX markets' growth, says Deutsche's LaScala. Ten or 15 years ago, retail investors had virtually no access to the institutional-type spreads and liquidity – and hence minimal transaction costs – available on FX, he notes. With online FX platforms 'that has all changed'.

Spreads are much tighter than ten years ago, agrees Jones. 'The cost of doing business in FX is very low compared to traditional shares. You have companies like us offering institutional-sized spreads for really small trades. The FX market is more open today than it has ever been for private investors.'

And despite FX markets' current volatility, traders have never been shut out, says LaScala. 'There has been no time where you couldn't get in or out of positions.'

FX's unmatched liquidity also provides multi-directional trading opportunities, notes GFT's Quintanilla. 'Traders can just as easily buy as they can sell, resulting in potential profit opportunities in either up or down trending markets.'

When the chips are down...

The ongoing credit crisis has shaken up many equity investors' belief systems that investing in a solid company always makes sense, says Niv. Many retail investors get trapped in the mentality of only looking for cheap times to buy, and multi-directional FX gives them a chance to change tack, he says.

'If we are heading in a major stock market decline, and people are worried about bear markets, then at least we're going to get movements both from the upside and downside in the FX markets,' says Jadeja. 'And that's great for a beginner to get involved in, because they can learn both sides very quickly.'

Including currency markets in an investor's trading portfolio is, meanwhile, a good risk diversifier, and their correlation with certain other asset classes makes them doubly attractive, says Saxo Bank's Nagle.

Currency markets also allow investors to take a punt on a specific country, LaScala adds. 'If you have a view that New Zealand is going to enter a recession, you can express that by selling its currency,' he says. 'You can't really do that in equities as some companies may actually benefit from the slower growth.'

'A lot of the recent interest in forex trading may be due to the recent fluctuations in the US dollar,' says Quintanilla. 'This currency, which used to be very strong compared to many other world currencies, has been steadily dropping in value.

'Because the declining US economy has been such a newsworthy topic around the globe, many individuals are seeing the opportunities that can be found in trading the dollar, or a variety of other currencies,' she adds.

A lot of the growth in FX is due to the dollar's current big break-out, says Phil Sisca, director of foreign exchange at E*Trade. 'It's created a very sustainable trend, and traders love trends,' he says.

'Trends tend to persist longer in FX,' with the US dollar's downward slide one example, says IG Index's Jones. 'We have seen persistent weakness year in, year out,' he notes.

Euro-dollar has moved 8.5% this year alone, and 18% year-on-year, notes LaScala– although this trend could be set to change. 'We have had a six-and-a-half to seven year downtrend in the dollar, and if you look back throughout history you can see that cycles tend to last about seven years.'

'It's tricky now to pick a bottom in the dollar… but we could be approaching the end of the downward trend,' he adds. 'I think sometime in the next six to nine months there will be evidence that the dollar has turned. Once we have evidence the Fed is in a neutral policy stance, the dollar could reverse.'

Which means for retail investors, the very next FX opportunity could be just around the corner.

©Taken from Shares Magazine Forex Feature 2008.