Currency Trading For Dummies. Kathleen Brooks

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for spot

      

Spot refers to the price at which you can buy or sell currencies now, as in “on the spot.” If you’re familiar with stock trading, the price you can trade at is essentially a spot price. The term is primarily meant to differentiate spot, or cash, trading from futures trading, or trading for some future delivery date. The spot currency market is normally traded for settlement in two business days. Unless otherwise specified, the spot price is most likely to be what you buy and sell at with your currency broker.

      Speculating in the currency market

      While commercial and financial transactions in the currency markets represent huge nominal sums, they still pale in comparison to amounts based on speculation. By far the vast majority of currency trading volume is based on speculation — traders buying and selling for short-term gains based on minute-to-minute, hour-to-hour, and day-to-day price fluctuations.

      Estimates are that upwards of 90 percent of daily trading volume is derived from speculation (meaning commercial or investment-based FX trades account for less than 10 percent of daily global volume). The depth and breadth of the speculative market means that the liquidity of the overall forex market is unparalleled among global financial markets.

      The bulk of spot currency trading, about 75 percent by volume, takes place in the so-called “major currencies,” which represent the world’s largest and most developed economies (see Chapter 8 for details). Trading in the major currencies is largely free from government regulation and takes place outside the authority of any national or international body or exchange.

Additionally, activity in the forex market frequently functions on a regional “currency bloc” basis, where the bulk of trading takes place between the USD bloc, JPY bloc, and EUR bloc, representing the three largest global economic regions.

      Trading in the currencies of smaller, less-developed economies, such as Thailand or Chile, is often referred to as emerging market or exotic currency trading. Although trading in emerging markets has grown significantly in recent years, in terms of volume it remains some way behind the developed currencies. Due to some internal factors (such as local restrictions on currency transactions by foreigners) and some external factors (such as geopolitical crises and the financial market crash, which can make emerging market currencies tricky to trade), the emerging-market forex space can be illiquid, which can be a turnoff for a small investor.

      Getting liquid without getting soaked

      Liquidity refers to the level of market interest — the level of buying and selling volume — available at any given moment for a particular asset or security. The higher the liquidity, or the deeper the market, the faster and easier it is to buy or sell a security.

      

From a trading perspective, liquidity is a critical consideration because it determines how quickly prices move between trades and over time. A highly liquid market like forex can see large trading volumes transacted with relatively minor price changes. An illiquid, or thin, market tends to see prices move more rapidly on relatively lower trading volumes. A market that only trades during certain hours (futures contracts, for example) also represents a less liquid, thinner market.

      

We refer to liquidity, liquidity considerations, and market interest throughout this book because they’re among the most important factors affecting how prices move, or price action.

      

It’s important to understand that, although the forex market offers exceptionally high liquidity on an overall basis, liquidity levels vary throughout the trading day and across various currency pairs. For individual traders, though, variations in liquidity are more of a strategic consideration rather than a tactical issue. For example, if a large hedge fund needs to make a trade worth several hundred million dollars, it needs to be concerned about the tactical levels of liquidity, such as how much its trade is likely to move market prices depending on when the trade is executed. For individuals, who generally trade in smaller sizes, the amounts aren’t an issue, but the strategic levels of liquidity are an important factor in the timing of when and how prices are likely to move.

In the next section, we examine how liquidity and market interest changes throughout the global trading day with an eye to what it means for trading in particular currency pairs. (We look at individual currency pairs in greater detail in Chapters 8 and 9.)

Around the World in a Trading Day

      The forex market is open and active 24 hours a day from the start of business hours on Monday morning in the Asia-Pacific time zone straight through to the Friday close of business hours in New York. At any given moment, depending on the time zone, dozens of global financial centers — such as Sydney, Tokyo, or London — are open, and currency trading desks in those financial centers are active in the market.

      In addition to the major global financial centers, many financial institutions operate 24-hour-a-day currency trading desks, providing an ever-present source of market interest.

      

Currency trading doesn’t even stop for holidays when other financial markets, like stocks or futures exchanges, may be closed. Even though it’s a holiday in Japan, for example, Sydney, Singapore, and Hong Kong may still be open. It may be the Fourth of July in the United States, but if it’s a business day, Tokyo, London, Toronto, and other financial centers will still be trading currencies. About the only holiday in common around the world is New Year’s Day, and even that depends on what day of the week it falls on.

      The opening of the trading week

      There is no officially designated starting time to the trading day or week, but for all intents the market action kicks off when Wellington, New Zealand, the first financial center west of the international dateline, opens on Monday morning local time. Depending on whether daylight saving time is in effect in your own time zone, it roughly corresponds to early Sunday afternoon in North America, Sunday evening in Europe, and very early Monday morning in Asia.

The Sunday open represents the starting point where currency markets resume trading after the Friday close of trading in North America (5 p.m. eastern time [ET]). This is the first chance for the forex market to react to news and events that may have happened over the weekend. Prices may have closed New York trading at one level, but depending on the circumstances, they may start trading at different levels at the Sunday open. The risk that currency prices open at different levels on Sunday versus their close on Friday is referred to as the weekend gap risk or the Sunday open gap risk. A gap is a change in price levels where no prices are tradable in between.

      

As a strategic trading consideration, individual traders need to be aware of the weekend gap risk and know what events are scheduled

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