that if they only feel comfortable with 10 or 20 times leverage or no leverage at all, they can elect to do so. It is extremely important to understand that leverage is a double-edged sword – it can magnify profits but also losses.
Profit in Both Bull and Bear Markets
In the FX market, profit potentials exist in both bull and bear markets. Since currency trading always involves buying one currency and selling another, there is no structural bias to the market. Therefore, if you are long one currency, you are at the same time short another. As a result, equal profit potential exists in both upward-trending and downward-trending markets. This is different from the equities market, where most traders go long instead of short stocks, so the general equity investment community tends to suffer in a bear market.
No Trading Curbs or Uptick Rule
The FX market is the largest market in the world, forcing market makers to offer very competitive prices. Unlike the equities market, there is never a time in the FX markets when trading curbs would take into effect and trading would be halted, only to gap when reopened. This eliminates missed profits due to archaic exchange regulations. In the FX market, traders would be able to place trades 24 hours a day with virtually no disruptions.
One of the biggest annoyances for day trades in the equity market is the fact that traders are prohibited from shorting a stock in a downtrend unless there is an uptick. This can be very frustrating as traders wait to join short sellers, but are only left with continually watching the stock trend down before an uptick occurs. In the FX market, there is no such rule. If you want to short a currency pair, you can do so immediately; this allows for instant and efficient execution.
Online Trading Reducing Error Rates
A shorter trade process minimizes errors. Online currency trading is typically a three-step process. A trader would place an order on the platform, the FX dealing desk would automatically execute it electronically, and the order confirmation would be posted or logged onto the trader's trading station. Typically, these three steps would be completed in a matter of seconds. For an equities trade on the other hand, there is generally a five-step process. The client would call his broker to place an order, the broker sends the order to the exchange floor, the specialist on the floor tries to match up orders (the broker competes with other brokers to get the best fill for the client), the specialist executes the trade, and the client receives a confirmation from the broker. The elimination of a middleman minimizes the error rates in currency trades and increases the efficiency of each transaction.
Limited Slippage
Unlike the equity markets, many online FX market makers provide instantaneous execution from real-time, two-way quotes. These quotes are the prices where the firms are willing to buy or sell the quoted currency, rather than vague indications of where the market is trading, which may or may not be honored. Orders are executed and confirmed within seconds. Robust systems would never request the size of a trader's potential order, or which side of the market he's trading, before giving him a bid/offer quote. Inefficient dealers determine whether the investor is a buyer or a seller, and shade the price to increase their own profit on the transaction.
The equity market typically operates under a “next best order” system, under which you may not get executed at the price you wish, but rather at the next best price available. For example, let's say Microsoft is trading at $52.50. If you enter a buy order at this rate, by the time it reaches the specialist on the exchange floor, the price may have risen to $53.25. In this case, you will not get executed at $52.50; you will get executed at $53.25, which is essentially a loss of ¾ of a point. The price transparency provided by the some of the better market makers assures that traders always receive a fair price.
Perfect Market for Technical Analysis
For technical analysts, currencies rarely spend much time in tight trading ranges and have the tendency to develop strong trends. Over 80 % of volume is speculative in nature and as a result, the market frequently overshoots and then corrects itself. Hence, technical analysis works well for the FX market, and a technically trained trader can easily identify new trends and breakouts, which provide multiple opportunities to enter and exit positions. Charts and indicators are used by all professional FX market traders, and candle charts are available on most charting packages. In addition, the most commonly used indicators such as Fibonacci retracements, stochastics, MACD, moving averages, RSI, and support/resistance levels have proven valid in many instances.
In the USDJPY chart shown in Figure 1.1, it is clear that Fibonacci retracements, moving averages, and stochastics have at one point or another given successful trading signals. For example, the 61.8 % retracement level served as resistance for USDJPY in December 2014, January 2015, and February 2015. The moving-average crossovers of the 10- and 20-day simple moving averages also successfully forecasted the rally in USDJPY in late October, along with the decline in early January. Equity traders who focus on technical analysis have the easiest transition, since they can implement the same technical strategies that they use in the equities market into the FX market.
Figure 1.1 USDJPY Chart
Source: eSignal
Analyze Stocks Like Countries
Trading currencies is not a big challenge for fundamental traders either, because countries can be analyzed like stocks. For example, if you analyze growth rates of stocks, you can use gross domestic product (GDP) to analyze the growth rate of countries. If you analyze inventory and production ratios, you can follow industrial production (IP) or durable goods data. If you follow sales figures, you can analyze retail sales data. As with a stock investment, it is better to invest in the currency of a country that is growing faster and fund it with a currency of a country that is growing slower. Currency prices reflect the balance of supply and demand for currencies. Two of the primary factors affecting supply and demand of currencies are interest rates and the overall strength of the economy. Economic indicators such as GDP, foreign investment, and the trade balance reflect the general health of an economy and are therefore responsible for the underlying shifts in supply and demand for that currency. There is a tremendous amount of data released at regular intervals, some of which are more important than others. Data related to interest rates and international trade is the most closely followed.
If there is uncertainty regarding the direction of interest rates, any bit of news on monetary policy can directly affect how the currency trades. Traditionally, if a country raises its interest rate, the currency of that country will strengthen in relation to other countries as investors shift assets to that country to gain a higher return. In contrast, an interest rates hike is generally bad news for stocks because it means that borrowing costs have risen. In response, some investors will transfer money out of a country's stock market when interest rates are increased, causing the country's currency to weaken. Determining which effect dominates can be tricky, but generally there is an advance consensus on how interest rates will move. Indicators that have the biggest impact on interest rates are producer prices, consumer prices, employment, spending, and GDP. Most of the time monetary policy announcements are known in advance with meeting dates by the Bank of England (BoE), the Federal Reserve (FED), European Central Bank (ECB), Bank of Japan (BoJ), and other central banks posted on their respective websites.
Another piece of data that can impact how currencies move is the trade balance, which shows the net difference over a period of time between a nation's exports and imports. When a country imports more than it exports, the trade balance will show a deficit, which is generally considered unfavorable. For example, if U.S. dollars are sold for other domestic national currencies (to pay for imports), the flow of dollars outside the country will depreciate the value of the dollar. Similarly, if trade figures
