Forex, also known as the foreign exchange market (or FX), is the largest and the most liquid market in the world. Its retail part came with the development of the Internet. This enabled retail clients to trade Forex online via various trading platforms. Forex opened its doors to retail clients in the late 1990s. At this time, the first retail online brokers began their operations.
Forex, as a market had been functioning for decades before that, but it only accepted institutional clients. Currently there are trillions of US dollars traded daily on the Forex market, with retail clients contributing nearly 5% of the total volume, or around 250 billion US dollars in daily turnover. But why is the Forex market so large?
Large multinational trade companies, financial institutions, hedge funds, and lots of other companies require foreign currencies to operate their businesses. For those unaware, one currency is bought online for another currency, and this creates quite a reasonable flow of funds. In other words, Forex is the global marketplace for trading currencies.
Currency markets are much larger than equity markets, with the daily trade volume in Forex estimated to be as much as 10 times larger than the combined volume of all of the world’s stock markets, making it a very liquid market. Due to the high liquidity of the Forex market, margins are low and leverage is high. It is not possible to find such low margin rates in the stock market as the majority of margin traders need to have around half the value of their investment in their margin accounts. Forex traders, meanwhile, only require an amount as low as one percent.
The Forex market is a market that trades around the clock. This means that if the price spikes after hours and you are a short-term trader, you can adjust your existing position or enter a new one without having to wait until the market opens the next morning. Forex market liquidity stays deep for most traders around the clock; there are of course, moments when currencies are less liquid, but for most participants, liquidity is fine even then. Spreads also stay tight with the euro-dollar exchange rate typically being 3 pips or less and although they may go to 5 pips when liquidity is not as high, there is rarely a major widening in spreads.
Flexibility to Go Long and Short
Forex offers the flexibility to go long and short with ease which doesn’t happen with stocks. Trading opportunities exist with Forex regardless of whether a trader is long or short, so traders always have equal access to trade in a rising or falling market. Stock markets on the other hand can frequently hit a lull, resulting in declining volumes and activity, making it difficult to open and close positions when a trader would like to. Furthermore, in a declining market it is only with extreme dexterity or luck that a stock market investor can make a profit. Forex offers the opportunity to profit in both rising and declining markets as, with every trade, a trader is buying and selling at the same time and short-selling is, thus, a part of every trade.
Manageable Amount of Trading Choices
The ease of choosing a currency to trade instead of choosing from thousands of stocks is one of the key factors. Stocks can decline even in a bull market if it’s not the best stock in its peer group or if a trader is not in the right sector. Quite often, a sector or stock will fall even as the general market rises, so an investor needs to be very good at choosing stocks or just plain lucky.
The currency market with its far fewer choices makes a trader’s job much simpler. As we have seen, most Forex traders stick to the major pairs and it is a fact that most currency trading is between the euro and the US dollar. Even leaving EUR/USD aside, there are only a few other major pairs and by watching those, traders are essentially watching the world. Even if a trader expanded their Forex trading into other types of currency pairs, it is a drop in the ocean compared to the tens of thousands of stocks that exist. Hence, in this respect, currencies are easier to follow.