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By Matt kaldor

More and more retail traders are looking to the currency market. The foreign exchange market, or forex, is where traders buy and sell currencies. Primary participants in the currency trading market are corporations, commercial and central banks, investment firms, pooled funds, and other retail traders. While there is no physical trading floor, the currency exchange market is the largest financial market in the world.

Currency values change continuously based on a variety of factors including changes in interest rates, inflation expectations, and other economic variables. Traders analyze currencies using both fundamental analysis and technical analysis to determine if currencies will appreciate or depreciate in value. Fundamental analysis can involve currency risk correlating to its applicable country while technical analysis would deal solely with trading patterns by the currency itself. An example of fundamental analysis in forex trading is valuing currencies based on current and expected Inflation. Common technical analysis tools used in the forex market include pivot points and Elliott Waves.

A forex quote can be presented as a direct quote or an indirect quote. A direct quote displays the foreign exchange rate of a domestic currency per foreign unit. An indirect quote displays the foreign exchange rate of a foreign currency per domestic unit. Forex quotes change by pips, or the smallest increment of change represented as a percentage in point.

Consider Trader X living in the United States. Trader X’’s domestic currency is the U.S. dollar. In this case, foreign currencies would include all other currencies such as the euro, yen, franc, peso, and yuan. Trader Y, who lives in Japan, has the yen as their domestic currency. The most common currency pair trades are the EUR/USD (Euro/U.S. dollar), USD/JPY (U.S. dollar/Japanese yen), GBP/USD (British pound/U.S. dollar), EUR/JPY (Euro/Japanese yen), and USD/CHF (U.S. dollar/Swiss Franc).

A common action in the forex market is the carry trade. The carry trade plays off differences in interest rates. Essentially, a trader would lend a currency whose domestic interest rate is higher and borrow a currency whose domestic rate is low. The risk of the carry trade is that when it unwinds, currency price movements can become extremely volatile as investors look to either take profit or unload their position quickly.

Although there are some key differences, forex trading is executed similarly to regular equity trading.
Currency trading can be done using an online brokerage account using limit orders, stop-loss orders, and other typical market orders. Forex brokers do not charge commissions. Instead, they collect fees through larger-than-equity-trade spreads. Forex traders generally employ leverage to magnify the impact of what are typically relatively small currency movements. Leverage involves borrowing money from your broker to execute trades. While leverage does magnify gains, it also enlarges losses.

Currency values are heavily influenced by the actions of major financial centers such as the Federal Reserve, European Central Bank, International Monetary Fund, and other central institutions. The principal in Forex trading is a Futures Commission Merchant (FCM), overseen by the Commodity Futures Trading Commission (CFTC). Forex brokers can act as currency brokers and market makers as well.

About The Author

Matt Kaldor is a senior content writer with Better Trades (http://www.better-trades-university.com/), the nation’’s No. 1 stock market education company.