Functions of the Forex Market

The foreign exchange market is not really a source of corporate finance. Rather, it facilitates corporate financial activities and international transactions. Investor use the foreign exchange market for four main reasons.

1. Currency conversion. Companies use the foreign exchange market to convert one currency into another. Suppose a Malaysian company sells a large number of computers to a customer in France. The French customer wants to pay for the computers in euros, the  European Union currency, whereas the Malaysian company wants to be paid in its own ringgit. Ho do the two parties resolve this dilemma? They turn to banks to exchange the currencies for them. Companies also must convert to local currencies hen they undertake foreign direct investment. later, hen a firm’s international subsidiary earns a profit and the company wants to return some of it to the home country, it must convert the local money into the home currency.
2. Currency Hedging. The practice of insuring against potential losses that result from adverse changes in exchange rates is called Currency hedging. International companies commonly use hedging for one or two purposes: (1) to lessen the risk associated with international transfers of funds  (2) To protect themselves in credit transactions in which there is a time lag between billing and receipt of payment.
3. Currency Arbitrage, is the instantaneous purchase and sale of a currency in different markets for profit. For example, assume that a currency trader in New York notices that the value of the European Union euro is lower in Tokyo than in New York. The trader can buy euros in Tokyo, sell them in New york, and earn a profit on the difference. High tech communication and trading system allow the entire transaction to occur within second. But if the difference between the value of the euro in Tokyo and the value of the euro in New York is not greater than the cost of conducting the transaction, the trade is not wort making.  Currency arbitrage is a common activity among experienced traders of foreign exchange, very large investors, and companies in the arbitrage business.Firms hose profits are generated primarily by another economic activity, such as retailing or manufacturing, take part in currency arbitrage only if they have large sums of cash on hand.
4. Currency Speculation, is the purchase or sale of a currency with the expectation that its  value will change and generate a profit. The shift in value might be expected to occur suddenly or over a longer period. The foreign exchange trader may bet that a currency’s price will go either up or down in the future. Suppose a trader in London believes that the Japanese yen will increase over the next three months. She buys yen with pounds at today’s current price, intending to sell them in 90 days. If the price of yen rises in that time, she earns a profit; if it falls, she takes a loss. Speculation is much riskier than arbitrage because the value, or price, of currencies is quite volatile and i affected by many factors. similar to arbitrage, currency speculation is commonly the realm of foreign exchange specialists rather than the managers of firms engaged in other endeavors.

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From http://hikamirzan.com/functions-of-the-forex-market/

Basic Guidelines for Trading Forex, commodity, and stock index

Plan your trade and trade with plan: You must have a trading plan to succeed. A trading plan should consist of a position, why you enter, stop loss point, exit the target, plus the strong money management strategy. A good plan will remove all the emotions from your trades.

• Trend is your friend: Do not fight the trend. If the market is bullish,you must take long position. Conversely, if the market is bearish, you must open short position. Do not fight the trend.

• Focus on keeping capital: This is the most important step you should take when dealing with your trading capital. Your main objective is to preserve capital. Do not trade more than 10% of your deposit in a single trade. For example, if your total deposit is $ 10,000, every trade should be limited to $ 1,000. If you do not do this, you will exit the market in a short time.

• Know when to cut your losses: If the trade goes against you, sell and let. Do not insist on poor trading and hope that the price will rise. You most likely end up losing more money. Before you open a transaction, set your stop loss price, the price at which you should sell when the trade turns unfavorable. It depends on your risk profile how much you need to set a stop loss.

• Take advantage when trading well: Before entering the transaction set how much profit you want to take.If the trade turns out to be good, take advantage. You can take all the profits or take advantage gradually. When you have earned your trading cost, you have nothing to lose. Sit quietly and watch the movement of profits.

• Without Emotion: Two biggest emotions in trading: greed and fear. Do not let greed and fear influence your trading. Trading is a mechanical process and it was not for the emotional. As said Dr. Alexander Elder in his book “Trading for Living”, if you sit next to a successful trader and observe, you may not be able to tell whether he earns or loses money. That’s the emotional stability of a successful trader.

• Do not trade if you only based on tips from others: You can trade only if you have done your own research or analysis. You should be a trader who has understanding.

• Make a trading journal: When you buy a market instrument, write down the reasons why you buy and how you feel at that time. Do the same when you sell. Analysis and write down the mistakes you make, and the things you’ve done it right. With reference to the trading journal, you learn from your past mistakes. Correcting your mistakes, continue to learn and continue to improve.

•  When you doubt, do not trade: If you have doubts and are not sure where the trend of the market, remains outside. Sometimes, doing nothing is the best thing to do.

• Do not over trade: Ideally you should have 3-5 positions at a time. Not more than that. If you have too many positions, you will tend to be out of control and make emotional decisions when there is a change in the market. Do not trade for the sake of trade.

(From: http://hikamirzan.com) 

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