Introduction to Forex Markets
The Forex market, a term frequently used in the media and daily life, is often associated with a historic building in Canary Wharf or on Wall Street. However, the Forex market is unique in many respects, and to understand it, we first need to comprehend its unique characteristics.
One of the most distinct features of the Forex market is that it has no physical existence. Unlike the stock and bond markets, which have physical locations such as the New York Stock Exchange or the London Stock Exchange, the Forex market is made up of money changers worldwide, connected through electronic information networks. Thus, the Forex market comprises an interconnected network of buyers and sellers, from your local currency dealer to one in a far-off place like Mexico City.
The Forex market is by far the largest market globally, with a daily transaction volume of over $4 trillion. The trading volume in the Forex market surpasses the trading volume in all stock markets globally and even some of the oldest and most advanced bond markets worldwide. Being the oldest financial market globally helps make the Forex market the largest.
The Forex market is the only 24/7 market globally, meaning it is operational all the time. Contrastingly, stock and bond markets operate for only a few hours every weekday. If you want to buy or sell Forex, there is always someone somewhere on the planet willing to buy or sell. The convenience and flexibility provided by the Forex market are unparalleled.
The Forex market's 24/7 availability and largest trading volume globally make it the most liquid financial market. Anyone who wishes to buy or sell their currency holdings can do so in a matter of seconds with a mouse click, with minimal loss of value. Forex prices are readily quoted in real-time by various individuals and organizations worldwide, and transaction costs for such trades are very low due to many intermediaries worldwide dealing in these currency markets. As such, there is minimal taxation on these trades.
Forex markets provide a benchmark for transparency that other financial markets can follow. The trades in these markets are conducted during different time zones worldwide, and the information systems are so well developed that all the information is available instantly at the click of a button, any time of the day. The data is collated and presented to the investor to enable them to make informed decisions. The Forex market is less susceptible to foul play as many individuals and organizations operate in it, and there are government organizations like Central Banks of various nations that regulate it.
Finally, the Forex market provides a wide variety of options when it comes to trading. There are long and short sides of any contract always available, contracts of various sizes and in various currencies, and a choice regarding varying degrees of leverage. However, it is advisable that traders exercise caution while using leverage.
These unique characteristics of the Forex market are essential to get a first impression of this massive market. As we progress later in this module, we will realize that each of these characteristics has far-reaching implications on the way trades actually happen and whether they are profitable or not.
History of the Forex Market: The Gold Standard
The history of money and currency is a long and complex one, and until a couple of centuries ago, money and currency were not the same thing. Prior to the modern monetary system, the world was on a system known as the gold standard. The gold standard was a monetary system in which the prices of everything in the economy were fixed by gold. Gold was recognized and used worldwide, much like the US Dollar today.
During the 17th century, trade happened only when gold changed hands, making gold the global currency in existence. In the 18th and 19th century, when trade expanded, it was difficult to carry around so much gold, and some sort of paper money was used. However, this paper money was only a receipt for the gold and not money in itself.
Under the gold standard, the prices of all currencies were fixed in terms of their weight in gold, and the name of currencies signified the promise of governments or private parties to give out a pre-determined weight of gold. The gold standard promoted efficiency by not allowing imbalances to grow in the market. If there was foreign trade between two currencies and one was importing a lot from the other, the importing country would have to pay out a lot of gold to the other, leading to deflation and automatically prohibiting an unhealthy trade imbalance between two countries.
Other benefits of the gold standard included the fact that the government could not manipulate the money supply to meet its own requirements. The money supply was fixed by the amount of gold in the system. The gold standard was prevalent in the world in one form or the other until 1970 when President Richard Nixon of the United States closed what is called the gold window, effectively taking the world off the gold standard.
When President Nixon took the world off the gold standard, all the currencies of the world suddenly had no backing in gold, and the exchange rate between them could not be calculated using arithmetic. The value of a currency now depended on a variety of factors, many of which were under the control of governments. The Forex market, where currencies have always been exchanged, came into prominence when the world went off the gold standard, as there was a need for a market where exchange rates would be determined on a real-time basis based on the information flowing through the markets. It is only after gold was removed as the common denominator between currencies that all of them became freely floating, and there was a need to value them against one another.
Advantages and Disadvantages of Fixed Currency Exchange Rates
Fixed currency exchange rates, also known as currency pegs, have become a popular monetary policy strategy for many countries. About one fourth of all countries in the world have fixed their currency to another major currency like the US dollar or the Euro. However, this strategy comes with its own set of advantages and disadvantages. In this article, we will explore both the advantages and disadvantages of fixed currency exchange rates.
Stable Basis for Planning: Fixed currency exchange rates provide a stable basis for financial planning for governments. Governments must purchase essential commodities such as oil and food grains from the international market and must pay for these expenses in foreign currency. If exchange rates are constantly fluctuating, governments cannot anticipate how much of their own currency they will need to convert to foreign currency to meet demand. Fixed currency exchange rates provide a stable rate, allowing governments to plan their revenue and expenditures in local currency without concern for fluctuating exchange rates.
Credible and Disciplined Monetary Policy: Fixed currency exchange rates are often used in third world countries that are breeding grounds for corruption. Such countries outsource their monetary policy to a more developed nation where policymakers will make more responsible decisions. Fixed currency exchange rates can help offset the threat of sabotage from local politicians, who are unable to reduce interest rates and cause a bubble in the economy when a fixed currency exchange rate is being followed.
Reduced Volatility: Fixed currency exchange rates also benefit local businesses, which can predict how their goods will be priced in the international market. Once they know the exact pricing, they can also predict the quantities that will be demanded at that price. They do not face any volatility and can insulate themselves from foreign exchange losses. This puts them at a major advantage as compared to other competitors who have to face such risks and have to include a risk premium in their prices.
Increased Foreign Influence: Countries that adopt fixed currency exchange rates face increased foreign influence in their domestic affairs. Their monetary policy is determined by another nation, which can lead to conflict situations. For instance, during the attack on the Pound Sterling, the British government had fixed its currency to the German Deutschemark. German Bundesbank increased interest rates because of domestic concerns on inflation, which the British wanted to fall. However, there was no drop in rates, and the British pound suffered because the Bank of England was no longer in control of its affairs.
Difficulty in Automatic Adjustment: Fixed currency exchange rates tend to exaggerate disequilibrium. For instance, if one country imports too much, they will have to pay out a lot, leading to a decrease in the currency supply in their economy causing deflation. Deflation means low prices and low prices make their exports competitive, leading to a situation of increasing exports. However, fixed currency exchange rates tend to exaggerate disequilibrium, as seen in the massive trade and current account deficits between the United States and China, caused by a peg between the dollar and the yuan.
Speculative Attacks: Fixed currency exchange rates can be vulnerable to speculative attacks on a currency that deviates too much from its value. As the Central Bank tries to artificially manipulate the value, it can lead to a huge difference between the fundamental value of a currency and its market value. Some financial funds with deep pockets can even take on Central Banks and force devaluations on such currencies. Whenever such an attack occurs, the common man of the country suffers increased losses since foreign trade as well as foreign investments face a massive impact.
In conclusion, fixed currency exchange rates provide a stable basis for financial planning and can help offset the threat of sabotage from local politicians, but they can also lead to increased foreign influence, difficulty in automatic adjustment, and vulnerability to speculative attacks
Common Terminologies Used in Forex Markets
Glossary of Terminologies Used in Forex Markets Financial markets have unique terminologies, and the Forex market is no exception. Although some terms are shared with other financial markets, they may have different meanings in Forex. Additionally, there are several terms that are unique to Forex. In this article, we explore some of the commonly used Forex terms that will be frequently used in this module.
Base and Counter Currencies In the stock and bond markets, securities can be sold for cash. However, in the Forex market, traders are already buying and selling currencies. Therefore, Forex trading involves simultaneous buying and selling of currencies, which are always quoted in pairs. The price quoted signifies the amount of the base currency that is needed to purchase the counter currency. The currency that is quoted first is the base currency, while the second currency in the pair is the counter currency. For example, in a USD/EUR pair, the US Dollar is the base currency, while the Euro is the counter currency.
Long and Short Positions Like other financial markets, Forex markets allow traders to take long and short positions. However, the meaning of long and short positions is different in the Forex market. Since currencies are traded in pairs, it can be confusing for new traders to understand what it means to go long or short. Going long means buying units of the base currency and selling units of the counter currency. On the other hand, going short means selling units of the base currency and buying units of the counter currency. In both cases, the trader is expecting a change in the exchange rate to generate profit. The act of adding to a long or short position is referred to as going longer or shorter.
Bid, Ask, and Spread Forex markets are run by market makers, who provide buy and sell quotes for all currencies at all times. The price at which they are willing to buy is called the bid price, while the price at which they are willing to sell is called the ask price. The difference between the two prices is called the bid-ask spread, which compensates the market makers for the risk of holding a volatile asset.
Lots The term 'lots' is frequently used when Forex derivatives are being traded. Forex futures contracts always have a fixed size, and for instance, US dollar contracts may be available in multiples of $5000. Hence, every $5000 contract is referred to as a lot. Therefore, if a trader wishes to buy USD 25,000 in the future, they will have to purchase five lots. Market makers provide more flexibility to currencies that have higher liquidity.
Pip A pip refers to the smallest unit by which a currency quote can change. The usual pip is 1/10000 of the quoted currency. This means that a currency must change by at least 0.0001 for the quoted prices in the Forex market to be affected. Since changes in prices and profits are expressed in terms of pips, it has become a part of Forex trader lingo. However, understanding the amount of money represented by a pip requires experience.
Value Dates and Rollovers The value date is the date on which the parties to a trade agree to settle their accounts. All open positions on derivative contracts are closed automatically on the value date, making contracts more volatile when closer to the value date. Additionally, traders may decide to rollover their contracts, meaning that they settle their contracts on the next value date instead of the current one. This requires an agreement between the parties involved and a fee based on the interest rate differences of both currencies.
While many more terms are frequently used in the Forex market, some may refer to specific strategies and are beyond the scope of this basic article. In summary, Forex trading has its own vocabulary, which traders need to understand.
Differences between Forex Trading and Regular Trading
When it comes to financial trading, foreign exchange trading is unique in several ways. The following are some of the key differences between trading foreign exchange and other financial assets.
Currencies are Traded in Pairs Unlike in the stock market, where investors buy or sell stocks, in the Forex market, investors buy one currency while simultaneously selling another. Currencies are always traded in pairs. This is because money itself is the commodity being traded. Therefore, when making a trade in the Forex market, an individual is always exchanging one type of currency for another.
No Centralized Exchange The stock market operates with the help of a centralized governing body that regulates all the trades taking place and provides an effective risk prevention mechanism. However, the Forex market has no centralized exchange, making it difficult to regulate the market's width and breadth. Consequently, anyone trading in the Forex market is exposed to counterparty risks and must enter into trades with parties that will pay up in the end.
No Commissions In the Forex market, there are no brokers and thus no fixed commissions. The market is run by market markers who provide two-way quotes. The difference between their buy and sell price is called their spread, and that is how intermediaries in the Forex market earn a reward.
Dual Role of Central Banks Central Banks of all nations are major participants in the Forex market. Firstly, these institutions have massive capital backing and can significantly dent the market if the need arises. Secondly, they can control the underlying commodity being traded. For instance, the Fed can buy or sell the US dollars in the Forex market. These central banks therefore play a dual role in the market. They are participants in the market and have undue influence on the commodity being traded.
No Regulation The Forex market is not regulated, making it difficult to prosecute individuals who obtain insider information about the currencies being traded and use it to make money. Additionally, there are no limits to trading, including no maximum amount of upside or downside that a particular currency can see in a given day. There is also no restriction on the amount of money that individuals can invest in the market at one go.
In conclusion, the Forex market provides the freedom for unrestricted trading. However, this freedom comes at a cost: increased risk of counterparty default.
Comparison of Gold and Bitcoin as Investment Classes
Investors have traditionally turned to gold as an alternative asset class in times of market or currency instability. However, Bitcoin has emerged as a viable alternative in recent years, given its meteoric rise in value. While some believe that Bitcoin is a bubble waiting to burst, others see it as a legitimate investment option that could overtake gold in popularity.
The main difference between the two assets is tangibility. Gold is a physical commodity that investors can touch and feel, while Bitcoin exists only in the digital realm. Gold is a regulated commodity that is difficult to corrupt, whereas Bitcoin is largely unregulated and vulnerable to manipulation. Bitcoin's volatility is also a cause for concern, with critics pointing to its susceptibility to insider trading and scams.
In terms of liquidity preference, gold has a long history of surviving crises and is the default currency when fiat money loses value. Even in a hyperinflation scenario like Venezuela, gold can be exchanged for goods and services. Bitcoin, on the other hand, is a relatively new asset with no track record of navigating crises. Its reliance on electricity and online transactions makes it vulnerable to power outages and compromised networks.
Stability is another area of comparison between the two assets. While gold has experienced price fluctuations, it has been a stable store of value for centuries. Bitcoin's value, however, rises and falls rapidly, making it an unpredictable investment. The energy consumption required for Bitcoin mining is another issue, as it is a significant drain on the world's energy resources.
In conclusion, while Bitcoin may seem like a viable alternative investment class in the short term, it is still a relatively new asset with significant vulnerabilities and unknowns. Gold, on the other hand, has been a stable and reliable asset for centuries, with a proven track record of surviving crises. As such, it remains the preferred choice for investors looking for a safe haven in times of market or currency instability.
Cryptocurrencies and Taxation
The taxation of cryptocurrencies has become an important issue as it affects the return generated by any investment. However, due to their relatively new status, there is still a great deal of ambiguity surrounding the taxability of cryptocurrencies.
In this article, we will examine some of the principles that are followed during the taxation process and the current laws regarding cryptocurrency taxation in various countries.
Australia and Canada Canada and Australia do not consider cryptocurrencies to be a real currency, as legal currencies can only be issued by central banks. However, they acknowledge that it is possible to use Bitcoin as a means of payment, so transactions using Bitcoin are considered to be barter transactions. Since barter transactions are exempt from Goods and Services Tax (GST), transactions denominated in Bitcoin are not charged GST. This loophole in the law is currently being addressed by the Canadian and Australian governments.
United Kingdom Taxation of cryptocurrencies in the United Kingdom is done on a case-by-case basis. In some cases, the tax authorities consider Bitcoin to be a highly speculative investment, akin to gambling. In such cases, gambling losses cannot be deducted from taxable income, nor are gambling gains added to taxable income. In other cases, the intention of the seller and their legal status are analyzed to determine whether a transaction should be taxed at an individual or corporate level. Sometimes, cryptocurrencies are considered to be foreign currencies, and businesses are required to account for them accordingly, with profits and losses booked based on Generally Accepted Accounting Principles (GAAP). Mining of Bitcoins is not considered an economic activity for taxation purposes, so investors who mine Bitcoins do not pay taxes on their gains.
United States The Internal Revenue Service (IRS) in the United States considers Bitcoin to be property rather than income. This means that people who make large sums of money from Bitcoin trading pay a lower tax rate than if it were considered income. However, the tax laws prohibit investors from offsetting investment losses against their income, except up to a maximum of $3000 per year. As a result, investors with large losses in the cryptocurrency market may still have to pay taxes on those losses.
India Developing countries such as India do not yet have a framework for taxing cryptocurrencies. The Reserve Bank of India has prohibited dealings in cryptocurrencies, but past transactions could be considered investments or profits depending on the source. If they are considered investments, they will be taxed at either the short-term or long-term rate, depending on how long they have been held. If they are considered profits, they will be added to the taxpayer's income and taxed at the relevant slab.
In conclusion, there is a need for a consensus on the taxation of cryptocurrencies. Currently, different countries have different tax regimes for cryptocurrencies, which can lead to traders moving their money to offshore locations with more favorable tax rates.
5 Principles of Forex Trading Systems
Forex trading is a complex undertaking due to the multitude of factors at play in the market, exacerbated by human emotions of greed and fear. To simplify the process, traders can utilize Forex trading systems, which are sets of rules that must be followed to suit their trading style and financial situation. Each trader must create their own system through trial and error, but all successful Forex trading systems are guided by the same principles.
Principle #1: Be Realistic. It's essential to approach the market with a realistic mindset and understand that trading is a risky business, with profits being the reward for bearing risk intelligently. Guaranteed returns are virtually nonexistent, and traders should aim for 25%-50% returns per annum, with consistency being the key. Using leverage is a strategy that should only be utilized after a certain level of proficiency has been achieved.
Principle #2: Keep It Simple. Complex trading strategies often fail in the market due to slippage, making simplicity essential for retail investors. Gradually increasing the complexity of the strategy and avoiding complicated techniques like straddle and reverse straddle is advisable. Alternatively, traders can begin by practicing on a demo account and moving on to a real account after achieving proficiency.
Principle #3: Benchmark. Judging performance based on an absolute return is not advisable in a market that moves randomly. Benchmarking performance against other traders is essential to correctly evaluate performance and modify strategies accordingly.
Principle #4: Drip-Feed Model. Traders should avoid putting all their money into a single trade and instead utilize the drip-feed model. Opening multiple trades and evaluating their performance helps to identify winning and losing bets. Traders should get rid of losing trades as soon as possible and use the freed-up funds to increase winning bets.
Principle #5: Do Not Argue With the Trend. Forex markets are trend-driven, with short-term trends being virtually unstoppable. Arguing with the trend is not advisable, but being conversant with technical analysis tools that help gauge the prevalent trend is valuable.
Why Fundamental Analysis is Ineffective in Forex Trading: 5 Reasons
Fundamental analysis has long been regarded as the ultimate tool for stock investors, with legendary investors like Warren Buffet claiming to have built their fortunes using it. However, when it comes to the Forex market, traders often opt not to use fundamental analysis. This is not just the opinion of self-proclaimed experts, but also traders working for big Wall Street firms like Goldman Sachs and Morgan Stanley. In fact, Forex traders are generally skeptical of the idea that fundamental changes are what drive their market. In this article, we explore the top five reasons why fundamental analysis is ineffective in Forex trading.
Infinite Factors Unlike stock markets, which are typically limited to one or a few economies, the Forex market is a global market affected by countless economic and political developments across the world. The sheer number of factors at play in the Forex market makes it impossible to track and make decisions based on all of them. Forex traders know through experience that fundamental analysis is an extremely time-consuming activity that provides little to no benefit in the long run.
Out of Date Data Forex traders rely on data released by countries, such as unemployment data, inflation data, and productivity data, to make decisions. However, countries typically release this data with a delay of three to six months, rendering it obsolete by the time it reaches the market. Making decisions based on outdated data is bound to lead to losses.
Manipulated Data Politicians' job security often depends on data related to unemployment, inflation, etc., giving them a strong incentive to manipulate this data. Countries like China have been known to manipulate their data to attract foreign investments. Unlike stock markets, there are no auditors to ensure that the data released to the public in Forex markets is genuine. As a result, data manipulation is rampant, and the way these numbers are calculated varies greatly between different countries. Making decisions based on fundamentally incorrect data is inappropriate at best.
Market Always Overreacts The Forex market is characterized by fast reactions and overreactions, with currencies suddenly shooting to the top or bottom based on the market's collective sentiment of greed and fear. Therefore, a currency's fundamental value is often merely a theoretical number that the market may never settle at, since the fundamentals of any currency are constantly changing.
Timing Not Revealed Even if a trader manages to decipher the complexities of the Forex market and determines that a currency is overpriced or underpriced, it's impossible to predict when a correction will happen. Forex traders typically use leverage to place bets, which have an expiry date. This means that even if a trader's bet is fundamentally correct, but it's placed at the wrong time, it's likely to result in losses due to accumulating mark-to-market losses and interest charges. On the other hand, if a trader were to avoid leverage and hold bets for decades, the percentage gains and losses would be so small that conducting fundamental analysis would be a futile activity.
Money And Business Insurance
Insurance is a contract between an insurer and a policyholder, where the insurer agrees to compensate the policyholder in case of a specified loss or damage in exchange for premiums paid. Insurance is a crucial aspect of business operations as it helps to protect businesses from financial losses resulting from unforeseen events such as accidents, natural disasters, theft, and lawsuits. In this essay, we will discuss the different types of insurance policies that businesses can purchase to protect their financial assets, as well as the importance of risk management strategies.
II. Types of business insurance
Business insurance can be broadly classified into five categories: property insurance, liability insurance, workers' compensation insurance, business interruption insurance, and cyber insurance.
A. Property insurance
Property insurance provides coverage for physical assets such as buildings, equipment, and inventory. Property insurance policies typically cover losses resulting from fire, theft, vandalism, and natural disasters such as hurricanes and earthquakes.
B. Liability insurance
Liability insurance protects businesses from lawsuits brought against them by third parties. Liability insurance policies cover legal costs and damages arising from accidents, injuries, and property damage caused by the business's operations.
C. Workers' compensation insurance
Workers' compensation insurance is mandatory in most states and provides coverage for employees who suffer work-related injuries or illnesses. Workers' compensation insurance covers medical expenses, lost wages, and disability benefits for injured employees.
D. Business interruption insurance
Business interruption insurance provides coverage for lost income and extra expenses incurred by a business due to a covered loss or damage. Business interruption insurance policies cover losses resulting from natural disasters, fires, and other events that disrupt business operations.
E. Cyber insurance
Cyber insurance provides coverage for losses resulting from cyber-attacks such as data breaches, network failures, and cyber-extortion. Cyber insurance policies cover losses related to data restoration, business interruption, and liability resulting from cyber-attacks.
III. Money and business insurance
In addition to protecting physical assets, businesses must also protect their financial assets. Financial assets include cash and cash equivalents, accounts receivable, inventory, and investments. Insurance policies that businesses can purchase to protect their financial assets include business property insurance, business liability insurance, crime insurance, directors and officers (D&O) liability insurance, and professional liability insurance.
A. Importance of protecting financial assets
Financial assets are the lifeblood of any business. Without adequate protection, businesses can suffer significant financial losses resulting from theft, fraud, natural disasters, or lawsuits. Protecting financial assets is crucial for businesses of all sizes, as it