Friday, March 10, 2006

FX - The Most Dynamic Market in the World

FX - The Most Dynamic Market in the World

Regardless of which instrument you are trading - be it stocks, municipal bonds, U.S. treasuries, agricultural futures, foreign exchange, or any of the countless others - the attributes that determine the viability of a market as an investment opportunity remain the same. Namely, good investment markets all possess the following characteristics: liquidity, market transparency, low transaction costs, and fast execution. Based upon these characteristics, the spot FX market is the perfect market to trade.

Liquidity:

Currency spot trading is the most popular FX instrument around the world, comprising more than 1/3 of the total activity. It is estimated that spot FX trading generates about $1.5 trillion a day in volume, making it the largest, most liquid market in the world. Compare that to futures $437.4bn and equities $191bn and you will see that foreign exchange liquidity towers over any other market. Even though there are many currencies all over the world, 80% of all daily transactions involve trading the G-7 currencies i.e. the "majors." When compared to the futures market, which is fragmented between hundreds of types of commodities and multiple exchanges, and the equities market, with 50,000 listed stocks (the S&P 500 being the majority), it becomes clear that the futures and equities provides only limited liquidity when compared to currencies. Liquidity has its advantages, the primary one being no manipulation of the market. Thin stock and futures markets can easily be pushed up or down by specialists, market makers, commercials, and locals. Spot FX, on the other hand, takes real buying/selling by banks and institutions to move the market. Any attempted manipulation of the spot FX market usually becomes an exercise in futility.

24-Hour Market:

Spot foreign exchange trading is the perfect market for active event driven traders. Unlike in stock and futures trading, currencies do not get halted, ensuring true 24-hour trading and the ability to trade during virtually any important event. The round-the-clock nature of the foreign exchange market ensures that there will be minimal gaps in the market; in other words, there is no potential for the market to close one day and reopen the next day at a drastically different price. In equities and futures markets, centralized exchanges end operations when the business day concludes. After-hours market liquidity is quite thin, thus making trading unfeasible. More importantly, traders who leave positions open after the market closes expose themselves to greater risk: should news be released after the market closes that affects positions, traders will not have the opportunity to immediately liquidate. As a result, they will be forced to cope with market conditions upon opening the following day, when the market may open at a very different rate than when it closed. The seamless continuity of the foreign exchange market ensures that the market is liquid at all times, thus alleviating traders of potential risks associated with market gaps and illiquidity.

Equity & Futures Markets are Constantly Halted


Market Transparency:

Price transparency is very high in the FX market and the evolution of online foreign exchange trading continues to improve this, to the benefit of traders. One of the biggest advantages of trading foreign exchange online is the ability to trade directly with the market maker. A reputable forex broker will provide traders with streaming, executable prices. It is important to make a distinction between indicative prices and executable prices. Indicative quotes are those that offer an indication of the prices in the market and the rate at which they are changing. Executable prices are actual prices where the market maker is willing to buy/sell. Although online trading has reached equities and futures, prices represent the LAST buy/sell and therefore represent indicative prices rather than executable prices. Furthermore, trading online directly with the market maker means traders receive a fair price on all transactions. When trading equities or futures through a broker, traders must request a price before dealing, allowing the broker to check a trader's existing position and 'shade' the price (in their favor) a few pips depending on the trader's position. Online trading capabilities in FX also create more efficiency and market transparency by providing real time portfolio and account tracking capabilities. Traders have access to real time profit/loss on open positions and can generate reports on demand, which provide detailed information regarding every open position, open order, margin position and floating profit/loss per trade.


Lower Transaction Costs than Equities and Futures:

As mentioned earlier, transaction costs can serve to lower profits or extend losses. Due to the decentralized nature of the FX market, transaction costs in the FX market are either zero or close to zero. The FX market is able to offer lower transaction costs because there is no centralized exchange for trading such as the NYSE or the CBOT. Therefore, clients need not pay any exchange of clearing fees. Costs are further reduced by the efficiencies created by a purely electronic marketplace that allows clients to deal directly with the market maker, eliminating both ticket costs and middlemen. Because the currency market offers round-the-clock liquidity, traders receive tight, competitive spreads both intra-day and over night. Online foreign exchange is far and away the best market choice for aggressive short-term oriented traders. Equity and futures markets are structurally very antiquated and need to take small pieces of each transaction to keep their systems afloat. Active stock and futures traders often see substantial portions of their gross profits go to brokers in the form of commissions, and exchanges in the form of exchange and data fees. Also with the growing trend of exchanges going public, it is reasonable to assume that these "hidden" costs will only rise, as these newly public entities will have shareholders to answer to.

Average Roundtrip Commission Charge On $100K Position

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