What is FX Trading?
FX is short for foreign exchange (or forex) and refers to currencies. Foreign exchange is the act of converting the currency of one country to the currency of another.
The aim of FX trading is to make a profit by predicting the movement in the relative value of two currencies.
In FX trading, currencies are quoted in pairs such as USD/AUD – U.S. dollar compared to Australian dollar.
ASIC’s MoneySmart website describes foreign exchange trading as very risky because:
- There are significant investment risks as currency fluctuations may move against you, causing you to lose money. Exchange rates are very volatile – they tend to move around a lot even within very short periods of time.
- Markets are open 24 hours a day, 6 days a week (due to time zones), so you need to devote a lot of time to tracking your investment
- Currency markets are extremely difficult to predict because so many factors affect exchange rates
- Because most FX products are highly leveraged, even small market movements can have a big impact
- Risk management systems such as stop loss orders, will only give you limited protection by capping your losses. You may have to pay a premium price to guarantee your stop loss order.
Where can you trade FX?
The table below is a list of Australian providers offering FX trading.
Canstar does not rate these providers for FX trading capability.
|Minimum amount to open account||Minimum Spreads for major currencies||Minimum Trade Size||Link to provider website|
|IG||$0||0.6 – 1.5 bps||1 lot||Visit website|
|Pepperstone||US$200||0.0 – 0.1 bps||0.01 lots||Visit website|
|CMC Markets||$0||0.7 – 1.5 bps||0.01 lots||Visit website|
|Saxo Capital Markets||AU$3000||0.6 – 1.1 bps||5000 units||Visit website|
|FP Markets||AU$100||From 0.0bps||0.01 lots||Visit website|
|Vantage FX||AU$200||0.0bps – 1.0bps||0.01 lots||–|
|TradeDirect 365||$0||0.8 – 3.0bps||0.1 lots||Visit website|
|FXCM||AU$50||0.1-2.1 bps||0.1 lots||Visit website|
What FX strategies are there?
Making a call on which way a currency might move can be based on fundamental analysis or technical analysis. Fundamental analysis is a strategy used to evaluate a security, in this case a currency, by examining the overall economic and financial factors. Technical analysis, on the other hand, examines the actual history of trading activity and the price of a security.
Due to the high volume of trades and different time zones around the world, foreign exchange markets generally trade 24 hours a day, six days a week. This means that conversion rates fluctuate constantly. Most FX traders tend to trade over short periods, generally hours or days, as they are looking to profit from short term fluctuations. However, some take long term positions, trading instead over weeks or months.
Monitoring trades overnight can be difficult, so a common strategy is to only run intra-day trades, where all positions are closed out at the day’s end.
What is leverage?
FX trading is a form of leveraged investing, meaning the cash outlay can be much smaller than the actual value of the trade. In FX trading, your outlay will typically be anywhere from 0.5% – 5% of the transaction value. The volume of leveraging allowed is set by the trading platform you choose to use.
Leveraging can multiply the gains achieved, but conversely it can also magnify losses incurred.
Case study: How FX Trading can work
For this example, the currencies chosen are the Australian dollar (AUD) and the US dollar (USD). The exchange rate for these can be expressed as AUD/USD (how much USD you get for each AUD) or USD/AUD (how much AUD you get for each USD). In Australia, the AUD/USD rate is typically quoted and that is what is used here.
In addition, the assumption is made that the trading platform you use provides 1:50 leverage. That means that using an AUD$1,000 of your own money allows you to trade a value of AUD$50,000. The reason the initial cash outlay is only $1,000 is because you are effectively borrowing the other 95%.
The strategy demonstrated here is a ‘long strategy’, or ‘going long’. You are effectively betting that the AUD will depreciate against the USD.
At the start of the day, the AUD/USD exchange rate is 0.775 (reflecting that AUD$1 can buy USD$0.775).
Using the available leverage, you use AUD$50,000 to purchase USD$38,750 (AUD$50,000 x 0.775).
During the trading day the AUD/USD exchange rate moves to 0.767, a 1% change.
At that exchange rate you exchange from USD back to AUD. So, USD$38,750 / 0.767, returning AUD$50,521.
The profit from this trade would be $521, based on risking $1,000 of your own money.
Conversely, if the exchange rate had moved in the opposite direction by the same magnitude, you would have experienced a loss of $521.
It is important to note, that by engaging in leveraged trading like this, you are risking more than just your own $1,000. For example, if your AU$50,000 investment in USD is only worth AU$30,000 by the time you convert it back, you will owe a lot more money than you put in.
Admittedly, this may not be very likely in the short term if you stick to major currencies, but it is still a possibility.
Costs involved with FX Trading
Most trading platforms will charge a commission for every trade made. These fees, where charged, are typically a few cents per thousand dollars.
The other major fee to consider is the spread. This is the difference between the buy and sell price a platform charges on each trade. A tight spread, or the closer these two prices are, the lower the cost to you.
Platforms that do not charge commission can at times have wider spreads to compensate.
Setting up an account
Setting up an account to trade FX is generally an easy process. You will need to provide standard personal details such as name, DOB, contact details, address, country of residence, and proof of ID, such as a driver’s licence or passport.
Platforms will then notify you once your account has been established.