What Is Forex?
FOREX stands for FOReign EXchange. The Foreign Exchange market is the biggest financial market in the world; with a daily turnover of over $5 trillion dollars (that’s a whopping $5,000,000,000,000!). Almost all forex trades are of speculative nature; without physical delivery of currency, it’s basically numbers flickering around on computer screens. Chances are your currency trades will be of the speculative kind, too. So what is forex exactly? Forex trading is the simultaneous buying of one currency and selling of another. Every deal goes through intermediaries called brokers or dealers. Currencies are traded in pairs, for example euro vs. US dollar (EUR/USD), US dollar vs. Japanese yen (USD/JPY), US dollar vs. Canadian dollar (USD/CAD) and so on and so forth.
As you are not buying anything physical really, forex trading can be somewhat confusing. So, assume that when you buy a currency, it’s like you’re buying a piece of a country as the rate of exchange of a given currency against the other currencies is a reflection of the state of the economy of this given country in comparison with the economies of the other countries. As opposed to other financial markets such as, for instance, the New York Stock Exchange, the London Stock Exchange, Bolsa de Madrid or Bursa Malaysia, the forex market is not based in any particular headquarters. It has no particular central exchange. The forex market is an over-the-counter (OTC) market – an interbank market, meaning that all the trades are executed electronically in a network of banks. The forex market “is open” non-stop for over 5 days a week, from late Sunday until the end of Friday.
ABOUT THE FINANCIAL MARKETS – SESSION 1
Every country is built on a certain economy; controlling, managing, sustaining is the main major role of an economy; Economy means the largest set of inter-related economic production and consumption activities which aid in determining how scarce resources are allocated. Each economy must encompass every single detail that is related to the production and consumption of goods and services in a certain allocated area, trying to sustain it in a way that might help to prosper and develop certain sectors.
In each economy there are two different types of policies; fiscal and monetary policy:
The Fiscal Policy: is a policy stimulated by the policy makers, it is divided into taxation law and government spending; the government can adjust these laws in order to modify the amount of non-refundable income available to its tax payers, for example a government could ask more taxes from individual which makes them have less amount of money used in spending on goods and services, then the government could use those money to inject it back again into certain companies and markets by something called Government Spending. The higher the government spending means that they are going to demand more taxes from individuals in the economy; but the major disadvantage of this policy is that it might take time in order to achieve all that.
The Monetary Policy: is the second type of polices used in managing a certain economy, this type of policy is mainly controlled by central banks, meaning that they control the supply of money into the economy, by putting cost on the borrowing of these money with something called Interest Rates. Interest rates are defined as the percentage amount of money charged on borrowed or lent money, as it could be variable or fixed.
Another classification to an economy is, Open and Closed Economy; an Open Economy means that it has bilateral trade with other economies all around the world for example the United States. A Closed Economy has a limited regulated trade with other world economies like China. Inside each economy there is a Financial System; Financial System is “found to organize the settlement of payments, to raise and allocate finance and to manage the risks associated with financing and exchange; developed to secure efficient payment system, security markets and financial intermediaries that arrange financing and derivative markets and financial institutions that provide access to risk management instruments”.
There are two major roles of a Financial System; the first one is to organize surplus funds from people and organizations, and to reallocate them into deficit facing organizations or people; as those mobilized funds are used to generate returns for the surplus entities, by enabling deficit entities to augment their productive and purchasing capacities.
A Financial System contains something called financial markets; a financial market is a mechanism that allows people to easily buy and sell financial securities, commodities, and other fungible items of value at low transaction costs and at prices that reflect efficient market hypothesis.
Securities: “essentially a contract that can be assigned a value and traded”.
Commodities: “a tangible good or product that are subject of sale or barter, such as grains, metals, and foods traded on commodities exchange or on spot market”.
Transaction Cost: “cost incurred when buying or selling securities, which includes commission and spreads (the difference between the prices the dealer paid for a security and the prices at which it can be sold)”.
Efficient Market Hypothesis: “means that each share price in a market must reflect all relevant information”.
ABOUT THE FINANCIAL MARKETS – SESSION 2
An Investor is a person who invests in any different type of markets, for example equities, commodities derivatives, currencies, real estate; as this term is connected with the individual who is looking for profit from a certain investment. Types of Investors’ can be classified on certain criterion which is known by risk (the possibility of suffering damage or loss). Risk is calculated by dividing the standard deviation over the historical average returns. Risk = Standard Deviation /Average Returns
Speculators
Are type of investors’ who take higher than average risks, seeking for abnormal profits, as they are mainly concerned about speculating which might be the futuristic prices of a certain asset e.g. currency or a commodity; mainly they are involved in buying and selling future and option contracts in the short term, as they represent almost 70% if investors’; which might be known by “Risk Seekers”.
Hedgers
Are types of investors’ who tries to avoid or cancel any risks that can be accompanied with certain investment, they try to take positions that might prevent them from any potential losses, these types of investors’ are widely found in markets that are full of uncertainties and high volatility. There are many types of hedging positions like natural hedges, hedging credit risk, hedging currency risk, hedging equity and equity futures. Which are also known by “Risk Neutrals”.
Arbitragers
Are types of investors’ who buy securities in one market then immediately resell it in another market in order to profit from prices divergence, as this type of dealing is only suggested only for well experienced investors’ as any delay in transactions could result of huge losses; the effect of these transaction would result in adjusting price differences between markets.
Markets
There are three types of markets:
Factor Market: it is the type of markets that include all features of production for example land, labor, capital.
Product Market: is the market that includes all distributing products like food, goods and services.
Financial Markets
Types of Financial Markets: Primary Market: type of market that only sells the newly issued securities. Secondary Market: it’s a market where buyers buy from the seller rather than getting it from issuing company. Over the Counter Market (OTC): it’s a type of market that trades occur via phone or a network instead of a physical trading. Those types of markets are found for companies that do not meet the exchange listing requirements.
Inside the OTC Market there are:
Market Makers: it’s a type of firm that takes in a certain type and number of shares in order to ease the trading in this security, each market maker displays buy and sell quotations for a certain number of shares, when the order is set the market maker instantly sells from his inventory, as this transaction takes only a small amount of time; for example NASDAQ is considered to be a market maker. The market maker profits from the spread, which is the difference between the prices for buying and the prices at which they are willing to sell at.
Ask Prices: is the price the seller is willing to take for a certain type of security and besides the ask prices there will be the amount of securities the market maker is willing to sell; which are also known by the Bears.
Bid prices: the prices the buyer is willing to take, which is the opposite of the ask prices, the bulls in the markets are known by the bidders.
Money Market: is a type of market instruments that mature in less than one year as they are very liquid, the instruments involved in this market have fixed income and low risk for example treasury bills and commercial papers.
Capital Market: it’s a market of trading more risky instruments with a longer maturity date, as this market consists of the primary and the secondary markets.
Bond Market: “the place where the issuance and the trading of the debt securities occur”, as most bond market instruments are traded in the OTC market.
Stock Market: is the market in which shares are traded through exchange floor or over-the-counter, which is known by another name equity market, this market helps investors’ to have a partial ownership in a certain company, and some gains or dividends based on the company’s performance.
A Stock is defined as share of ownership in a certain company, and the more stocks you obtain the bigger your share in the company, which is confirmed by a certain piece of paper called a certificate. The managers of a company are supposed to increase the value of those investments to increase the confidence of investors’ in the company to raise its share price. There are two types of stocks, preferred and common stocks. A common stock are type of shares that are released to public were anybody can acquire; a preferred stocks are another type of stocks that are sold to certain people, not publicly available. The difference between both types of stocks is that preferred stocks have the priority in taking distributed dividends and in the liquidation of the company.
Functions of Financial Markets
Borrowing and lending: financial markets provides money to investors’, by giving out certain amount of money but with certain interests which is known by cost of borrowing.
Price Determination: sets or defines fixed or volatile prices for each type of instrument in the market.
Information Collection and Analysis: provides information for market participants to value or estimate prices of a certain instrument.
Risk Sharing: financial markets eliminate a type of risk known by systematic risk, by diversifying investments.
Liquidity: markets provide sufficient amount of buyers and sellers helping any investors’ to directly convert instruments into cash.
Efficiency: markets reflecting all the publicly available information on a certain instrument.
Major Market Participants
Broker: a broker’s job is to locate a buyer to the seller, as they involve in assets transformation.
Dealer: smoothes the process of matching the buyer with the seller.<br/>
Investment Banks: contributes in selling the newly issued securities.<br/>
Financial Intermediaries: They are foundations that act as mediator between investors and firms.
ABOUT THE FINANCIAL MARKETS – SESSION 3
Derivatives
Are type of securities that their value is abstracted from other financial instruments; these types of derivates are used as a hedging bargain to stop any losses from any reversal movement in the market, so the main use is to “Control Risk”; it is mainly used with currency and interest rates.
The Derivative is used by the three types of Investors:
Hedgers: the Hedger uses the derivates in order to minimize the losses by taking a position opposite to the transaction that he/she is having, so if the market reverse no major losses will occur.
Speculators: the speculator will get in market just looking for abnormal profits, with accepting higher risk, by taking an open position.
Arbitragers: the arbitrager try’s to look for low risk profit, by taking advantage of difference in prices.
A derivative includes different types of instruments:
Forward Contracts: are negotiated between two parties, to buy a long position and sell a short position of a specified amount of a commodity, as the buyer hold the right to undertake the action but not obligated, and setting the price (known by the spot price) of the commodity at a specified date.
Future Contracts: are standardized contracts that are traded on a regulated floors, obligating the delivery of the agreed amount of commodity or a currency or an instrument for example treasury bonds, foreign currency. These types of contracts are considered to have low risk.
Options: is a contract that designed to specify in it the quantity of a certain commodity with the specified date of transaction, were options have the right to buy or sell but not the obligation.
There are two types of option contracts:
Call Option: gives the buyer the right to buy (but not the obligation) a specified amount of securities at a certain price at a set date.
Put Option: gives the buyer the right to sell (but not the obligation) to the writer of the option by a certain prices and a specified date.
Swaps: “is a flexible, private, forward-based contract or agreement, which is used to hedge against exchange risk from mismatched currencies on assets and liabilities”.
There are different types risk associated with Derivatives:
Basis Risk: it is the price of the hedged asset subtracted from it the price of the derivative contract.
Credit Risk: it’s the risk of the chance of one party offsetting the financial obligation under the contract.
Market Risk: it’s the loss due to changes in the value of the derivative, including different types of risks control, accounting and legal risks.
ABOUT THE FINANCIAL MARKETS – SESSION 4
Market Mechanism
Depth
Market Depth is defined as the capability of the market to generate enough or extra orders without having an effect on the price of a security, as it can be defined in another way, it is measured also with the liquidity, the more liquid the markets are the more depth it has; moving security prices in large markets is really hard, because of the depth of the markets large orders must be taken in order to change prices slightly.
There are certain factors which affect market depth:
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Tick Size
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Prices Movement Restriction
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Trading Restriction
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Allowable Leverage
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Market Transparency
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But there is a very big role that takes place in the markets that we can’t ignore, which is known by Investors’ rationality, or Market Psychology.
Markets in general are really built on speculations, forecasts and fears; if certain gossip spreads in markets average investors’ would really panic which at the end leads them to take irrational acts, that could really affect the trend that is going into markets, but let’s not forget the bigger influential which is known by attitude toward risk.
We all know a rational investor won’t really take into consideration any spread of rumors into markets they will concentrate more risk; but the enigma starts when the amount of average investors’ in markets gets bigger which would eventually affect the overall movement, obligating rational investors’ to take different actions to wipe away any extra risk that can be added on them.
