Forex for Beginners Part 2: Currency, Hedge
Forex Glossary – Basic Concepts and Definitions
INTRODUCTION
At first glance, financial markets may seem abstract, alien, and even intimidating. The people who trade and work within them often appear as untouchable experts or higher beings. However, if you look beyond the myths, rumors, and exaggerated media portrayals, you’ll discover that financial markets are actually created and controlled by ordinary people. While there may be an aura of exclusivity, almost anyone can break into this world with enough effort and dedication.
Most of the famous financiers you hear about today started from the bottom. Their success in the financial markets was achieved through sheer perseverance and a commitment to learning and self-improvement.
What is FOREX, and What Should We Prepare to Study?
FOREX stands for Foreign Exchange Operations, referring to currency trading. These transactions form a major part of the global financial market, where we track the movement of the world’s leading currencies—those that dominate the FOREX market. Through our learning, we will come to understand that these currencies act as the “calling cards” of the countries that shape global economic trends.
These currencies include:
- The British pound sterling,
- The Swiss franc,
- The Japanese yen,
- The euro, which replaced the German mark,
- And, of course, the US dollar.
We will explore how these currencies move in the market, influenced by the actions and policies of their respective governments. As we dive deeper, we will uncover the many factors that drive the FOREX market—economic developments, political decisions, and other elements that dictate currency values.
Becoming a FOREX Trader
To participate in the FOREX market means to become a trader—a currency speculator. For many, the term “speculator” carries negative connotations, especially in countries where, for much of the last century, speculators were viewed as criminals. In fact, in the 1970 dictionary by S.I. Ozhegov, “speculation” was defined as:
“the illegal buying and selling of goods, property, or valuables for profit, typically by exploiting price differences.”
However, the term “speculator” originates from the Latin word meaning “observer”, which is a much more accurate and positive description. A speculator is someone who carefully watches market movements and makes decisions based on their insights. So, there’s no need to be embarrassed—observation and insight are the true tools of successful traders!
In the world of currency speculation, gender plays no role. Women stand alongside men, demonstrating equal levels of ingenuity and skill. One notable example is Muriel Siebert, the first woman to obtain a seat on the New York Stock Exchange (NYSE) in 1960, later founding a major brokerage firm in the U.S. Her legacy highlights that, in financial markets, opportunities are available to anyone with the determination to succeed.
The name George Soros is also widely known, even beyond financial circles. His fund has historically generated substantial profits from FOREX market operations. Soros’ most famous trade occurred in 1992, when he shorted the British pound (GBP) against the German mark (DM) and the U.S. dollar (USD), earning a billion dollars within two weeks. This move made Soros famous, enabling his extensive philanthropic efforts. However, even Soros faced losses, such as in August 1998, proving that no one is immune to the risks of the market.
This leads to a critical point: while the high liquidity of the FOREX market attracts investors from all over the world, it is also one of the riskiest endeavors. Understanding this risk is essential, but the ultimate decision to participate remains your choice.
What Attracts Investors to the FOREX Market?
The FOREX market is highly attractive for several reasons. It is characterized by a large number of participants, massive trading volumes, and the fastest cash flow of any financial market, ensuring almost absolute liquidity. This means that traders rarely face difficulties buying or selling the desired amount of a currency at the right time. Unlike the stock or commodities markets, where liquidity can be an issue, the FOREX market provides a nearly seamless trading experience.
1. 24-Hour Market Access
Unlike stock markets, which operate within strict time frames (for example, the U.S. stock market is open from 17:00 to 24:00 Moscow time), the FOREX market is open around the clock. It begins Monday morning in New Zealand and continues until Friday evening in the United States. This flexibility allows traders to react to global events in real time, without waiting for market hours. You can trade at any time that suits you—whether before, after, or even instead of work. The choice is entirely in the hands of the trader.
2. Global Reach
The development of the FOREX market has been driven by advancements in telecommunications and the Internet, enabling anyone with an Internet connection to access the world’s largest financial markets. Today, information flow is instantaneous, and those who leverage these technological advantages are better positioned to succeed. The FOREX market has no centralized trading venue, which means that no matter where you live, you can participate in this market.
3. Objectivity
The FOREX market is one of the most objective markets in existence, as no single participant can significantly influence its direction. Unlike other markets, there is no external regulatory body that manipulates prices—everything is governed by supply and demand. Moreover, all investors have access to the same quality and volume of market information, thanks to the transparency and speed of the Internet.
4. Ease of Entry
One of the key attractions of the FOREX market is the ease of entry. Unlike the stock market, where investors often have to pay commissions to brokers, the FOREX market offers commission-free trading, with the only cost being the spread between the buy and sell prices. For example, in the stock market, purchasing a block of shares often involves paying a commission, which varies depending on the broker’s capabilities. A discount broker may charge $20-30 per transaction, while a more established broker like Charles Schwab could charge $40-50 for a trade. In contrast, in the FOREX market, investors can trade with no direct commission fees, making it a more attractive option for many.
5. Leverage and Margin Trading
Historically, the main participants in the FOREX market were banks, transnational corporations, and large brokerage firms, with minimum fund requirements often exceeding one million U.S. dollars. However, with the introduction of margin trading in the mid-1980s, the landscape changed dramatically. Margin trading allows traders to use leverage, which means they can control larger positions with a relatively small deposit. This development has made the FOREX market accessible to a much broader range of investors, allowing individuals with smaller capital to potentially earn substantial profits.
In his book “Trading for a Living”, A. Elder perfectly captures the essence of the FOREX market:
“You can be free, live and work from any corner of the globe, be independent of the daily routine, and unaccountable to superiors—that is the life of a successful trader.”
To these words, we can add that a trader can also be free from negligent subordinates, unreliable or dishonest partners, frequently changing legislation, economic instability, and political uncertainty. Moreover, this profession is considered one of the most profitable types of legal activity.
Two Popular Misconceptions:
1. “FOREX is like playing roulette”:
One of the most common misconceptions is that trading in the FOREX market is akin to gambling, where participants place bets and, while some win big, most lose. However, this is far from the truth. Unlike roulette, the movement of currency exchange rates is governed by specific patterns. A currency’s value is determined by:
- Economic performance of the country.
- Preferences and expectations of market participants.
While predicting these factors can be complex, it is certainly possible. It’s no coincidence that the most negative and skeptical attitudes towards the FOREX market come from those who have never worked in it. Direct experience with the market often changes this perspective, as market analysis tends to be more objective and methodical than pure chance.
2. “Gains in FOREX come at the expense of others”:
Another common question (or misconception) is whether the profits of some traders are always offset by the losses of others. However, not all market participants are speculating on currency fluctuations. Many large entities, such as exporters, importers, investors, and tourists, use currency exchange operations for other purposes, where short-term rate changes are not a priority.
The primary users of these transactions are export-import companies. When these companies sell products abroad, they receive payment in foreign currency. To reinvest this revenue in their domestic operations, they need to convert that foreign currency back to their home currency. Banks or brokerage firms handle these currency conversions, as many of the world’s leading currencies are freely convertible at floating rates.
In reality, like all financial markets, the foreign exchange market is never truly in equilibrium. Instead, it is in a constant state of seeking balance, adjusting continuously in response to various economic forces.
What is Needed for Successful Trading?
The key components of successful trading can be summarized as follows:
- Accurate forecasting of exchange rate movements.
- Minimizing losses when the market moves unfavorably.
- Effective management of capital used in operations.
Successful forecasting largely depends on in-depth market research. Experts recognize three primary types of market analysis that form the foundation for accurate predictions: fundamental analysis, technical analysis, and psychological analysis. The correct combination and application of these factors are critical for successful forecasting in the foreign exchange market.
1. Fundamental Analysis
Fundamental analysis involves studying the economic and political factors that impact the foreign exchange market. This includes key elements such as:
- The monetary policy of the U.S. Federal Reserve.
- Emerging macroeconomic indicators.
- Statements by influential government officials.
- Major international events.
The primary goal of fundamental analysis is to assess and forecast the impact of these factors on currency price dynamics. As a FOREX trader, you will need to stay up to date on global economic and political developments that can influence the market.
2. Technical Analysis
Technical analysis focuses on the historical price movements of currencies. It involves analyzing charts that display price fluctuations over specific time periods. By examining past trends and patterns, technical analysis provides insight into the current state of the market and helps in predicting future currency movements.
Technical analysis is based on the principle that price movements reflect all factors influencing the market, whether they are economic or political.
3. Psychological Analysis
The psychological analysis deals with the behavior and mindset of market participants. Understanding the psychological drivers that influence trader decisions can help anticipate market trends and identify opportunities or risks that may arise from market sentiment. Psychological, and other factors – all of them are already taken into account by the price movement.
FINANCIAL MARKETS
The trading processes and operations carried out in various segments of the financial market are often quite similar, with many common features. Each market segment generally shares the following characteristics:
- Large volumes of cash flow.
- Participants including governments, transnational companies, banks, and major financial institutions.
- Standardized processes with a high degree of technological integration.
While financial markets share these common traits, they differ primarily in the financial instruments and transactions that occur within them. Based on these distinctions, global financial markets can be categorized into several segments:
- Stock Market
- Capital Market
- Managed Money Markets
- Commodity Markets
- Currency Market
- Futures Markets
Classification of Financial Markets
1. Stock Market
The stock market is a key institution within the global economy. It facilitates the trading of company shares and various types of securities. Securities traded in the stock market range from pledge receipts and certificates of deposit to bills of exchange.
Each type of security comes with specific characteristics, such as:
- Liquidity: The ease with which a security can be bought or sold at any time and in any quantity.
- Income Potential: The expected returns from owning a particular financial instrument.
Investors use these characteristics to decide whether to buy or sell securities based on their own financial goals.
Major Stock Exchanges:
- New York Stock Exchange (NYSE)
- American Stock Exchange (AMEX)
- North American Electronic Stock Exchange (NASDAQ)
- London Stock Exchange (Europe)
Stock Indices
Stock indices are often used as indicators to forecast the overall state of the securities market. They reflect the general performance of a segment of the market and provide insight into market trends and investor sentiment.d to obtain generalized information about the state of the market. They fix the change in the prices of shares circulating on the largest stock exchanges in the world.
Capital Market
The capital market is where bonds and other long-term, fixed-income financial obligations (typically with maturities of more than one year) are issued and traded. Governments (both federal and local), corporations, and banks issue and sell bonds to raise additional capital. Bonds are typically backed by a fixed interest rate and come with a guarantee of repayment after a certain period. For investors, bonds represent a relatively secure investment, often backed by government guarantees.
Managed Money Markets
The term “managed” money markets refers to a specialized segment of the financial market that is professionally managed by highly skilled managers at various financial institutions, such as investment funds. These managers are experts in various tactics and strategies, including diversification and hedging, to manage risks and optimize returns in selected market segments.
Interest in managed money markets stems from the high profitability and reliability that professionals can offer through their expertise. Managed funds are collective financial intermediaries that provide professional money management services for private investors. These funds collect capital from individual investors and invest it in financial instruments across various market segments. Investors then have rights to the assets acquired by the fund and the profits generated from them.
Advantages of Managed Funds
For investors, managed funds offer several advantages:
- Cost Savings: Due to economies of scale, funds acquire assets in larger volumes, often at lower costs.
- Professional Expertise: Fund managers are experienced professionals with access to extensive market information, and in some cases, even insider information.
- Risk Management: The diversified nature of these funds helps reduce risks, as investments are spread across different asset classes and market segments.
Types of Managed Funds
In Europe, the most common types of managed funds include:
- Investment trusts
- Unit trusts
- Insurance funds
- Pension funds
- Offshore funds
In the United States, the equivalent of European-managed money markets is known as mutual funds.
Product Markets
In the product markets, the main commodities include raw materials, foodstuffs, and primary materials. However, the most liquid assets traded on commodity exchanges are energy carriers (such as oil and gas) and precious metals (like gold and silver). Contracts worth tens of billions of U.S. dollars are executed daily in this market segment. While the potential for high income exists, commodity markets also carry significant risk. As a result, a relatively small number of highly professional traders, often acting as speculators, dominate this market.
Derivatives Markets
Unlike traditional markets where assets are delivered immediately, the derivatives market operates on the principle of deferred delivery. In this market, financial instruments known as derivative securities are traded. A derivative security derives its value from an underlying asset, which could be an exchange-traded commodity, stock, or other security.
Examples of underlying assets include:
- Securities and shares
- Commodities
- Stock indices
- Futures contracts
Although futures contracts—agreements to buy or sell an asset at a future date—are common in the derivatives market, it’s important to note that only about 5% of futures contracts result in the actual delivery of the underlying asset. The remaining contracts are typically settled through speculative transactions.
Key financial instruments in the derivatives market include:
- Futures
- Forward contracts
- Options
These instruments allow traders to hedge against potential risks or speculate on price movements, making the derivatives market a critical component of the global financial system.
Currency Market
The currency market is a system of stable economic and organizational relations facilitating the buying and selling of foreign currencies and payment documents in foreign currencies. It is the largest financial market globally by size. The primary commodity in the currency market is any financial claim denominated in foreign currency.
Key Participants
The main participants in the currency market include:
- Dealer banks and other financial institutions
- Exporters
- Multinational companies
- Investors
- Government agencies
- Enterprises and individuals
Each participant has diverse needs, such as:
- Hedging open positions in the foreign exchange market.
- Investing in various parts of the world.
- Transferring purchasing power between countries.
Market Dynamics and Risks
The currency market follows the laws of competition, and participants aim to maximize their profits by capitalizing on exchange rate differences. The extent of these profits is influenced by a range of political and economic risks. Under certain conditions, participants’ actions can lead to significant exchange rate fluctuations, which may destabilize the market, causing social costs and economic challenges.
Institutional Structure
From an institutional perspective, the currency market consists of a network of large commercial banks and financial institutions connected via modern communication systems, from telephones and telexes to electronic and satellite networks, through which currencies are traded. The foreign exchange market is not a physical marketplace; instead, it operates through this complex communications network.
Transaction Types
Most currency transactions occur in non-cash forms, typically through current and urgent bank accounts. Only a small portion of the market involves cash exchanges.
Modern communication systems enable 24-hour trading, moving from one time zone to another. For example, a Western European bank with global branches can trade dollars in Sydney, Frankfurt, New York, and San Francisco, ensuring continuous operations across time zones.
As a result, national currency markets are interconnected and form an integral part of the global currency market.
Functions of the Currency Market
The primary functions of the currency market include:
- Foreign Exchange and Credit Services: Facilitating export-import transactions and cross-border capital investments.
- Hedging Foreign Exchange Risks: By hedging, economic agents protect themselves against adverse exchange rate fluctuations. This involves balancing assets and liabilities in foreign currency to reduce risk.
- Currency Speculation: Participants can engage in currency speculation by forecasting future price movements. Profits from such activities depend on the difference between interest rates in national and foreign markets, as well as expected changes in exchange rates.
The FOREX Market
The FOREX market is a critical segment of the currency market, known for its rapid growth and youth. The profitability of investments in this market is directly tied to exchange rate fluctuations. Its attractiveness lies in the speed of transactions and additional services, such as lending transactions, which further increase its appeal to investors.
FOREX Market
The FOREX market (Foreign Exchange operations) was established in 1971 when U.S. President Richard Nixon ended the direct convertibility of the U.S. dollar to gold, effectively eliminating the gold standard. This change led to the formation of a global market for currency exchange, where the value of currencies began to fluctuate based on supply and demand.
Today, the FOREX market operates as a global, interconnected market that opens on Monday morning in New Zealand and closes on Friday evening in the United States. It operates continuously during the week, moving from one time zone to another as different regional market participants enter the market. This creates a series of trading sessions that cover various regions around the world.
Regional Trading Sessions
The table below outlines the main regional sessions in the FOREX market:
| Region | Opening Time (GMT) | Closing Time (GMT) |
|---|---|---|
| Sydney | 10:00 PM | 7:00 AM |
| Tokyo | 12:00 AM | 9:00 AM |
| London | 8:00 AM | 5:00 PM |
| New York | 1:00 PM | 10:00 PM |
Each trading session overlaps with others at certain times, creating periods of increased liquidity and market activity. Traders take advantage of these overlaps to execute trades with tighter spreads and increased price volatility.
FOREX Market Opening Hours
(Kiev Time)
| Region | City name | Opening time | Closing time |
| Oceania | Wellington Sydney | 23:00 00:00 | 07:00 – 08:00 08:00 – 09:00 |
| Asia | Tokyo Hong Kong Singapore | 02:00 03:00 03:00 | 10:00 – 11:00 11:00 – 12:00 11:00 – 12:00 |
| Europe | Frankfurt Zurich London | 08:00 08:00 09:00 | 16:00 – 17:00 16:00 – 17:00 17:00 – 19:00 |
| America | New York Chicago | 15:00 16:00 | 22:00 – 23:00 23:00 – 00:00 |
As the sun rises in New Zealand and Australia, the first currency trades begin. However, due to the relatively small volume of funds managed by the countries of Oceania, this session sees minimal impact on exchange rates. Significant changes start to occur when Japan and other Asian countries join the market, as these regions contribute to a much larger trading volume, leading to wider fluctuations in currency quotes.
European and American Trading Sessions
Around 8 AM (Kyiv time), the first European currency dealers start trading, with activity intensifying by 9 AM. This period marks the cross-trading between the European and Asian financial markets, creating high market activity. The time from 9 AM to 12 PM is often considered the most productive for trading on FOREX, as market movements are more predictable and exhibit sufficient amplitude for profitable trades.
By 12 PM, as Asian markets gradually close, there is a reduction in trading volumes, and along with it, a decrease in market volatility.
At 3 PM, the American financial markets open. During this time, especially around 3:30 PM, significant economic reports are often released, providing insights into the direction of the U.S. economy. This period can be highly unpredictable, and inexperienced traders are generally advised to avoid trading during this time due to the heightened risks.
At 8 PM, European financial institutions begin winding down their activities, and trading volumes gradually decline until they almost completely cease by around 1 AM. By 2 AM, the cycle begins again as Japan re-enters the market.
Global Financial Centers
The vast majority of currency conversion transactions are conducted through a few major financial centers: London, Paris, Zurich, New York, San Francisco, Tokyo, Singapore, and Hong Kong. According to the Bank for International Settlements (BIS) in Basel, Switzerland, the volume of currency conversion operations in 1989 was approximately $932 billion USD per day. By 1993, this figure had surpassed $1.1 trillion USD.
The annual growth rate of international currency trading is between 5-7%. The London market is the largest, accounting for about 20% of all transactions, followed by the New York market at around 10%. The Tokyo market handles approximately $170 billion USD per day, or about 8% of total global volume.
Today, up to $3 trillion USD flows through the international interbank currency market daily, and this volume continues to grow. To put that in perspective, it represents nearly three times the annual budget of the United States.
