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    Portfolio Diversification in Forex Trading

    The strategy of diversifying an investment portfolio allows the fund manager to spread risk between various different investment types with the same portfolio. In this way, they avoid having all of their investment “eggs” in one basket.

    In essence, if you keep all of your funds invested in similar securities like either bonds or stocks denominated in a single currency, then your portfolio will not be protected against adverse general moves in the relevant markets.

    Nevertheless, if you instead diversify your portfolio by placing funds in different types of investment instruments denominated in different currencies, then you will have less exposure to any one security, currency or market.

    How Portfolio Diversification Traditionally Works

    Using traditional portfolio diversification techniques, investors will often purchase a mixture of stocks and bonds to hold in their investment portfolio.

    They generally do this to protect or hedge against the risk of an economic downturn by holding bonds that will continue to pay interest, while at the same time still being able to profit from good economic times due to the probable appreciation of the equities they are holding.

    The primary disadvantage of using this strategy arises when economic conditions deteriorate and inflation eats into the investment currency’s value. When this happens, the bond interest received may not adequately compensate the investor for the loss of capital experienced on their equity investments.

    Adding a Currency Dimension to Your Portfolio

    Although Forex trading is certainly not the same as investing, those involved in investment management might wish to consider adding an extra diversification element to their portfolios in the form of using different currencies.

    Basically, given the volatility experienced in today’s relatively free floating forex market, investing in assets denominated in a foreign currency might well be something that could both enhance and protect a portfolio’s value.

    Furthermore, according to the goals of an investor, they could even choose attractive fixed income or equity assets from several different countries to add currency diversification and balance to their portfolio.

    An alternative for those who need to maintain all of their assets denominated in their local currency would be to exchange just the portion of the portfolio held in cash into a different currency. Ideally, they would choose to switch into a currency that would be expected to appreciate relative to their local currency and which may even provide a superior interest rate return on deposits.

    Investing in Currencies

    Since currencies can be looked at as the stock of a nation, investors could even elect to hold a diversified basket of currencies. This would allow them to invest in various nations that they expect to show superior growth rates and moderate inflationary pressures.

    In general, the currencies of countries which are growing well and offer higher interest rates and low inflation will tend to have a stronger currency that may well appreciate relative to the currencies of those countries that have weak economies, lower interest rates and higher inflation.

    For example, with U.S. growth flagging and its interest rates currently near zero, a U.S. based investor well might be inclined to consider alternative currencies to switching their U.S. Dollars into. Furthermore, Australia’s deposit market currently has interest rates of over four percent, and the Australian economy has shown much healthier signs of growth.

    Accordingly, the investor who switches from U.S. Dollars to Australian Dollars would benefit from an interest rate differential of roughly four percent on their cash. Also, provided that inflation remains under control in Australia, these factors should eventually lead to a higher exchange rate for the Australian Dollar versus the U.S. Dollar over time as an added investment incentive

    Forex Information Availability

    Because of the largely unregulated nature of the forex market and the fact that it involves national currencies, most information affecting the market is made available instantly worldwide. This provides a major advantage for forex traders.

    Also, this widespread information available in the forex market differs considerably from the way information is released that can affect individual stocks in the stock market.

    As a result, insider trading, as it is commonly understood in the stock market, does not really exist in the foreign exchange market.

    Read our previous article: Twenty-Four Hours Forex Trading

    Information Availability in the Forex Market

    Most of the information that affects the currency markets involves the release of economic data from different governmental sources in each currency’s home country.

    In addition to world current events, which tend to influence currency movements, forex traders also watch price charts and technical price indicators. Technical traders believe these analysis tools give them an edge when trading, and they can readily be obtained via software that has access to the Internet.

    A notable exception to the general openness of information available in the forex markets involves order flow. Generally, the only parties that are privy to large transactions occurring in the forex market are the two parties conducting it.

    The Internet Leveled the Playing Field Considerably

    With the exception of the aforementioned order flow data, the majority of forex traders obtain their market and economic information from the same sources. Essentially, news which influences the currency markets is now available to anyone with Internet access and the knowledge about how to obtain it.

    At the dawn of the modern electronic age and before the Internet had become widely available, technical price data and information feeds from companies such as Reuters and Telerate (Associated Press/Dow Jones) would cost a fortune that only banks and wealthy individuals could afford.

    Thankfully, the Internet has helped level the playing field in the forex market by bringing all of this information and the capability to trade the forex market to millions of individuals. Many of these people would not otherwise have been able to afford access to this huge market and its key information sources.

    How News Affects the Forex Market

    Most of the economic data and other information released by these sources are already anticipated by the various professional observers analyzing the economy. Nevertheless, news that differs significantly from the consensus expectation in the market can have a substantial impact on the forex market.

    For example, if the Gross Domestic Product or GDP for a nation came out at 1% when the market was expecting 2%, that would tend to provoke a sell off in that nation’s currency.

    Other currency pairs demonstrate notable sensitivities to the price of one or more commodities. For instance, a sharp increase in the price of crude oil would tend to produce a negative effect on the USD/CAD exchange rate. The reason for this involves the fact that Canada is a major exporter of oil to the United States, which is a net importer of oil.

    Read next: Few Profitable Currencies to Follow

    Twenty-Four Hours Forex Trading

    Among the numerous advantages that trading in the forex market offers, perhaps the most significant for many traders consists of the round the clock availability of forex trading during the five day business week.

    Specifically, forex trading opens the week in New Zealand on Sunday afternoon at 4 PM EST and then continues trading non-stop until Friday at 5 PM EST when the market closes for the weekend in New York.

    Basically, because different trading centers around the world operate on different time zones, and the forex market is global, the market can trade 24 hours a day. Accordingly, if you are a trader with workaholic tendencies, then trading the forex market might be just the right fit for you!

    The following sections cover various aspects related to forex trading times, and all times mentioned below will be expressed as U.S. Eastern Standard Time or EST for consistency.

    Time Table for World Forex Markets

    Forex trading begins each week with the opening of markets on Sunday in Auckland and Wellington, New Zealand at 4:00 PM. This is followed one hour later by the Sydney open at 5:00 PM. These markets stay open until 1:00 AM and 2:00 AM respectively.

    At 7:00 PM, the market in Tokyo opens, followed by Singapore and Hong Kong at 9:00 PM. Tokyo closes at 3:00 AM, while Hong Kong and Singapore close two hours later at 5:00 AM.

    The beginning of the European day begins at 2:00 AM, which is when the Frankfurt trading opens. The day in Tokyo then comes to a close at 3:00 AM as London is opening at the same time. London then closes at 11:00 AM.

    The European trading day overlaps with the United States beginning when Europe is in full swing at 8:00 AM and continues until London closes at 11:00 AM. Trading in New York then continues until 5:00 PM which brings us once again to the 4:00 PM opening time of New Zealand, followed by Australia at 5:00 PM.

    Overlapping Time Zones Increase Liquidity

    The periods when different world markets open simultaneously during the day can be the most liquid times to trade for some currency pairs. They also often provide the widest pip range in exchange rate moves from which a speculator can profit.

    Essentially, since higher liquidity and more volume tend to benefit speculative forex traders, these overlapping time frames in which trading is usually more active can give the trader an edge to increase profits.

    Less Liquid Forex Times to be Aware Of

    While the benefits of around-the-clock trading can seem obvious, certain trading times can be considerably less liquid than others. For example, the opening in New Zealand at 4:00 PM often results in a very thin market for an hour or so, at least until trading in Sydney, Australia gets active after 5:00 PM.

    Also, between the hours of 5:00 PM and 7:00 PM when Tokyo opens, the only markets open after the New York close are Chicago until 6:00 PM and some West Coast offices of large banks, as well as Sydney and New Zealand.

    Also, more caution should be observed when trading in the forex market on Sunday nights and bank holidays, since trading can often be thin during those times.

    Fridays can also present an issue for traders since the market generally moves countertrend as positions are squared ahead of the weekend. In addition, key economic numbers are often released on Fridays.

     

    Forex: The Most Traded Asset in the World

    As a whole, currencies make up the most actively traded assets in the world. Almost $6 trillion in different currencies change hands each day in the foreign exchange market, which has become the largest financial market on the planet.

    The forex market consists of many participants, some wishing to hedge foreign exchange risk for commercial ventures, while other participants trade the market with the sole intention of making a profit.

    Because of the enormous depth of the market and a large number of participants — including a growing number of retail forex traders — no other financial market can offer the profit-making possibilities of the forex market.

    Read our Previous Article: The Euro’s Rising Influence

    The Incomparable Size of the Forex Market

    As mentioned above, the daily turnover in the forex market approximates $6 trillion. This number surpasses the size of the international bond market by a factor of 10 and that of the international equity market by a factor of 50, according to some recent estimates.

    Because of this large size, and the fact that currency trading goes on continuously 24 hours, five days a week, trading in the forex market offers more opportunities than any other market in the world.

    Furthermore, trading in the forex market was once limited to large banks, multi-national enterprises, and high worth individuals. Nevertheless, with retail Internet forex brokers, anyone with a computer, an Internet connection and a small amount of money can now trade in the forex market.

    With a large number of participants in the forex market and the recent growth provided by the retail market, the resulting liquidity makes for even better trading conditions.

    Liquidity and its Benefits in the Forex Market

    One of the major reasons that the currencies traded in the forex market has become the most traded asset in the world is because of the high degree of liquidity generally seen in the forex market.

    In basic market terminology, the word liquidity refers to the ability to convert an asset into hard cash, as well as the amount of activity which occurs in an asset over a period of time.

    For example, the market for real estate would not fit the description of a liquid market. Essentially, owning real estate as an investment will not guarantee that you can liquidate the asset quickly since sometimes it can take years to liquidate real estate.

    A spot forex transaction, on the other hand, usually settles within two days of the transaction, and when trading the Canadian Dollar against the U.S. Dollar, spot trades settle in just one day.

    Some of the pricing advantages of liquidity consist of lower transaction costs and tighter bid/offer spreads. Also, high liquidity means that large transactions can be handled smoothly and it tends to ensure a more orderly market, with an absence of price vacuums which can cause extreme price swings.

    The Euro’s Rising Influence

    One of the most important events in the foreign exchange market over the last 25 years has been the consolidation of many of the former national currencies of Europe into the single currency of the European Monetary Union that is usually known as the Euro.

    The concept of a common currency for a united Europe to simplify transactions among European nations was an idea which had become popular among many corporations and residents of the European community.

    At first, various exchange rate regimes were attempted such as the currency snake and the European Exchange Rate Mechanism or ERM. Their eventual failure ultimately led to the development of the Euro which brought the 28 members European trading bloc much closer to having a single currency.

    Read our Previous Article: Understanding Reserve Currency

    How the European Union was Formed

    The EU or European Union has its roots in the European Community or EC founded in Rome in 1957. This led to the signing of the Maastricht Treaty enacted on November 1st, 1993.

    In 1995, Austria, Sweden, and Finland joined the European Union, followed by another ten nations in 2004. With Romania and Bulgaria joining in 2007, that brought the total number of member nations in the European Union to 27 countries.

    Having a combined population estimated at more than 500 million people, the European Union contributed approximately 28% of the nominal gross world product in 2009, amounting to over 16.5 trillion U.S. Dollars.

    The Euro as a Reserve Currency

    The Euro was released in Europe as an accounting currency in 1999, and a circulating currency in 2002. Since then, a growing number of national central banks have begun replacing the U.S. Dollar with the Euro as a reserve currency.

    A number of reasons behind this situation include the exorbitant U.S. government fiscal spending, seemingly endless wars fought overseas by the U.S. military, worsening U.S. trade and budget deficits and a real estate crisis to top it all off. Overall, these risk factors do not contribute to the safety of the U.S. Dollar as an investment, and central banks are increasingly acknowledging this.

    For these and other reasons, the Euro has become the number two reserve currency in the world, accounting for a total of 28% of global currency reserves as of 2009 and significantly increasing its influence.

    This is considerably higher than the nearly 18% of the global reserves the Euro made up when the currency was initially introduced in 1999. For comparison purposes, the same ten year time period saw U.S. Dollar reserves drop from 71% to 61% of global currency reserves.

    The Euro’s Influence on International Trade Increases

    Because of the United States’ status as a trading partner with many nations in the world, the U.S. Dollar has traditionally been held as the reserve currency of choice for many major U.S. trading partners.

    Nevertheless, as the further consolidation of the Eurozone progresses, many smaller countries that are non-members with strong commercial ties to European countries are considering pegging their regional currencies to the Euro.

    Even so, the U.S. Dollar continues being the primary currency for trading in key commodities such as crude oil and gold. Still, the Euro is increasingly becoming the currency which oil producing nations are favoring over the U.S. Dollar for transactions in oil.

    The move to the Euro on oil transactions would further hurt the Dollar’s status in favor of the Euro, and would very likely lead to an even further increase in the Euro’s overall influence in global financial markets.

    Understanding Reserve Currency

    In forex market terminology, a reserve currency consists of a currency held by a nation’s central bank set aside, or “in reserve”, for the purpose of paying international debts and for stabilizing or otherwise influencing the exchange rate of their own currency.

    Reserve currencies often also make up the accepted method of payment for key commodities such as crude oil and gold.

    Read our Previous Article: Forex Market Players – Know Types of Participants

    Although the U.S. clearly predominates as a reserve currency, accounting for over 60% of global reserves, other currencies are also commonly held in reserve.

    The primary currencies which governments hold in reserve in their central banks, listed in order of importance, are:

    • The U.S. Dollar
    • The E.U. Euro
    • The U.K. Pound Sterling
    • The Japanese Yen
    • The Swiss Franc

    Before being replaced by the Euro, the German Deutschmark and the French Franc were also held as reserve currencies.

    Why the U.S. Dollar is the Primary Global Reserve Currency

    Since the early part of the 20th century, the U.S. dollar has been the leading global reserve currency. In fact, many currencies were pegged to the Dollar because of the Dollar’s convertibility to gold since it was on the gold standard at that time.

    Near the end of the Second World War, the Dollar was the currency selected at the Bretton Woods conference to which all other major national currencies would be pegged, with gold fixed at $35 U.S. Dollars per ounce.

    This led to an era of relative global monetary stability until 1971, when then President Richard Nixon ended the Dollar’s convertibility to gold, effectively taking the U.S. Dollar off of the gold standard.

    The event heralded the arrival of the age of floating exchange rates for fiat currencies, i.e. paper currencies issued by governments that were backed by nothing but the faith and credit of the issuer.

    Despite the Dollar being taken off of the gold standard and serious problems with the U.S. economy and huge fiscal deficits, the U.S. Dollar continues benefiting from being the world’s number one reserve currency by having access to lower borrowing costs, for instance.

    The Rise of the Euro as a Reserve Currency

    As a result of the recent European sovereign debt crisis in 2009-2010, the beleaguered Euro has lost a considerable amount of its value against other currencies, prompting some central banks to cut down on their Euro holdings.

    Nevertheless, the Euro continues having avid supporters who often believe the Euro is due to become the world’s next primary reserve currency. Only time will tell if these supporters are right, although when the Euro was introduced in 1999 it made up only 17.9% of global reserves, compared to the 28.1% that it accounts for now.

    Compare this notable increase in Euro reserves to the corresponding fall in Dollar reserves, which declined from 70.9% of global reserves in 1999 to just 61.5% by 2009. Basically, it seems that the rise of the Euro as a reserve currency is now well underway.

    Read Next: The Euro’s Rising Influence

    Forex Market Players – Know The Types of Participants

    The huge forex market has several types of participants that vary considerably in their trading size, activity level and in their motivations for making foreign exchange transactions.

    These players range from the major banks and financial institutions that act as market makers in the Interbank forex market to the small personal traders who speculate online through retail forex brokers.

    The sections below discuss the main kinds of forex market participants, as well as why they typically get involved in trading forex.

    Read our Previous Article: When and Where Forex is Traded

    Financial Institutions

    The largest players in the foreign exchange market with respect to the volume transacted are major financial institutions like international commercial and investment banks.

    Overall, they account for more than 60% of all forex deals, and they deal and make markets to each other and to clients primarily in the Over the Counter Interbank forex market.

    The professional forex dealers who work for these institutions make trades on behalf of their employers, often also handling forex business and orders for the customers of the bank.

    International Corporations

    Large corporations doing business across international borders often have to take part in the forex market for a variety of commercial reasons, and they form a strong customer base for the financial institutions acting as forex market makers.

    Sometimes they make international acquisitions, need to bring back profits from a foreign subsidiary to their domestic head office or purchase their raw materials from an overseas source.

    The forex activities of corporations tend to fall into the category of hedging in which they aim to protect themselves against adverse foreign exchange rate movements with spot, forward and currency options transactions, as appropriate.

    Fund Managers

    These professional forex traders tend to fall into two main groups:

    The first group includes hedge fund managers who speculate on forex movements.

    The second group consists of investment fund managers that often require forex transactions to either make an investment denominated in a currency other than their own base currency or to repatriate the currency resulting from closing out such a foreign investment.

    Central Banks

    The central banks of major nations can take more or less active roles in managing their country’s currency, depending on their exchange rate policies.

    They can intervene in the currency market directly and publically, adjust reserves quietly or change benchmark interest rates. Due to their large size and official importance, all of these actions can influence the forex market substantially.

    Often, their public involvement in the forex market occurs at times of extreme movements for smoothing purposes to help maintain an orderly market or when substantial under or overvaluations in their national currency exist relative to historical rates.

    Interbank Forex Brokers

    In general, these professional forex market participants will act as intermediaries between Interbank forex traders working at major financial institutions.

    They feature the ability to obtain optimal pricing for clients in the currency pairs for which they provide such broking services, and they profit by charging their clients a small commission on every trade.

    Online Retail Forex Brokers

    These forex brokers take deposits from their clients and allow them to trade forex on margin via online trading platforms. Most of their business comes from personal forex speculators.

    They often profit by charging a commission on trades or by widening the bid/offer spread.

    Individuals

    Wealthy individuals have been able to trade forex through banks and futures exchanges for years, but forex trading has only recently become available to a much wider audience via online retail forex brokers.

    Although some individuals might require foreign currency for commercial transactions, most are involved in speculating on foreign exchange rates for profit.

    Read Next: Understanding Reserve Currency

    When and Where Forex is Traded

    A primary reason for the forex market’s popularity among retail forex traders is that it trades virtually around the clock during the usual work week.

    In essence, you can get a competitive quote on the active currency pairs from the Sydney open at 5 PM EST on Sunday until the New York close at 5 PM EST on Friday. Although the best times to trade forex tend to be when two major financial centers like Tokyo and London or London and New York are open.

    A significant advantage of this 24-hour forex trading is that you can leave a Good ‘Til Canceled or GTC order with your forex broker or bank. Such an order will then be worked overnight or even throughout the week until you request that it be disregarded.

    This significantly enhances your chances of being executed at your desired price, which is a good thing if the order involves taking profits at a better level than the prevailing market.

    Read our Previous Article: Forex Majors, Minors and Exotics Currencies

    When Forex Trades in the Major Financial Centers

    The forex trading day starts at 5 PM EST as the market opens in Sydney, Australia. Nevertheless, the start of this trading session can be quite thin and hence dealing spreads can widen and it may be easier for large traders to trigger stop-loss orders.

    Liquidity then grows significantly as Tokyo opens at 7 PM EST. Tokyo’s session subsequently overlaps with the forex market’s primary trading center of London between the hours of 3 AM EST when London opens and 4 AM EST when Tokyo closes.

    New York then opens at 8 AM EST. This starts a very active trading period for the forex market as the trading sessions of the major financial centers of New York and London overlap between the New York open at 8 AM EST and the London close at 12 Noon EST.

    New York then closes and hands off to Sydney at 5 PM EST, as another trading day begins in the forex market.

    Benefits of Trading During Overlapping Sessions

    Although the forex market trades around the clock, the forex market is most active when trading sessions for the major forex trading centers of London, New York, and Tokyo overlap.

    By having more than one major dealing center open simultaneously, the forex market generally sees a higher trading volume and an improved degree of liquidity that can include better-dealing spreads as market makers in both centers compete for business.

    Traders employing short-term dealing strategies like scalping or day trading will often have a better chance to profit during such highly liquid periods.

    Fewer Holidays in the Forex Market

    Although stock markets tend to subject to closure on bank holidays in the country in which they are located, the forex market observes far fewer holidays, and then usually only partially.

    Basically, when a bank holiday closes trading in one country due to a regional, religious or national holiday, other countries that do not celebrate that event often may not close down forex trading at all due to differing cultures.

    For example, Asian countries like Japan may be celebrating the Buddha’s birthday and take the day off, while the forex market will generally remain open in the United States, Australia, and Europe.

    Although trading may be thinned down somewhat and show tighter trading ranges during such partial holidays, you can generally still get a forex quote if necessary.

    Read Next: Forex Market Players – Know Types of Participants