Trading is the act of exchanging one currency or currency for another, for example buying $100 for $150 or selling $150 for $100. Trading takes place on FOREX, which is an interbank market, therefore it is not centralized as a market place. The Exchange Rate is the exchange price between 2 currencies. For the EUR/USD for example, if the rate is 1.3450, this means that for 1€ you get 1.3450.$ in exchange.
The structure of the Forex market
A few figures to take as an example: in April 2007, the daily trading volume is 3200 Million US Dollars, with the United Kingdom in first place and United Kingdom in third place. Asia accounts for about 20 percent but is currently a rising power. Indeed, at the time of writing (End of August 2013), Thai brokers are starting to offer retail trading platforms to trade the SET Index (Stock Exchange of Thailand), with EUR/THB, EUR/USD, USD/THB, Gold and SP500 available.
Nature of stakeholders
- 5% of the daily volume comes from governments or trading companies,
- 95% comes from speculators,
- 80% of the positions traded in Forex are held for less than 7 days,
- 40% of the positions traded on the Forex market are held for less than 2 days,
- 85% of Forex transactions are made on the major pairs EUR/USD (28% of overall volume), USD/JPY (17%), GBP/USD (14%).
Among these stakeholders, we still find all equity managers:
- Central banks,
- Institutional investors,
- Multinational firms,
- Commercial Banks Brokers,
- Private traders.
Brokers execute the orders and provide the transactions.
The transaction pattern is therefore very simple:
What will be of particular interest to us as individual traders is this form of trading contract called CDF. What is a CFD?
CFDs (Contracts for Difference) allow you to take advantage of changes in the financial markets, both up and down. You can access a wide range of international securities such as currencies, stocks, futures and commodities. In London, CFDs are called spread betting.
Briefly, a CFD is a contract that exchanges the difference in value of the underlying asset between the beginning and end of the contract.
With CFDs, you only invest in the price movement of the underlying asset. You never become the owner of the asset.
CFD trading allows you to trade in real time and intervene in the markets as they evolve.
Some CFDs have an expiry date, while others are unlimited, allowing you to study the market and close positions at the time you feel is most favourable.
You can choose to trade CFDs on individual stocks, commodities, currencies (Forex/FX), bonds, interest rates and ETFs.
It is the strong variations observed in this asset class that create the many trading opportunities, especially intraday trading (opening and closing positions in a single day).
Your broker will often use the argument of the low deposit required to open a position to demonstrate the popularity and accessibility of CFDs. “Although you only have to pay a small amount to make a trade,” they say, “you will benefit from its full value. They forget to add: “but also potential losses that can be catastrophic if the market moves against you“.
Even though this unique aspect of CFDs allows for higher profits, it is still a matter of extreme caution. You need to have a comfortable enough account to be able to support you in case of sudden or unexpected price rises or falls. For example, if you have an account with 50 euros, trading will be very risky because if the price goes down or up by a hundred points (or pips), your entire account will be swallowed up. You then risk falling into this alienating spiral of replenishing your account with 50 euros, losing them again, and so on. As we will see later, this can be avoided with good Money Management and risk settings on the platform, but it is better to have an account of around 1000 euros to start with, which will support you during phases of high volatility.
One advantage: trading CFDs is exempt from stock exchange tax. On the other hand, in United Kingdom, profits made on CFDs are taxed in the same way as on the traditional stock exchange.