I have been practicing trading on a bunch of demo accounts for a little while now and I am almost done with an economics undergrad degree so I feel like I have an ok understanding of how this stuff works but…
#1 Who am I actually selling to or buying from? every time I sell a pair am I trading with another forex trader? or a bank? or a buisness? When I make money selling a pair is there always some one on the other side who is losing money in order for me to make money or visa versa? Am I always going to be trading “against” some one else in the market?
#2 How am I able to buy or sell a currency that I do not own. For instance, I have my money in USD but I can still trade pairs like GPB/JPY or EUR/JPY yet I do not technically own any of those currencies, do my dollars have to be exchanged for one of the currencies in the pair before I carry out the trade?
It is the same as if you take $100USD go to your local money exchange. Exchange it for Jap Yen. Then go back in a couple of weeks exchange your yen back to USD. You might be up, you might be down. You probably lose due to the high commissions of your exchange.
So you are trading against a countries value of their currency.
You dont own a currency when you trade it. You exchange your money for another currency.
Sorry, I have to disagree with goldylox on this one.
Arcturis,
[B]1.[/B] In retail forex trading (which is what we do), there is no buying or selling of any currency.
As a trader, either you take a LONG position, in which case [B]your broker[/B] takes a corresponding SHORT position — or — you take a SHORT position, in which case [B]your broker[/B] takes a corresponding LONG position.
In every case, [B]your broker is your counter-party,[/B] meaning that he has the other side of your trade. He may hang on to it, or he may offset it by trading upstream with one of his liquidity providers. But, whether he holds your trade or offsets it, he is your counter-party initially, and he will remain your counter-party until you close your trade.
Because spot forex is a zero-sum game, there is indeed a loser (somewhere) for every winner, but you will never know who that other person is.
[B]2.[/B] Your second question requires a bit more discussion.
Both of your questions have been asked and answered many times on this forum, by me, and by others here. So, rather than repeat, or copy-and-paste, stuff that has been posted previously, let me offer you three links to previous posts. You will see a lot of repetition in these posts, but hopefully you will be able to glean the answers you are looking for.
Thank you Clint those were all very informative threads.
When I first got into this I assumed that I was doing what Goldylox described but I understand I am not really doing that at all. You were basically saying in the other thread that in order for me to actually physically trade Dollars for Yen (or whatever the pair) I would need to be working with an international bank, which the common person does not have access to, correct?
So when I trade retail forex is there ever any actual real foreign currency being exchanged at all, even after the deal goes through all the middle men involved in the transaction? Or are we just trading on some virtual electronic market made up by a bunch of brokers?
Sorry one more question,
Say there are a fixed number of traders in the forex market and they all take a short position (sell), would none of the orders be processed? So can a downtrend only occur when there are available buyers or traders taking an equal long position?
What I said was that, when you trade in the retail spot forex market (our market), you are speculating on the relative value of two currencies, the base currency and the cross currency. You are not buying, selling, or exchanging any currency.
If an actual currency conversion is what you want, there are ways to do that [B]without[/B] access to the interbank network, and [B]without[/B] resorting to the currency kiosks at the airports. One broker that I know of — OANDA — has just such a program for converting currency A into currency B, and then remitting currency B to an overseas address. Oanda might allow you to do a currency conversion, and then remit currency B [B]to your own local bank account[/B] — but, I have no experience with this. Contact Oanda, if you are interested in this. There may be other retail forex brokers who offer a similar service.
Note that this is a [B]sideline[/B] to the business of retail spot forex speculation. This sort of currency conversion does not involve a LONG or SHORT position in a currency pair. Unlike a retail spot forex transaction, this sort of currency conversion [B]does[/B] involve buying one currency and selling another currency — or, more accurately, buying one currency and paying for it with another currency.
Yes, further up the forex food-chain, trades are settled in full notional amounts, for cash.
Let’s say that you take a long position in USD/JPY, and let’s say that your position size is one standard lot (100,000 units of base currency, which is $100,000 in this case). Presumably, you took this position on margin, meaning that you did not post $100,000 of your own real money, and quite possibly you don’t even have $100,000.
Your position size ($100,000) is properly referred to as the notional value of your trade, and you are, in effect, betting on how the notional value of this position will change. If it increases, that increase represents profit in your LONG position. In order to bet on how $100,000 worth of USD/JPY will change in value, you don’t have to [B]own[/B] $100,000 worth of currency. In much the same way, you can go to the racetrack and place a bet on a million-dollar racehorse, without having to buy the horse.
When you take this 1-lot LONG USD/JPY position, your broker immediately becomes SHORT 1 lot of USD/JPY. If he chooses to shed the risk associated with that short position, he will do so by buying dollars, or selling yen, or both, through one of his liquidity providers (a big bank, say Deutsche Bank). That transaction is not done on margin; it’s a cash transaction, booked at actual value against a line of credit which your broker has with the bank.
Transactions with, or between, the mega-banks which make up the so-called interbank network are not leveraged transactions. Leverage is a device created for the retail market, to make it possible for small speculators to trade meaningful position sizes.
In the absence of outright fraud, prices are not “made up” by forex brokers.
However, it’s fairly accurate to say that prices are “made up” by the banks in the interbank network. Each bank quotes the BID and ASK prices at which they are willing to either buy or sell. And, while the banks’ quotes may be similar, they are not necessarily identical.
FXCM, an STP broker, advertises that they continuously receive BID/ASK prices from a dozen big banks; and, when you place a market order with FXCM, you receive the best bank price available at that moment, plus FXCM’s retail mark-up.
In a sense, all prices are “made up” in all markets. Price discovery is one of the fundamental functions of a market.
If you’re visualizing a huge, worldwide forex market made up of millions of small traders like you and me, well, I need to point out to you that the entire retail spot forex market is less than 3½% of the $4-trillion/day worldwide foreign exchange market. So, there’s a lot driving currency prices worldwide, other than just us.
But, for the sake of argument, let’s say that we — all the retail spot forex traders in the world — are the whole currency market. And, let’s say that we all decide to go SHORT the same currency pair, at the same time. What would happen?
When you say, “they all take a short position”, your question implies that there is a market for these traders to trade into. And a market implies BID/ASK prices. So, immediately prior to this onslaught of sell orders, your broker, acting on BID/ASK prices from the banks, is offering to buy at a price. As soon as your broker (and his liquidity providers) detect the extreme imbalance in buy/sell orders which is implicit in your question, he (or they) will widen the spread precipitously, by lowering the BID price.
Recall that you, the retail customer, buy at the broker’s ASK price, and you sell at the broker’s BID price. So, the BID price presented to you — the price at which you can sell (go SHORT) — will collapse. It might gap down 100 pips, or 1,000 pips, or x-number of pips, depending on how your broker’s pricing system, and the banks’ pricing systems, are designed to handle this sort of emergency.
Only a tiny fraction of the sell-orders which precipitated this collapse will be filled at the pre-collapse price. Many market orders will be filled at much lower prices, representing horrendous downside slippage. Limit orders will likely not be filled at all.
At some point, hundreds or thousands of pips lower, the price collapse will terrify some of the SHORTS who were filled, and some of the would-be SHORTS who were not filled. They will be terrified of a potential snap-back (to the upside) every bit as vicious as the collapse (to the downside). The terrified SHORTS will place orders to buy, in order to grab their profits and get out. Some of the terrified would-be SHORTS will place orders to go LONG in an attempt to bottom-fish.
If you doubt the psychology of the scenario I just laid out, consider a collapse in the price of something a little more tangible than a currency pair. Say, a collapse in the price of gold. Today gold trades at about $1,586 per troy ounce.
Suppose the price suddenly collapsed to $900. Would you be enticed to buy?
If the price continued lower, but the rate of decline began to slow, would you be tempted to buy at $650?
If the gold price appeared to find support at $475, and then rose to $525, would you be inclined to buy?
I think you will agree that at some point, drastically lower prices will attract buyers.
My first inclination was not to tackle this hypothetical question. I’m starting to think that my first inclination was correct.
Anyway, I hope you find some of this to be useful.
I thought I already thanked you for your help but I guess it didn’t go through. Anyway all of your posts in this thread and the one you linked have been a huge help to me.
So I understand that when I am trading currencies in the spot forex market (say GBP/USD) and I take a position on the pair, somewhere down the line after my order goes through to the broker (My demo is with fxcm) it then goes through to a liquidity provider and an actual exchange of currencies takes place at the interbank level correct?
If this is so, what happens when I am trading a commodity like silver, gold or oil; which is offered by fxcm. Does an actual exchange of those goods ever take place? I was considering investing in silver a while back but I decided not to when I saw that you could trade it on forex. What is the difference between buying x dollars worth of silver on a forex account vs buying x dollars of silver and physically holding it in a safe place?
That’s only one of the ways that your position can be handled by your broker, and not the most likely way.
Your filled order could cancel out another trader’s (opposite) filled order, in which case your broker has nothing to offset, and therefore no need to transact upstream.
Your filled order, along with a few hundred other filled orders, could result in your broker holding a net LONG or SHORT position in the pair you are trading. He (your broker) might then offset that net position with his liquidity provider.
Your broker might transact trades through an ECN (electronic communications network), in which case the order matching and/or aggregating described above will be out of your broker’s hands, and in the hands of the ECN.
The mega-banks in the interbank network will not handle currency transactions of less than about $5 million. So, the idea that your individual retail forex trade somehow gets forwarded to Deutsche Bank, or HSBC, or whomever, is just wrong.
First, if you are in the U.S., you are prohibited, by our pathetic Nanny State, from trading gold or silver on the forex market. When you say that FXCM offers gold and silver trading on the spot forex market, you are referring to FXCM-UK. And, as a U.S. resident, you are prohibited from trading with them. If you have a legitimate overseas residence address, that prohibition may not apply to you.
Before you get your hopes up about trading precious metals on the forex market, check the laws that apply to your particular situation.
As for the difference between trading physical metals versus trading metals on the spot forex market, I would describe it this way: Buying physical metals is like buying groceries, whereas buying on the forex market is like buying in the futures market. That’s an oversimplification, but (if you have a basic understanding of the commodity futures markets) you probably get the point.
The forex market is a cash-settled 2-day forward market, meaning that you enter into a contract to settle the profit or loss on your position in cash (that is, in your account currency) two days from the date on which you entered your position. There is no transfer of the underlying asset (currency, gold, silver, oil, whatever), in any case. Furthermore, the “settlement date”, on which your position is to expire, never arrives — because every day it is rolled forward by one day.
If you understand the commodity futures markets, then you will notice the two major differences between the futures market and the spot forex market.
First, it’s possible to hold a futures contract to expiration, and then either make or take delivery of the underlying asset (as the case may be). As noted above, in spot forex, there is no contract expiration, and no way to unwind a position other than through cash settlement.
Second, in the futures market there is no automatic rolling forward of the contract expiration date. The only way to remain in a futures contract after the contract expiration (settlement) date, is to close the position, and then open an equal position in a more distant contract month.
When you are trading a demo account, you order does not reach the interbank level. your order is processed in-house (broker-side). When you trade a live account, your order may or may not reach the interbank level.
As an online speculative trader, you are not trading with physical assets (currencies, commodities): everything is virtual, and there is no physical exchange of anything. If you want something ‘physical’, you can buy things like gold or silver at prevailing prices, online or offline.