Foreign Exchange Market: What Is It?

To buy foreign goods or services, or to invest in other countries, companies and individuals may need to first buy the currency of the country with which they are doing business. Generally, exporters prefer to be paid in their country’s currency or in U.S. dollars, which are accepted all over the world.

When Canadians buy oil from Saudi Arabia they may pay in U.S. dollars and not in Canadian dollars or Saudi riyals, even though the United States is not involved in the transaction.

Associated Careers

FX traders are good at strong and immediate decision making, and many apply this skill to other trading environments, such as stock trading, sales, or institutional buying. Their mathematical and financial skills recommend them to Wall Street firms in a number of positions, from back-office account settlement to options valuation analysis. In general, though, FX traders seek the adrenaline rush of trading and enjoy the open unregulated market-the number who leave (a small 20 percent over the course of a career) actually provide the largest single industry donation of manpower to the world of professional gambling.

Paying Your Dues

Economics, mathematics, and statistics majors have a distinct advantage in applying for positions in this field, as do history majors whose coursework included economics. A bachelor’s degree is required. Any experience in a trading environment is valued, as is any work that demonstrates the ability to work hard, make fast and accurate decisions, and manipulate numbers. Many employers appreciate study abroad, international work experience or fluency in a foreign language. As a number of entry-level positions are account representatives as opposed to trading positions, candidates who have good interpersonal skills and access to capital may have an advantage. While on the job, keeping abreast of changes in the industry is important; continuing education is the norm. Few people leave to get advanced degrees in this field-there is a reverse snobbery associated with most trading floors that holds that traders are born, not made, and that no advanced degree will ever make anyone a more competent trader.

A Day in the life of a Foreign Exchange Trader

A foreign exchange trader looks at the various factors that influence local economies and rates of exchange, then takes advantage of any misvaluations of currencies by buying and selling in different foreign exchange markets. Those with the most information, the best contacts, and strongest decision-making skills come out ahead. “It’s the wild west of trading,” wrote one foreign exchange (FX) trader, “and remember: A lot of people died in the wild west.” Those who are comfortable with a high degree of risk and uncertainty should look into this exciting career. A foreign exchange trader manages an account, looks at reports, reads the press from various countries, and most importantly, spends time on the phone. He may spend up to 80 percent of the day on the telephone and working at his computer. Traders must act fast to exploit valuation differences: “You’ve got seconds to decide how millions of dollars should be spent,” said one trader, “so you have to have confidence.” Confidence ranked second right after “guts” in qualities important in new traders. A sharp analytic mind is also crucial; while a variety of degrees are helpful, those with technical or scientific analysis backgrounds tend to find the job more manageable. Accounting strengths are helpful in keeping track of positions and profit and losses throughout hectic days. FX traders specialize early in their careers, following one currency and the underlying economy of its country. Many traders specialize in groups of geographically related countries, such as those who trade Central American currencies or Pacific Rim currencies. Since foreign exchange trading is international, it can take place at any time of day. Many managers run twenty-four-hour shops and do business around the clock; most employees do have regular shifts, but world events may demand being summoned from bed late at night. Eighty percent of the traders we surveyed were satisfied with their choice of profession, but over 40 percent responded that they were exhausted at every day’s end.

peculating

Speculating is by nature profit-driven. In the forex market, futures and spot forex are not all that different. So why exactly would you want to participate in the futures market instead of the spot market? Well, there are several arguments for and against trading in the futures market:

Advantages
• Lower spreads (2-3).
• Lower transaction costs (as low as $5 per contract).
• More leverage (often $500+ per contract).

Disadvantages
• Often requires a higher amount of capital ($100,000 lots).
• Limited to the exchange's session times.
• NFA (National Futures Association) fees may apply.

Hedging

There are many reasons to use a hedging strategy in the forex futures market. One main purpose is to neutralize the effect of currency fluctuations on sales revenue. For example, if a business operating overseas wanted to know exactly how much revenue it will obtain (in U.S. dollars) from its European stores, it could purchase a futures contract in the amount of its projected net sales to eliminate currency fluctuations.

When hedging, traders must often choose between futures and another derivative known as a forward. There are several differences between these two instruments, the most notable of which are these:

• Forwards allow the trader more flexibility in choosing contract sizes and setting dates. This allows you to tailor the contracts to your needs instead of using a set contract size (futures).

• The cash that's backing a forward is not due until the expiration of the contract, whereas the cash behind futures is calculated daily, and buyer and seller are held liable for daily cash settlements. By using futures, you have the ability to re-evaluate your position as often as you like. With forwards, you must wait until the contract expires.

Forex Futures versus Traditional Futures

Both forex and traditional futures operate in the same basic manner: a contract is purchased to buy or sell a specific amount of an asset at a particular price on a predetermined date. (For an in-depth introduction to futures, see Futures Fundamentals.) There is, however, one key difference between the two: forex futures are not traded on a centralized exchange; rather, the deal flow is available through several different exchanges in the U.S. and abroad. The vast majority of forex futures are traded through the Chicago Mercantile Exchange (CME) and its partners (introducing brokers).

However, this is not to say that forex futures contracts are OTC per se; they are still bound to a designated 'size per contract,' and they are offered only in whole numbers (unlike forward contracts). It is important to remember that all currency futures quotes are made against the U.S. dollar, unlike the spot forex market.