Editor's Note: Introducing a new feature on Kitco.com! Veteran Technical Analyst Jim Wyckoff will introduce viewers to the ins-and-outs of the FOREX market – the world's largest traded market. Catch Jim daily on Kitco.com as he breaks down the importance of following the FOREX market, especially for investors who hold physical assets that are exchangeable worldwide, such as the precious metals.
Thursday September 06, 2012 8:20 AM
The largest traded "market" in the world is not the U.S., Asian or European stock markets. It's the foreign exchange market. It's also called FOREX or FX for short, or called the cash currency or spot currency market. Speculators and hedgers worldwide can and do trade this huge market, in which well over 3 trillion U.S. dollars (and other currencies) can change hands every trading day.
The purpose of this feature is to not only introduce you to the FOREX market, but also to also stress the importance of following the FOREX market if you hold physical assets that are fungible worldwide—such as the precious metals. I will just scratch the surface here, and I suggest you read further about FOREX trading if you want to learn more about the world's largest traded market.
Here's an example to help you better understand the FOREX market. If you have ever traveled to another country and needed to exchange your own currency for another country's currency, then you know why foreign exchange is a necessity. (Americans are spoiled when they travel to other countries because many retail merchants in other countries will accept U.S. dollars for payment.)
The "exchange rate" for your currency is usually posted at the institution at which you exchange your currency for another currency--for example, a bank branch at an airport.
Currency exchange rates fluctuate on a daily basis. Factors that impact an individual country's currency exchange rate are the health of its economy, political events, natural disasters and events around the world that could impact that particular country's economic or political well-being.
Exchange rate fluctuations can be significant for those traveling in other countries and exchanging currency, or for those investors holding fungible assets like precious metals.
FOREX trading is done in "currency pairs." In other words, when you trade spot currencies you are trading in pairs. It has to be that way. Think about it: When you go to the airport to change out American dollars for Euros (the European Union single currency), you are actually making a transaction in the "Euro-Dollar" currency pair. The first currency listed in every pair is known as the "base currency." The exchange rate refers to the amount of the second currency that can be exchanged for one unit of the base currency.
Here are some major currency pairs that are traded by hedgers and speculators worldwide: Euro-U.S. Dollar, U.S. Dollar-Swiss Franc, U.S. Dollar-Canada Dollar, U.S. Dollar-Japanese Yen, Euro-Japanese Yen, U.S. Dollar-Australian Dollar and British Pound-U.S. Dollar. Notice that the U.S. dollar is the "base" currency for most major currency pairs. There are many, many other currency pairs that are traded worldwide, but the aforementioned pairs are the most popular and liquid.
There are also currency futures and options that trade at the Chicago Mercantile Exchange, part of the CME Group in Chicago. You can trade the British pound, Swiss Franc, Australian Dollar, Canadian Dollar, as well as others. But again, even though the CME currencies are not labeled as "pairs," that is in fact what the futures are based upon. For example, Japanese yen futures prices are based upon the Dollar-Yen currency pair.
One big advantage to trading in the FOREX market is that it is a very liquid market (remember, it's the largest traded market in the world). The FOREX market trades from about 7:00 p.m. Eastern U.S. time on Sunday night, straight through until about 3:00 p.m. Eastern U.S. time on Friday afternoon.
There are some nuances in FOREX trading that futures traders do not encounter. One is the fact that since FOREX trading occurs continuously for 24 hours per day, five days per week, there is a daily settlement period designated. FOREX traders must theoretically "settle up" or square their positions at the end of every day. There is usually a small fee charged for this daily settlement process.
The margin required for trading the FOREX market varies depending upon the broker used, but is usually around 1%, meaning that a $10,000 account can trade about $1 million worth of currencies. However, given the recent popularity of FOREX trading, individual trading accounts can likely be opened for a significantly smaller amount, among some FOREX trading firms.
It is important for holders of fungible physical assets, such as precious metals or other major raw commodities—which are priced in a specific currency (most are priced in U.S. dollars)--to know the exchange rate for the currency in which their commodity is priced, and also the currency for which might be exchanged to buy a commodity priced in another currency.
Also, veteran market watchers know that precious metals prices tend to move in an inverse relationship with the value of the U.S. dollar (U.S. dollar index) on a daily basis. On days when the U.S. dollar index is higher, precious metals prices can at least see buying interest limited, or be trading lower based upon the stronger greenback. And on trading days when the U.S. dollar index is lower, precious metals will at least see underlying support from the weaker U.S. currency. Thus, precious metals and other commodity traders need to pay close attention to what the U.S. dollar index is doing, or what it could be about to do, in the near term, or in the future.
Given the importance of foreign exchange rates on raw commodity pricing, on daily movements in the prices of precious metals and other commodities, and in determining the actual value of an investor’s own physical assets being held, I will very soon begin producing daily FOREX technical/analytical charts on the major currency pairs traded worldwide. These charts will be easy to understand and help better guide you in your quest for better knowledge and better trading/investing decisions.
By Jim Wyckoff, contributing to Kitco News; firstname.lastname@example.org