FX may be the largest global financial market, but many retail traders do not understand the mechanics of it. This financial market used to be dominated by secretive hedge funds, multinational corporations and large financial institutions, but the popularity of the internet has made it possible for individual investors to gain access to this market.
Regardless of whether you are a novice or an experienced trader, there are still many common questions of interest you might ask about this market.
What is the Difference between FX and other Markets?
The first and most important difference between the FX market and others is that currency trading does not occur on a regulated exchange. There is no central body governing this financial marketplace. There are no guarantees of the trades via clearing houses and no arbitration board to handle disputes. Members trade with each other on a credit agreement basis. In essence, this large liquid market is based on a virtual handshake.
This may seem quite flimsy to investors who have become accustomed to the structures of stock exchanges. This arrangement works very well in practice in the FX market. Participants in this market must co-operate and compete with each other and this self-regulation has proven very effective for control in the marketplace. There are global countries that have introduced regulatory bodies and it is highly advisable for retail customers to consider trading through firms who are registered with the regulatory body only.
There are other differences in the FX market that often cause raised eyebrows among traders in the commodities markets. For example, if you think that the EUR/USD is about to decline, you can short the currency pair at will. There is no uptick rule in foreign exchange as there is in the stock market. The uptick rule states that every short transaction should be entered at a price higher than what the price was on the previous trade. This rule prevents short sellers from compounding the asset’s downward spiral when it is already declining sharply.
There are no limits placed on the size of the positions you place, as is in the futures market. This means that if you were able to sell $100 million worth of currency, you are able to do so. For example, if your tennis partner had inside information regarding an increase in interest rates, you could go out and buy as much of that currency as you like. If your trade pays off, you will not be prosecuted for insider trading. In fact, in the forex market, there is no such term as insider trading. It is known that European economic data is often leaked several days before the official announcements which give traders the chance to make huge profits in this market.
Although all this information may give you the impression that the FX market is wild, with no structure or rules, there are other advantages linked to this trading market. There are some rules related to trading and participants in this market generally hold their own and allow the market to run in an orderly fashion. This is the most fluid and liquid market globally which trades all day and night, so your chances of making money in this market are extremely high.