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What is Forex and how it works

Forex (Forex) is an international market for currency trading at free prices. However, this term is generally associated with speculation in the general public through dealing centers. Its essential attribute is the presence of a leverage. Let's try to understand what is Forex and how it works, who its main participants are, how the deals are going and what a beginner trader have to do with it.

What is Forex

The name Forex is an abbreviation of the English phrase "FOReign EXchange". Currency exchange operations are conducted through central, commercial and investment banks, as well as through networks of brokers and dealers. The chain involves insurance companies, foundations and large corporations. Assess the essence and rules of the system is easier if you know what the OTC market is.

OTC market or Over The Counter (OTC) - a financial space without a specific physical location. Bidding occurs in electronic form between the two sides directly, and quotations are formed without fixed values. One of the peculiarities of over-the-counter trading is that it is possible to sell assets in any acceptable amount - there are no complete and incomplete lots.

OTC markets are organized or not. In the unorganized version of the transaction are made without compliance with the rules, the trade is spontaneous and prices are not fixed. On organized OTC markets, trades are conducted through special programs in an auction with full publicity. Forex is the most famous example of such a market. There are rules, there is a system for collecting applications from participants, the prices reached are fixed within a particular broker or dealer. Thus, the client can trade only at the price set for him.

This is not the "Forex", the advertisement of which you can find in the Internet - it is a question of a true over-the-counter market where transactions occur between banks where the trade is conducted to space amounts and where it simply does not get so because of the high entry point for the average trader. On one trading terminal alone it would be necessary to spend about 6 thousand dollars a month.

Basic Forex participants

Participants in the Forex market are financial intermediaries between the system and the end customer. They conduct transactions, taking as a payment for their services a percentage of the trade turnover, which is taken into account in the form of a commission or spread. The main ones are market makers - banks and brokerage houses providing liquidity, and dealers supplying quotes to customers.

Commercial banks

The main functions are the fulfillment of clients' requests and ensuring the liquidity of available funds. Commercial banks perform currency conversion for enterprises of different economic zones. These are the most significant volumes of transactions on Forex, they make about 2/3 of daily operations and dictate intraday movement of quotations. Such exchange transactions represent the interbank market.

Market makers

A market maker may be a bank or a brokerage firm that assumes the obligation to withhold a spread or the difference between the prices of buying and selling within the prescribed limits for a given period of time. Its task is to squeeze out as much money as possible from ordinary traders. MM act on the over-the-counter market as direct participants in transactions - sellers or buyers. The three most important market makers are Deutsche Bank, UBS and Citi. They can be learned from large volumes of transactions, leading to significant movements in quotes.

Foundations

Companies that practice foreign investment of assets. As a rule, we are talking about investments, including production. Funds manage diversified portfolios of assets, often place money in securities, but do not shun and currency speculation. Among them, the Soros Foundation is most known, to whom the collapse of the pound was attributed in 1992.

Central banks

The main task of the Central Bank is to prevent sharp movements in the exchange rate of the national currency. To maintain the trade balance and prevent economic crises, currency regulation is practiced. The influence of central banks is different in strength and volume of infusions. This may be an indirect impact on quotes through interest rates or direct - currency interventions.

Brokers and dealing centers

The main functions - to help meet the seller and the buyer of the currency, to conduct an exchange transaction between them. Dealing centers differ from brokers in that they accumulate in their accounts small amounts of individuals before accumulating the necessary minimum volume before transferring them further along the chain. For intermediary services, both those and others are charged a commission - the percentage of the transaction amount. With multidirectional bids from a large number of clients, intermediaries regularly make a compromise in the form of internal clearing - work according to the "kitchen" scheme. When trading a deposit of up to tens of thousands of dollars in most cases, the trader will deal with the DC.

Individuals

Take into account both direct transactions for the purchase of currency, and non-trading transactions of individuals - tourism, foreign fees, etc. Individuals who participate in trading on Forex, use their personal funds to make a profit by currency speculation.

Trading platforms: Currenex, ECN, STP etc.

There are a number of automated systems where trading is supposed without dealer intervention or No Dealing Desk, abbreviated NDD. Transactions are executed with Market Execution at the current price, even if it has changed during processing time. The system is characterized by a complete absence of requotes. NDD-broker - an agent that automatically sends quotes to a trader, and orders - a liquidity provider. Based on NDD, several effective systems have been created, the most famous of which are: ECN and STP.

Electronic Communication Network or ECN - the network for executing transactions without the participation of questionable intermediaries. Trader positions are provided through ECN withdrawal to direct liquidity providers, broker-intermediary does not interfere with trading.

Applications that are entered in the ECN come in a single database. The system selects and automatically executes opposite orders of different clients within the same asset, if their number and price coincide.

Among the advantages of electronic systems are such items:

  • absence of requotes;
  • instant execution of transactions;
  • the impossibility of trading a broker against a client;
  • round-the-clock trading;
  • the opportunity for an individual to get into real trading, where his transactions affect the market dynamics;
  • transparency of information on transactions.

ECN has the status of a market maker and acts as an impersonal broker for its customers.

Currenex is an open ECN system that creates for participants orders to debit funds from their own accounts, provides information and analytics. Calculations between the participants the system does not produce. To participate in trading through Currenex, you need to be an officially registered person. It can be banks, international organizations, government departments or representatives of large financial departments.

STP - continuous processing of information, which excludes manual intervention in trade. It is assumed that customer orders are placed on the external market with the help of an automatic intermediary in the person of a brokerage company. STP clients can not form their own orders for transactions - only to accept offers from larger players. The totality of these proposals determines the current liquidity of the market.

Dealing centers and conflict of interests

Habitual game for the average person at exchange rates, which occurs under the aegis of Forex and is more often associated with scam, has its own peculiarities and laws. Consider them.

Making transactions with currency, a forex broker client, as a rule, is sincerely convinced that he is trading against real banks and market makers. But the truth is that for the dealing center the revenue from the client's commission is not very profitable, since most traders simply lose money and leave the office. It is much more profitable not to take the transaction out of the company at all. Thus, there is a conflict of interest, because the client's loss is the profit of his DC. This scheme of work is called "kitchen" - all transactions are "brewed" inside the company.

The idea of ​​"kitchens" is not new and was practiced long before the appearance of "Forex". As early as the 19th century, this scheme was described by the legendary Charles Dow in the editorials of Wall Street. She went down in the history of the trade called Bucket Shop. Later "baket-shops" got the maximum popularity thanks to the book about the speculator Jesse Livermore, who became a boy in them persona non grata because of too successful trade.

To distinguish the "kitchen" is easy, if you carefully read the contract to open an account. Most DCs do not advertise the fact that they do not show client transactions anywhere, but in contracts there are usually points that clearly talk about it.

What should a normal trader do who realizes that he is trading in the "kitchen"? First of all, there is no need to panic, but you need to weigh the minuses as well as the advantages of this approach. In doing so, it is critical to treat all sorts of "horror stories" from the Internet forums about the "kitchen" DCs that rob their customers, since most of these stories refer to the times of the "wild" forex of the late 90s, early 2000s. Since then, the forex market has changed quite a lot. Let's try to figure out which of these fears has long been irrelevant, and which ones to pay attention to. So, among the most serious disadvantages of Forex most often called the following:

  1. Forex broker can not give money. In fact, brokers now give money almost always. The time when DC was openly deceiving its customers, was over in the early 2000s. Now, forex brokers are not focused on one-off profits, so they value their reputation and honestly pay out the money earned by traders. A few years ago, we had to resort to various manipulations, so that the DC did not set the client up. For example, constantly withdraw funds, depriving yourself of the benefits of reinvestment. Now the situation is much better. Not only in large, but in average DC, you can safely withdraw funds, including, and bonus. In addition, now in many countries, forex trading is subject to special regulation, so the broker can no longer simply not give money to the client.
  2. A broker can interfere with trading. But this really has a place to be. But again, the times of the open game of the DC against the client, when brokers could at their own desire move the price and "shoot down", long ago passed. Now brokers begin to intervene in trading, usually only after the client has earned a lot of money, and his account will show a steady growth (most often this happens when a trader uses arbitrage strategies). In this case, the methods that brokers use are usually quite soft, designed simply to make further trade meaningless. Most often brokers begin to return more requotes or increase the opening time of transactions. In addition, they can transfer the account to the category of market (with market execution) or increase the spread. In any case, the goal is to force an overly successful customer to stop trading and close the account. In this case, the money earned is usually always given.

Thus, summarizing the above, we get that: firstly, in the modern world, if we choose large and licensed DCs, rather than small offices that are not registered where, it is also safe to trade on Forex, as, for example, on the stock exchange. Secondly, you need to be prepared for the fact that if the trade is too successful, the broker will begin to put the sticks into the wheels, hinting that it's time for you to leave.

Now consider the advantages of trading on Forex. And we will consider the advantages in comparison with trading on the stock exchange, since it is usually considered as the main alternative to Forex. So, among the main advantages of Forex there are the following:

  1. Minimum deposit and skills. The entry point to the stock exchange is quite high - about $ 10,000. A newcomer without skills is more difficult to understand - from the scheme of work to the harsh terminals. Compared to the stock exchange, "Forex" is relatively simple. A lot of understandable guides and trade strategies, friendly interface of the terminal contribute to the fact that you can make profit even from the first day of trading, not immersing yourself in studies for months. In addition, many brokers have a minimum deposit of $ 1 or no lower limit at all. However, it is better to start trading, having at least $ 100 on the account.
  2. Availability of trading instruments. Only on Forex CFD-contracts for indexes, futures, stocks, crypto-currencies and other instruments are available. You can trade them even with a small deposit, while on a real exchange, much higher amounts would be required. Reduced margin requirements, cent or mini accounts for small deposit holders allow the full use of these tools.
  3. Low trading costs. Despite the fact that the commission and spreads on the stock exchange are often lower than in the Forex market, the total trading costs for trading on the stock exchange may be much greater. The fact is that on the stock exchange players pay the commission not only to the broker, but also to the site itself. In addition, on Western exchanges, you have to pay extra for the use of a trading terminal, for access to a source of quotes, for access to historical data, for the possibility of autotrade, etc. In addition, many stock brokers still have separate fees for maintaining a trading account. Of course, with large trade turnover, all these expenses become invisible. But in relation to a small trading account, the share of these costs becomes significant. On Forex, a trader pays only a commission, which can be either explicit, or in the form of a spread, and that's all.
  4. Some trading strategies are possible only on forex. There are trading strategies that can be implemented only through the DC. An example is the so-called forex arbitrage, also known as high-speed arbitration or arbitration for advancing. This strategy, which is one of the most profitable of all known, uses the technical feature of trading in dealing centers, which consists in the fact that DCs are forced to transmit to terminals and use the prices they receive from various liquidity providers to calculate. As a result, there are regularly backlogs of quotes, which are easy to detect, with alternative access to leading sources of data. Using this information it is possible to make highly profitable arbitrage transactions on the side of the DC in the direction of the leading source, receiving practically guaranteed profit. Obviously, such an arbitrage would not be possible on the stock exchange.

Thus, despite the conflict of interests of the trader and the broker, trading on forex does not make sense. As for the comparison of the forex and the stock exchange, then you can not make an unambiguous choice. When choosing one or another trading platform, it is first of all necessary to focus on the task of maximizing profits. And for this you need to carefully calculate all the costs that arise in the case of implementing a trading strategy both on the forex and on the stock exchange, and only after that make the final choice.