Trading on Forex – How to Make Money on Currency Exchange

The Foreign Exchange market (known as Forex or the FX market for short) is the largest financial market in the world and paradoxically one of the least well-known among individual investors. No goods or services are traded on Forex; instead investors are buying and selling money with profit taking place based on the difference between currencies. As the most liquid market in the world, transactions on FX market easily total four trillion daily and it’s rare for an investor to be stuck with assets they don’t want.

Forex’s main purpose is to make currency exchange easier for companies that need to manage a lot of international transactions, such as payroll, foreign suppliers and clients, or global mergers and acquisitions. Yet in the last few years, FX has moved well beyond its utilitarian role and 80 percent of the trades are currently essentially ‘speculative’. Many professional traders need to combine both aspects of the FX market. Ashay Mervyn manages Emerging Market Assets in various parts of the world, so working in different currencies is necessary as well as profitable.

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Previously, the FX market was the domain of large multinational organisations, massive hedge funds, and corporations with a lot of financial weight. This has changed recently to allow more space for individual investors who want to try their hand at a different market.

Read on for the answers to four important FAQ’s about Forex.

What makes FX different from other markets?

How is FX regulated?

How does trading work on FX?

What do you need to know to start trading?

What makes Forex different from other markets? – One of the major differences is that there is no regulatory body to oversee exchanges and handle disputes. Unlike structured stock exchanges, deals on the FX market take places based on a ‘credit agreement’, a virtual ‘handshake’ so to speak. There is no ‘uptick rule’ so investors are free make profitable investments on dropping currencies. There is also no penalty for insider trading; investors can gamble as much they are able to afford on a reliable tip that a certain currency will drop. This freedom increases the ease with which currency is traded on Forex. There are few gaps or dead spots and large amounts of profit can be gained through smart negotiation.

Another difference is that the FX market does not work on a commission basis. Firms that trade in foreign currency are not brokers; rather they are dealers working in a ‘principals-only market’. They act as ‘counterparty’ to the trade and assume market risk. Since they don’t charge commission, dealers on Forex make money through the ‘bid-ask-spread’, the difference between the seller’s asking price and the buyer’s bid. As the most liquid asset in the world, currency has the lowest bid-ask-spread.

How is Forex regulated? – The lack of traditional regulatory structures doesn’t make the FX market a free for all. To survive, Forex traders have to work both with and against each other. Shady dealing and dishonest transactions will initiate an investor’s downfall, so the system of ‘self-regulation’ works fairly well. Reputable Forex traders also become members of independent regulatory organisations, like the National Futures Association (NFA) in the US. Funded exclusively by member dues, the NFA handles disputes through ‘binding arbitration’ and helps to ensure that currency traders are held to the same ethical standards as other markets.

How does trading work on Forex? – Currencies are traded in pairs. In any transaction, the investor will always be ‘short’ one currency (the selling currency) and ‘long the other (the buying currency). By trading frequently, investors profit on currency fluctuation to increase the net value of their investment. There is no physical exchange of commodities; all transactions take place electronically and profits are calculated in USD. Investors could be described as ‘buying a share in the country’. When they change money into a certain currency, they are betting on whether the country’s ‘stock’ will go up or down. Just like other markets, profits are made on the accuracy of the bet and the ability of the dealer to astutely judge the timing of each trade.

What do you need to know to start trading?

  • Just like other markets, financial jargon on Forex can be intimidating for a new trader. There are four ‘major’ currencies and three ‘commodity’ pairs (see our PDF) which account for 95 percent of the ‘speculative’ trading on Forex. The most common type of trade is called a ‘carry trade’ which is based on converting ‘interest rate differential’ between different currencies into profit by using a low interest currency to invest in one with a higher interest rate. Widely divergent interest rates can allow investors to carry a huge profit margin on this type of transaction.
  • PIP is a common Forex term which stands for ‘percentage in point’. This is the smallest amount to which a currency will be calculated, usually the fourth decimal point with the one major exception. Trades that exchange US dollars and Japanese yens are only calculated to two decimal points. A round number is referred to as a ‘Figure’ on FX while the term ‘Yard’ is shorthand for one billion units.
  • Knowing currency nicknames is another vital asset for investors on the FX market. For instance the UK pound can be called ‘Cable’ or ‘Sterling’, while US dollars are known as ‘Greenbacks’ or ‘Bucks’. ‘Swissie’ and ‘Aussie’ are obvious nicknames for Swiss and Australian currencies, but nicknames for the Canadian dollar, ‘Loonie’ or ‘Little Dollar’ might be less easy to recognise.

It takes many years to become an experienced currency trader like Ashay Mervyn. As with all financial markets, much knowledge can only be gained through actual practice. However the nice thing about Forex is that it’s open to anyone, anywhere in the world.  Novice investors need only a computer and internet access to open an account and begin trading on this profitable market.

Highlighting Some of the World’s Biggest Emergent Markets

The previous article from Ashay Mervyn explained why investors are drawn so intently to emergent markets and the big rewards that they offer, despite the risks. This article aims to expose some of the biggest markets to invest in and what opportunities they offer.

China        

The world’s biggest population also generates the biggest GDP for the emergent markets as classed by Morgan Stanley. While its economy has grown at a slower pace recently it has still achieved a GDP increase of 1700% since 1992. Investors in this market could look at natural resources such as aluminium, coal and oil, as well as the traditional consumer products – especially clothing, electronics and toys.

India

India’s claim to be the second-largest English speaking country in the world has helped to attract foreign investors. With big leaps in economic liberalisation in the 1990s, the government has established a great market for investment opportunities in areas such as metals, construction and textiles to name just a few.

Brazil

The strength of South America’s biggest nation has been in its quiet but rapid economic development. If it continues at the same pace then Brazil will soon be considered a developed, rather than emergent market and now is the best time to invest there. Big industries include aerospace engineering, cement, lumber and steel, and with the Olympics coming up no doubt the government will be pulling out all the stops to further facilitate growth from foreign investment.

The above examples are just three of the strongest emergent economies in the world, and there are countless others that have seen remarkable growth while traditional markets have stagnated. Investment today means buying in to these new areas at a far lower price than in the future, as the low price points won’t be around when the World Bank or Morgan Stanley grants these nations their well-deserved ‘developed’ status.

Discover the Appeal of the World’s Emerging Markets

For anybody with even the most passing interest in economics, they will have noticed that growth in the last ten years or so has been sluggish at best for most established markets. On the other hand, and this will require spending a little more time researching global economics, emergent markets such as China and India have experienced unprecedented growth over the past 20 years. With projected development set to outpace traditional markets in Europe and the US, many investors are being drawn in to try and make a quick return.

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Expansive GDP Growth

Ashay Mervyn is the Head of Emergent Markets at JNF Capital Ltd, and therefore is no stranger to the burgeoning markets in developing countries like China and Brazil. China’s GDP has grown by a factor of 17 in the 20 years between 1992 and 2012, and with the huge migration of outsourced communications and technology services to India, the world’s second most populous country saw an increase of 500% to its GDP. The bottom line with rapid increases such as these means that the average person has more disposable income, giving far greater opportunities to investors than ever before.

To put that into perspective, in the US GDP fell by 0.9% in 2014 after a long period of recession that affected most of the developed markets and one of the reasons why the US economy has been able to bounce back so far, is partly to do with the strength of investment in non-US markets. In the early ‘90s it was nearly impossible to convince investors to put capital into emergent markets, but over the last ten years the roles have reversed and now India, China, Brazil and Sub-Saharan Africa are the markets traders are really interested in.

Greater Diversity

Experienced investors will already be aware of the benefits of creating a diverse portfolio that will reduce their overall risk. The same is true when talking about investment on a macroeconomic level. While Western markets are bouncing back, the ease at which they slipped into recession following the collapse of the Lehman Brothers should be enough to dissuade investors from investing solely in these markets again. During the same time period, emerging markets fell too but their return to higher growth levels than before gives greater credence to the idea of diversification.

Higher Risk, Lower Price

Another reason why investors are attracted to emergent markets is that the risks for some areas have been exposed and this has further driven down the price for investment, in spite of the rate at which the markets returned to profitable levels. What this means for investors is that they can get in to emergent markets at a lower price, diversify their portfolio to minimise risk and potentially yield a slightly reward than in the domestic market. All investments carry some levels of risk, but with the entry price remaining low for most developing countries then the ratio of price to risk is far better.

It is important to remember that together, the emergent markets represent a third of the world’s total GDP and they have achieved this level of growth quickly. Careful consideration must be taken before investing in more volatile markets, but the rewards can pay off in a big way if the market continues to grow like in recent years.

Exploring the Economic Potential of Sub-Saharan Africa

With a market in the West proving to be slow to recover following the economic downturn of the last decade, there has been a trend for businesses to look towards emergent markets elsewhere as a means to improve immediate returns. In spite of the exciting opportunities that markets in Kenya, Nigeria and South Africa present, there are a number of myths that surround these economies that are still holding investors back. The Ashay Mervyn business focussed YouTube channel highlights the benefits of investing in emergent markets; this article has been created to try and dispel the myths of trading in Sub-Saharan Africa.

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Lack of Urgency

China’s economic growth towards the end of the 20th Century has been one of the most talked about topics in business but it has only been in the last 10 years that the focus has swung to emergent markets in Africa. While it can be said that it is easier for an emergent market to exhibit faster growth than established ones, this fact does not diminish the huge leaps in development that countries like Ethiopia and Ivory Coast has made.

One factor that is preventing expansive foreign investment in these nations however, is the thought that there is no immediate competition to drive growth even further. Certain sectors are already dominated by Asian corporations, while markets provide strongholds for domestic businesses. The lack of true competition might be a disadvantage now, but with the world’s attention turning to Sub-Saharan Africa it would make sense to see investment in the area as a long term solution in order to snap up market share while competition is slow.

Lack of Diversity

Africa is well known as a continent rich in natural resources – from fossil fuels to precious metals, and Nigeria in particular has made its mark in the oil and gas industry as it is the 11th biggest producer of oil. A secondary market has sprung up following the establishment of the nouveau riche oil producers, with a high demand for consumer products as a result of the extra disposable income. These two have dominated economic headlines for a long time, giving rise to the misconception that investors will struggle to create a diverse portfolio in Africa.

In actual fact, oil and gas is only responsible for 11% of Nigeria’s GDP a clear indication that the nation’s economy can provide a diverse and interesting market for foreign investors. Additionally, while there is of course a high demand for consumer products, the more an economy grows, the greater the demands on its infrastructure will be. Investors in construction, logistics and even healthcare will be able to find a market to invest in as these markets develop.

Lack of Stability

Some sub-Saharan nations have developed a poor reputation for political stability leading many investors to develop concerns regarding the economy.

However, despite recent political and social upheavals in Kenya and Nigeria, very few international corporations have suffered large losses during these relatively short periods. By developing contingency plans to offset these losses, future investors in Sub-Saharan Africa can still benefit from the rapidly expanding markets there.

Lack of Experience and Data

These two myths go hand in hand and although many investors will be put off by the idea of not having experience with trading in Sub-Saharan Africa the advantage is that particularly entrepreneurial and adventurous executives will enjoy the relative freedom of these markets. Relying on conventional data to predict buying habits in the future will also provide a unique challenge to foreign investors as emergent markets will demonstrate certain trends that most established markets will not.

For instance, as economies grow and more individuals have access to disposable income, they will look to buy fundamental items that most people in the West would take for granted. In order to stay ahead in Sub-Saharan Africa, it is necessary for investors to maintain a physical presence and analyse data from the area on a case by case basis.

All in all, the signs point to a bright future for many of Africa’s developing nations and investors should start occupying space in these expanding markets now to avoid being left behind in the future. It will take a different strategy to those used in the West but through analysing the right data and taking stock of current political affairs it is possible to see long term returns.

What is a Service Performance Guarantee?

While not suitable for all, countries with stable governments could find that SPGs give foreign investors more confidence where governments are held more accountable. Previous posts featured on the Ashay Mervyn blog and the attached PDF document both report on the recommendations from the Centre for Global Development think tank that certain Sub-Saharan countries could well benefit from the introduction of Service Performance Guarantees. SPGs are essentially a form of insurance which can be used to protect investors from various risks. These could be risks such as loss of output due to power supply failure or they could be guaranteeing service such as VAT rebates will be performed within a pre-decided timescale. Where specified targets were not met, the country’s government would be required to step in and provide compensation for the firm or investor who had purchased the insurance.

Variants of SPGs have been used effectively among many developed nations for some decades. Authors of the suggestion to introduce SPGs argue that the system could be self-sustaining as with other forms of insurance, with the premiums paid by investors funding any compensation pay-outs. There is also the possibility that certain aid agencies could be brought on board to help bring down the cost of premiums or even to bail out corporations in cases where things have gone wrong. However, aid agencies would need to be very careful about the extent of their involvement. At present there is virtually no SPG take-up by governments of developing countries or by multilateral aid agencies.