$5.1 Trillion of Trading per Day: How the Forex Works

in Investment
Forex

It’s important for traders to understand that in order for any market to move, large transactions need to take place.

And because the currency market is the largest and most liquid market on Earth, even larger transactions are required to move it, than for example a less liquid market like the stock market.

So this leads us to the question who has this kind of money to trade?

With over $5.1 trillion of trading volume per day, the foreign exchange market is by far the largest and most liquid financial market in the world. Also known as the currency market, it is a global decentralized market that unlike the stock market doesn’t have one central exchange trade building, but instead there are many places all over the world where you can trade currencies.

Governments, central banks, big retail banks, investment firms, financial firms, corporations and businesses.

All those participants in the Forex market have a significant capital. The small retail trader practically has no effect on the market prices as his orders are very small in comparison to other market players.

So let’s take a look at the more important currency traders:

  1. The goal of most central banks and governments is price stability accompanied by economic growth or expansion. The central bank adjusts interest rates according to the current economic situation. With that, they control the flow of money in the economy and therefore directly influence the value of their respective currency. By rising rates they tighten the flow of money, hence it’s good for the currency. By cutting rates, or easing monetary policy they cut the value of the currency.
    Governments ease or tighten the money flow by adjusting tax rates, or spending on public projects like infrastructure, education, the military etc.
  2. The banks act as market makers in the Fx market, they make money from the spreads on the transactions. Most retail Forex broker, like yours for example, are connected to a bank and they just pass on clients’ orders to the bank, also known as a liquidity provider in this case.
    Aside from profiting on the spreads, the banks also speculate in the Forex market and profit on the currency moves.
  3. Financial firms like mutual and hedge funds are the main speculators in the market and like the retail trader, their goal is to make profits from market fluctuations. They have huge capital at their disposal and they trade clients’ funds, for which they charge commissions and take a portion of the profit they generate.

Watching what those 3 groups of participants in the Forex market is important and what they do usually has a direct impact on the currency pairs we trade. Central banks often set and end trends in the currency market.

In essence, those places are the banks around the world and they are the market as transactions occur directly between them. Therefore, the Fx market is opened 24 hours a day, 5 days a week.

Literally every one of us takes part in the currency market in one way or another. And exchange rates can significant effects on the daily life of everybody.

For, example:

If you live in Europe and the Euro loses value against the US dollar, you are likely to see an increase in prices on products imported from the USA.

Large international corporations are closely watching exchange rates also, as fluctuations can have huge implications on their costs profits.

Usually to combat such risks, corporations will hedge currencies in the forwards or futures market where they pre-agree a price with a counterparty trader.

Like in any financial market, large fluctuations in price occur on daily basis. Traders or speculators are people who look to profit from these price changes in the market.

Traders can be professionals working at a bank or at an investment company, or they can be retail traders trading on their own. With the growing availability of the internet, Forex trading has become a very popular hobby for many people as traders can now easily trade from home via online trading platforms.

Generally, traders use 2 types of analysis for determining trading opportunities, and those are fundamental and technical analysis.

Fundamental analysis

Fundamental analysis tries to understand the underlying drivers of a currency and the economy of that country. Following the calendar and what the reports mean for the economy is a big part of the fundamental traders’ job.

Technical analysis

On the other hand, pure technical analysis traders look only at prices and pay little or no attention to economic trends in the countries of the currencies they trade.

Very often traders will use both technical and fundamental analysis to some extent to make their trading decisions.

  1. Fundamental analysis better determines the general direction of currency pairs,
  2. while technical analysis is better at identifying precise entry and exit points.

Obviously, the Forex market offers unique advantages that will suit some traders a lot better than other markets. Some of these include the very high liquidity and flexibility of the Fx market.

It’s open 24h a day and traders with a full-time job can also benefit from trading Forex.

Unlike other markets, a trader can open a retail Forex account for as little as $50, though that is not recommended. In comparison, most brokers on other markets, require at least a few thousands of dollars before you can be in the game.

Smaller accounts with a few hundred dollars can be useful because of the high leverage offered by Forex brokers. Again, in other financial markets the most leverage you are going to get will be around 1:10 at most.

In Forex, traders regularly get as high as 1:500 and sometimes even more. While high leverage does have a bad reputation among some, it can be a very valuable tool if used correctly and if the trader understands all the risks involved.

Technical levels like support and resistance work very well because of the high liquidity in the market, unlike in a thin market where a lot of choppy moves occur. This makes trading a little easier for the retail trader as most rely on technical analysis to make a profit.

Because of the high liquidity orders are executed instantly almost always. The only time you might get a requote is during news moments when rapid market moves occur. In other markets getting the price you want can be a hassle in and of itself.

Another good way to make money in Forex is the famous carry trade. Essentially it is profiting on the base interest rate differentials between the currencies.

Even if the price doesn’t move at all, the trader still makes money from the difference in interest rates. The bigger the difference in the interest rates the bigger the profit for the trader.

For example

take the EUR/NZD pair where the interest rate on the Euro is 0.00% and on the NZD, it’s 2.25%. In this case, if the trader sells EUR/NZD he can make 2.25% on his invested amount if he holds the trade for 1 year.

Now 2.25% is not much, but consider that there are currencies with an interest rate of over 10%. The risk with the carry trade is of course if the trade goes against you the currency you bought significantly depreciates against the currency you sold.

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Momentum indicators and Oscillators

Momentum indicators or oscillators are mostly used for two purposes.

To identify the momentum of a market move and to identify possible exhaustion levels, also known as overbought and oversold levels.

Momentum indicators and oscillators provide good information to the trader if a top or bottom is forming in the market. Most of the ways they are used in have the goal to signal a trend reversal.

Whether it’s a slowing momentum, an overextended level or divergence, they all signal a price reversal and they can all be identified by using an oscillator.

Momentum, defined as the size of changes in the price over time, in essence, is the acceleration or deceleration of price movement. It’s logical then, that when the trend is at full power, usually in the middle of the swing the momentum would be accelerating.

Towards the end of the trend momentum usually starts to wane and this can be better identified with the help of these indicators. Traders use a waning momentum as a sign that the trend is coming to an end and they start to look for confirmation from other indicators.

A momentum signal alone should not be used to enter the market, but rather it is always advised to confirm it with other trading tools first.

Most popular oscillators for judging overbought and oversold levels are the Stochastic oscillator and the Relative Strenght Index (RSI).

The Moving Average Convergence/Divergence (MACD) is usually not suited for this purpose although there are some traders who use it in this way. The reason is because the MACD is not a normalized oscillator.

Unlike the MACD, the Stochastic and the RSI are normalized oscillators with their values oscillating between 0 and 100. An overbought level for the Stochastic is considered if the reading is at or above 80 while for the RSI it’s if the reading is at or above 70. An oversold level is a reading below 20 for the Stochastic and a reading below 30 for the RSI.

Oscillators are also often used with success for trading divergences. That is a divergence between the oscillator value and price. Usually comparing the highs and lows shaped by the price and the highs and lows on the indicator’s reading.

The basic premise is that when price makes a higher high momentum should also if the trend would to be real. So when price makes a higher high but the indicator makes a lower high instead it’s called bearish divergence and is a warning sigh of a market top. The laws are used in the same manner to look for bullish divergence.

Support and resistance trading

Support and resistance levels are usually one of the first things beginners learn, and for good reason because they have proven to give good results so many times over so many years.

The basic logic behind support and resistance levels is that any past price where the market turned or reversed becomes a price at which traders will enter the market again in the future. Such levels are called support and resistance levels.

Horizontal support levels are previous low swings on the chart while horizontal resistance levels are the previous swing highs. Price is always above support and below resistance.

Box-range on a GBPUSD chart Support levels are the 2 lines at the bottom of the chart and resistance levels are the 2 lines at the top of the chart

Very often, when broken, support becomes resistance in the short term, and vice versa resistance becomes support. Traders use these levels to enter the trend after they have a confirmation of a true breakout.

Trendlines

Trendlines or sloping support and resistance levels serve a similar purpose as horizontal ones, with the difference that the levels change slightly with each time period. These are particularly useful to trend traders as they trail price nicely and usually the trader gets a good exit point after the trendline is broken.

USDJPY chart showing a bullish channel. Note how the end of the trend came after a down break of the support trendline

For a trendline to form on the chart there needs to be at least 2 swing lows for an up trendline and at least 2 swing highs for a down trendline. It’s important to note here that the more times price reverses from the trendline the stronger the support or resistance becomes in the future.

A channel like on the picture above is formed by 2 parallel trendlines that go in the same direction. In an uptrend channel like this one you start with the support trendline, lower on the chart and then draw a parallel line off the highs.

This is because the support line is more important here because the trend is up and the support trendline is the stop loss level for the trade. The parallel resistance trendline can be used as a take profit level.

For a downtrend channel, you would start with the resistance line on the top which would be the point at which to sell the pair and then draw a parallel support trendline which would act as a profit target trendline.

Volatility indicators

Volatility indicators are built to help the Forex trader know in advance what will be the most probable size of the swing for a given currency pair.

Different currency pairs have different average daily pip range, for example, the usual daily range for the EUR/GBP pair is around 50-60 pips, for EUR/USD it’s around 100 pips and for EUR/NZD it’s as high as 170-200 pips!

However, those are the usual ranges for the pairs, but that doesn’t mean it’s always like that. In fact, volatility changes over time, different months or periods during the year have different volatility.

If we take for example EUR/USD, we can observe that there were periods where its average pip range was as little as 50 pips and at other times as much as 170 pips. Being aware of the size of the market swings is often critical to your trading success as it is directly connected with the risk you take with every trade.

Many volatility indicators exist, here we’ll take a look at two of the more popular:

Average True Range

The Average True Range (ATR) is a very simple indicator, which calculates the average pip range for a given currency pair or market. You can set any calculation period you want though most commonly used periods are the 14 and 21 days.

The ATR calculates the average range for all timeframes giving a more detailed view of the volatility, however, keep in mind most traders look at the daily range and it is considered the most relevant value.

Bolinger Bands

The Bolinger Bands indicator, on the other hand, is based on something different and it looks really interesting. It is constructed of 3 lines: an upper, a lower band and the middle line which is a simple 20-day moving average.

The bands closely follow price by contracting when volatility is low and expanding as soon as volatility starts to increase. Hence, most of the time the price stays within the bands giving traders a good sense of where price is likely to trade next.

Notice how the indicator’s bands tighten or contract when volatility is low, and how they expand or diverge as volatility increases

Bolinger Bands can also give a good indication of when the market is overextended. Though you should never buy or sell only because the price has touched the lower or upper band, such an event can be an indication that the market is getting exhausted.

The recommended way is to always have a confirmation from other signals before taking a trade to ensure a higher probability trade.

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The Forex Managed Accounts

Forex managed accounts are an opportunity for ordinary people to invest in the foreign exchange market without the need to understand it or trade it themselves. As the name implies the account is “managed” by a professional trader who has a proven track record of successful results.

The Forex market offers highly attractive opportunities for making money, for all types of investors. However, it is one of the most difficult markets to trade yourself because of the frequent sharp fluctuations that occur in currencies.

Unlike the stock market where a Warren Buffet style buy and hold strategy can work extremely well, in the currency market there is no such strategy. Currencies constantly fluctuate both short term and long term. They are affected by a multitude of domestic, global economic and geopolitical factors.

To trade the currency market yourself you need to have good knowledge, understanding and skills, which all require at least a few years of practicing to acquire.

So, investors who either don’t have the time to or simply don’t want to learn to trade the Forex market can invest their money in companies that offer managed Forex accounts.

These companies will have a manager or a team of managers that will manage client funds on their behalf.

Usually, by signing a limited power of attorney agreement the client hands over limited power to the trading firm to trade his funds, while only he retains the right to withdraw his money.

The agreement with vary with different companies, most often they will charge the client a monthly fee or percent of the profits they generate, or both.

The account managers will usually be veteran traders in the foreign exchange market with a history of consistent profits on a year over year basis. Often, expected returns will be stated on the company’s website and the profit percent may be somehow included in the contract between the client and the managing firm.

For example, if no profit is generated no commissions to be charged, or if higher profit is generated higher commissions to be deducted.

Many different companies offer Forex managed accounts, from small individual traders to large mutual and hedge funds. These days, even a lot of retail Forex brokers offer some type of managed Forex accounts.

Keep in mind that there are a lot of good opportunities to earn In the Forex market, so be sure take as much time as you need to make a good, sound decision on what will be the best way for you to grow your capital using the opportunities in the Forex market.

Types of Forex Managed Accounts

Nowadays, with so many investment options available, most of them with very low capital requirements it is reasonable to say that almost anyone can invest in the Forex market with a managed Forex account.

If you want to invest in currencies, but don’t want to give up your regular job for it, then finding a good manager to do it can be extremely profitable for you. For that, you will need to open a managed account with a company that offers such an option.

Generally, two main types of managed Forex accounts are offered, and those are pooled managed accounts and separately managed accounts.

Pooled managed Forex account

A Pooled managed Forex account is literally a pool of money in which a group of investors put their money in. Financial markets usually have high capital requirements in order to trade or invest in them. Pooled managed accounts are intended for investors with smaller capital, who would be unable or it would we unsuitable for them to invest individually.

Hence, the need to create a pool where all the money from different investors will be gathered together making one large account balance. The advantage is that with this larger account balance the manager will have more flexibility in trading and a more competitive portfolio can be created.

Similar to the popular mutual funds, the account pool is managed by the manager as a total and the investors don’t have any authority over the investment decisions that the managers make because all positions are opened on behalf of all investors at the same time. Clients can only deposit and withdraw funds from their account.

Separately managed accounts

Separately managed accounts (or SMA) are most often intended for high net worth individuals. Clients’ funds are held and traded separately and the investor can check how the trades perform at all times. He can even choose to close positions if he doesn’t want to be in them.

Now, self-managing the account certainly is not the goal when you are already paying a professional manager to do it, but having the option to do so is definitely an advantage.

Finally, at the core, both the pooled and separately managed Forex accounts achieve the same thing which is a professional trader managing and trading your funds.

Separately managed accounts are considered the better option of the two because they are a more transparent option which retains greater power and control to the original investor.

But, then again, not everyone has the minimum required capital to invest in a separately managed account.

How to choose a Forex Managed Account?

After you’ve decided to invest in a Forex managed account you need to choose one company where you will put your money.

There is a huge number of different options available and you should, of course, choose one with terms that will best suit your own financial goals and personal needs.

After you do that, you need to check how legitimate the company is because unfortunately there is a large number of outright frauds in all aspects of the Forex industry. Managed accounts are no exception.

trusted forex brokers
Source: Forex-ratings.com

As a rule, you should under any circumstance not invest with a company until you’ve seen a long track record of profitable trades.

The longer the better, but usually a minimum of 2 years profitable track record is considered ok. However, consider that even if they show you a track record, you know how easy it is to fabricate one.

Be sure to make a thorough investigation on the company and their statements. See if you can find positive reviews from existing or former clients. Look for as many proofs as possible to verify that their track record is indeed genuine.

After you are sure that the guy you are going to give your money to is really a profitable trader, next very important thing to avoid scams is regulation.

You should never invest in a company that is not regulated. So, make sure that the company is regulated in the country it is headquartered in.

Now, you will want that country to be in the developed world like the USA, UK, and the European Union because these countries have very good regulatory bodies that make it extremely hard for scams to exist.

From financial firms, they require frequent detailed reports and certain high requirements must be met before the company can open a business.

Even if you have problems and a regulated firm somehow doesn’t allow you to withdraw your funds or it goes bankrupt, those regulatory bodies have laws that guarantee clients a partial or full return of funds.

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If you are considering an investment company on some third world island that nobody ever heard of, then good luck if you happen to have withdrawal problems.

For regulation in the UK you need to check with the Financial Conduct Authority (FCA) and in the USA, the Securities and Exchange Commission (SEC) is responsible for regulating financial matters. You should be able to find the registered number of the company on the website of these regulatory bodies if they are truly regulated.

Lastly, do an extensive research on the company and its historical reputation. A firm with a credible long history of good reputation that is regulated and proves it’s long track record of profits is probably going to be a good choice.

Forex Tip: DMAM Managed Forex Account

Dynamic Multi Account Manager, or DMAM for short, is a highly innovative trading software designed for managed Forex accounts and Forex brokerage firms.

It is an exceptionally precise system that allows brokers, money managers, and clients to achieve maximum efficiency in their efforts to profit from the challenging and ever-changing Forex market.

This trading platform is unlike anything else that is currently offered on the market. Complete transparency, outstanding technical support, balanced – percent lot distribution and more features, all come with super easy to use options.

In this article, we are going to take a look at some of the key features and options that make the DMAM system one of the best solutions for money managers and Forex brokerage firms to run managed accounts on, specifically designed for the foreign exchange market.

Here are 5 things where the Dynamic Multi Account Manager system absolutely shines. And not just that, but any investor who is considering to invest in a managed Forex account, should seek these features before deciding to put any money in a managed account.

Some of this special features can prove absolutely crucial in protecting clients’ capital from unnecessary losses and even enhance profits to a substantial degree.

Fully integrated and compatible with MetaTrader 4 – the most popular trading platform for the Forex market.

The DMAM system is implemented in the MetaTrader 4 platform, thus traders won’t need to change their habits and preferences, considering that MetaTrader is the world’s most famous Forex trading platform. So, you can easily use the benefits of the DMAM system that no other MAM system provides while still keep the trading platform you love.

Unprecedented precision in lot calculations

The Dynamic Multi Account Manager system runs the most precise calculations of all MAM systems in determining lot allocation size to clients. The calculations are up to 10 decimal places, giving clients an unprecedented precision when distributing position sizes based on capital invested.

This is especially important for accounts with very large capital because even the smallest calculation error can make a significant difference in the final output result for the client.

You may think it’s not that big of a deal, but consider that in a master account with total invested capital of a few million, one decimal place in the position size can mean a difference of several thousand dollars.

Very flexible and easy to join or leave the Dynamic MAM

Due to the highly precise and effective technologies, the DMAM employs, it’s very easy for clients to drop in and out of the managed account without affecting the trades and capital of the other clients.

Normally, on other multi account manager systems, there is the so-called rounding of calculations.

That is, the system instead of calculating the portions of each client’s capital in several decimals, it rounds the calculation to a whole number.

Often times this produces very different results for clients than they originally expected and can even sometimes cause positions to be closed out due to insufficient capital. You can see how this rounding can end up pretty badly for the net profits of clients.

Withdraw free capital at any time

This is absolutely a very important option to have with your trading or investment account. Basically, free funds that are not locked into an open position can be effortlessly withdrawn by the client at any given time.

Then, the new positions will be perfectly executed based on the remaining capital in the account, hence the risk on those positions, percentage wise will be the same as originally.

Protect capital by setting maximum drawdown allowed

Crucial point. Nobody should give his money to some money manager without being able to control how much of that money this person can lose. It’s a must have feature if you want to have peace of mind about the safety of your capital.

The Dynamic MAM does this perfectly. It lets clients assign a percentage of maximum drawdown they are comfortable with and if this limit is surpassed, the money manager will be disconnected from the client’s funds and he will not longer be able to trade it unless the client decides to give him permission again.

It’s an option all investors should exercise. Without this, who knows what will happen to your hard earned money?

Some money manager may just have such a bad period that he loses 80, 90 or even 100 percent of YOUR capital.

Believe it or not, this has happened in the past with professional money managers, so it’s never bad to be cautious about these things. In fact, doubting, questioning and taking precautions are some of the very critical investing skills for achieving success in the long run.

So, if you ae really serious about making an investment into a Forex managed account, finding a broker that uses the Dynamic MAM system could be just the thing you were looking for.

What you will find with many Forex brokers is, that not only they don’t have the precise calculations and executions of the DMAM, but many also lack some other key options like limiting losses and withdrawing funds at any time.

By the way, having difficulties in withdrawing funds is a warning sign, a red flag for the credibility of the broker and should not be tolerated.

Investors should be always able to withdraw as much of their capital as they want at any given time, quickly and easily.


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