A number of firms are presently offering off-exchange foreign currency transactions to investors. If you are a retail investor considering participating in this market, you need to fully understand the market and some of its unique features. This website does not suggest weather you should or should not participate in the retail off-exchange foreign currency market. You should make that decision after consulting with your financial advisor and considering your own financial situation and objectives. Kerford’s effort in this page is to give perspectives on broad aspects of Forex to be considered in order to make an informed decision.
The Concept
Companies and inh2iduals may speculate in foreign currency exchange rates (commonly referred to as “Forex”).
As the value of one currency rises or falls relative to another, traders decide to buy or sell currencies to make profits. Retail customers also participate in the Forex market, generally as speculators who are hoping to profit from changes in currency rates.
Off-exchange Forex Market
The off-exchange Forex market is a large, growing and liquid financial market that operates 24 hours a day. It is not a market in the traditional sense because there is no central trading location or “exchange.” Most of the trading is conducted by telephone or through electronic trading networks. The primary market for currencies is the “interbank market” where banks, insurance companies, large corporations and other large financial institutions manage the risks associated with fluctuations in currency rates. The true interbank market is only available to institutions that trade in large quantities and have a very high net worth.
In recent years, a secondary OTC market has developed that permits retail investors to participate in Forex transactions. While this secondary market does not provide the same prices as the interbank market, it does have many of the same characteristics.
Currency pairs quote
Currency pairs are often quoted as bid-ask spreads. The first part of the quote is the amount of the quote currency you will receive in exchange for one unit of the base currency (the bid price) and the second part of the quote is the amount of the quote currency you must spend for one unit of the base currency (the ask or offer price).
Forex transactions are quoted in pairs because you are buying one currency while selling another. The first currency is the base currency and the second currency is the quote currency. The price, or rate, that is quoted is the amount of the second currency required to purchase one unit of the first currency. For example, if EUR/USD has an ask price of 1.2178, you can buy one Euro for 1.2178 US dollars.
The standard symbols
Currencies are designated by three letter symbols. The standard symbols for some of the most commonly traded currencies are:
- EUR Euros
- USD United States dollar
- CAD Canadian dollar
- GBP British pound
- JPY Japanese yen
- AUD Australian dollar
- CHF Swiss franc
Offsetting or liquidating transaction
Retail Forex transactions are normally closed out by entering into an equal but opposite transaction with the dealer. For example, if you bought Euros with U.S. dollars, you would close out the trade by selling Euros for U.S. dollars. This is also called an offsetting or liquidating transaction.
Service charges
There are no rules about how dealer charges a customer for the services the dealer provides or that limit how much the dealer can charge. Before opening an account, you should check with several dealers and compare their charges as well as their services.
If you were solicited by or place your trades through someone other than the dealer, or if your account is managed by someone, you may be charged a separate amount for the third party’s services.
Some firms charge a per trade commission, while other firms charge a mark-up by widening the spread between the bid and ask prices they give their customers.
In the earlier example, assume that the dealer can get a EUR/USD spread of 1.2173/75 from a bank. If the dealer widens the spread to 1.2170/78 for its customers, the dealer has marked up the spread by .0003 on each side. Some firms may charge both a commission and a mark-up. Firms may also charge a different mark-up for buying the base currency than for selling it. You should read your agreement with the dealer carefully and be sure you understand how the firm will charge you for your trades.
Rollover terms
Most retail Forex transactions have a settlement date when the currencies are due to be delivered. If you want to keep your position open beyond the settlement date, you must roll the position over to the next settlement date. Some dealers roll open positions over automatically, while other dealers may require you to request the rollover. Most dealers charge a rollover fee based upon the interest rate differential between the two currencies in the pair. You should check your agreement with the dealer to see what, if anything, you must do to roll a position over and what fees you will pay for the rollover.
Account size and security deposits
Kerford has set its own minimum account sizes based on investment experience, so you will have to ask how much money you must put up to begin trading. Most dealers will also require you to have a certain amount of money in your account for each transaction. This security deposit, sometimes called margin, is a percentage of the transaction value and may be different for different currencies. A security deposit acts as a performance bond and is not a down payment or partial payment for the transaction.
Kerford guarantees that you will not lose more than you invest, which includes both the initial deposit and any subsequent deposits to keep the position open. Other dealers may charge you for losses that are greater than that amount.
Leverage a double edged sword
Security deposits allow customers to control transactions with a value many times larger than the funds in their accounts. In this example, $1,217.80 would control $121,780 worth of Euros.
Value of Euros = $1.2178 X 100,000= $121,780
This ability to control a large amount of one currency, in this case the Euro, using a very small percentage of its value is called leverage or gearing. In our example, the leverage is 100:1 because the security deposit controls Euros worth 100 times the amount of the deposit.
Since leverage allows you to control large amounts of currency for a very small amount, it magnifies the percentage amount of your profits and losses. A profit or loss of $1,217.80 on the Euro trans-action is 1% of the full price (with leverage of 1:1) but is 100% of the 1% security deposit. The dollar amount of profits and losses does not change with leverage, however. The profit or loss is $1,217.80 whether the leverage is 100:1 or 25:1 or 1:1.
The higher the leverage, the more likely you are to lose your entire investment if exchange rates go down when you expect them to go up (or go up when you expect them to go down).
Market movements
No one can predict with certainty which way exchange rates will go, and the Forex market is volatile. Fluctuations in the foreign exchange rate between the time you place the trade and the time you close it out will affect the price of your Forex contract and the potential profit and losses relating to it.
Lack of a central marketplace
Unlike regulated futures exchanges, in the retail off-exchange Forex market there is no central marketplace with many buyers and sellers. The Forex dealer determines the execution price, so you are relying on the dealer’s integrity for a fair price.
Understand the language
You should also understand the language of the Forex markets before trading in those markets.
A retail customer trades directly with a counterparty and there is no exchange or central clearing house to support the transaction. Off-exchange trading is subject to limited regulatory oversight.
High level of risk
Off-exchange foreign currency trading carries a high level of risk and may not be suitable for all investors. In fact, you could lose all of your initial investment. Therefore, you need to understand the risks associated with this product so you may make an informed investment decision.
Understand risk
Although every investment involves some risk, the risk of loss in trading off-exchange Forex transactions can be substantial. Therefore, if you are considering participating in this market, you should understand some of the risks associated with this product so you can make an informed decision before investing. You are relying on the dealer’s creditworthiness and reputation
The trading system could fail
If you are using an Internet-based or other electronic system to place trades, some part of the system could fail. In the event of a system failure, it is possible that, for a certain time period, you may not be able to enter new orders, execute existing orders, or modify or cancel orders that were previously entered. A system failure may also result in loss of orders or order priority. You are relying on the dealer’s integrity for a fair price.
Victim of fraud
As with any investment, you should protect yourself from fraud. Beware of investment schemes that promise significant returns with little risk. You should take a close and cautious look at the investment offer itself and continue to monitor any investment you do make.
Non affiliated firms
Unlike Forex dealers, firms and individuals that solicit retail accounts for Forex dealers and manage those accounts do not have to be regulated or affiliated with a regulated firm. Therefore, you should find out if the person’s Forex activities are regulated and by whom. If the person is not regulated, you may be exposed to additional risks.
Rights and obligations
Your relationship with your dealer is governed by your Forex account agreement. Just as you wouldn’t consider buying a house or a car without carefully reading and understanding the terms of the contract, neither should you establish a Forex account with-out first reading and understanding the Account Agreement and all other documents supplied by your dealer. You should know your rights, responsibilities and the firm’s obligations before you enter into any Forex transaction. If you have questions about the Agreement, don’t hesitate to ask.
