For better part of the past fifty years foreign exchange has been out of reach of most individual investors. Although most of the industrialized worldâ€™s currencies have been free floating since the middle 1970â€™s the foreign exchange market was a decidedly â€œold boysâ€ club accessible only to the most sophisticated hedge funds, the largest investment banks and the biggest corporations in the world.
That inner sanctum began to be challenged in earnest at the end of the 20th century with the advent of electronic trading and the introduction of the euro. The EUR/USD quickly became the single most tradable financial instrument in the world, exceeding volumes of more than 1 Trillion in turnover per day. Although the currency pair is clearly not without its flaws it represents the two largest economies in the world and therefore is extraordinarily important to capital markets.
As all capital markets became electronic the foreign exchange market joined the trend and opened itself up to individual investors for the very first time. The investor response across the world has been nothing short of phenomenal. Individual currency trading quickly went from a novelty to a significant slice of the overall market. Presently individual investors comprise more than 20% of the daily flows with estimates of turnover exceeding $200 Billion per day.
Investors are attracted to currencies as an asset class for a variety of reasons. Currencies are truly the only round the clock financial market that exists today. Spot FX is fully fungible and tradable across the world from 5 PM New York time Sunday to 5 PM New York Time Friday.
Currencies are also what is known as an absolute return market, meaning that they have no directional bias. Unlike equities which have a clear tilt to the long side, currencies can be both bought and sold short without any restriction whatsoever. There are no bear markets in FX because when one currency falls another rises allowing investors who correctly anticipated the move to capture the profits in the trade. Of course investors who were on the other side of the trade will suffer losses.
In addition to being the most liquid market in the world FX is also one of the least expensive instruments to transact. The advent of electronic trading and greater competition has resulted in a marked reduction in transaction costs to the point where individual investors now receive pricing that is nearly equivalent to the institutional level. Typical spreads in the EUR/USD are usually as little as 1 or 2 basis points per trade. That means that transactions costs on 100,000 units of EUR/USD are as little as $10 to $20 per trade, although they can vary widely from dealer to dealer and could increase markedly during times of high volatility.
Although currency trading initially started as a way for multinational corporations to hedge their foreign exchange risk, the market quickly attracted speculators to the point where presently the FX market is 97% speculative in nature. This development can sometimes result in highly exaggerated price moves as sentiment reaches extremes on both the short and the long side. Although currency markets can become turbulent especially in times of geopolitical stress, allocating a small portion of a portfolio to a liquid, non correlated, absolute return instrument such as foreign exchange could provide investors with a unique diversification strategy to deploy their capital more efficiently.
Forex (and Futures) trading involves high risks, with the potential for substantial losses, and is not suitable for all persons. These testimonials may not be representative of the experiences of other customers and are no guarantee of future performances or successes.