It may surprise new traders that currency is one of the most liquid markets of all commodities and securities with the possible exception of government bonds. At least as far as private traders are concerned, currency represents a very liquid and deep market. Apart from liquidity it also offers virtual 24/7 trading given that there is a currency market trading somewhere at almost any time of the day or night and virtually every day of the week. It is estimated that daily, global turnover on currency markets is around $US4 trillion and it keeps growing – exponentially!
It’s a trader’s delight – at least from the perspective of liquidity and ease of trading, which probably explains why there are around 4 million trades a day globally. These trades comprise not just financial traders, but also traders who are working in the dealing rooms of trading houses as well as in banks who need to exchange currency for their clients and for their own trading desks. The other attractive factor is that currencies are often considered easier to understand as they do not require the in-depth stock selection process that is associated with the trader or investor in the stock market who stock-picks.
There are however fundamentals to deal with in currency trading. They are, after all, in many ways the public face of the underlying economy. Hence a currency is affected by a wide range of economic indicators such as interest rates, unemployment rates, terms of trade, political stability, demographics, and geopolitics. Because it is so widely tradable by literally millions of traders, the downside of currency trading is that at times a currency can be very volatile – not just due to changes in relation to the fundamentals but also due to changes in sentiment.
A technical analysis of the behavior of a currency can provide the trader with sufficient information to trade on. “Rules” in currency trading thus are no different to rules in any commodity or share market: there are essential money management principles as well as psychological principles in involved. Many people enter currency markets on a whim, believing it’s an easy and quick way to make money. If they have never traded in a market before they may be facing an expensive lesson as most will tend to extend themselves too far and make poor decisions and lose money. They then become discouraged and move on. Others rely on technical analysis thus eschewing the need for fundamental analysis.
Investors and traders need to exercise good money management because coming into this market there is often much volatility and a trader is usually trading on margin, that is, in effect, on borrowed money.
Most traders – sensibly – begin their trading experience in currency markets with what is called a “demonstration” account (which is free). It is an excellent way to see how a position plays itself out. If a trader, for example, wanted to trade the upside on the Australian dollar versus the US dollar he would enter with one contract on paper (so to speak) watch it for a while, noting what he may do in the event of the currency moving the wrong way. It’s important to understand one’s own psychology as people who are risk averse often a frightened off by the first sign of an adverse movement and never get to see how a current trade can play itself out.
The other warning side for newbies is to avoid currency markets where there is large volatility as these can be very damaging if caught out on the wrong side of a trade. Any trader, whether a newbie or an experienced investor should spend time studying historical charts of the currency movements that they are interested in, noting the high volatility events and understanding why these movements occurred. That time spent is a sound money management investment.