Pips and pairs: forex trading comes to a screen near you
Phil Thornton takes a look at some of the new retail forex platforms out there
Just a decade ago, the closest that even the savviest investors came to foreign exchange trading was deciding when and where to buy foreign currency for their summer holiday.
Thanks to financial liberalisation and massive advances in technology, private investors can now embark on trading currencies as easily as they can with shares.
Making money out of money is popular for other reasons. The slump in equity and property prices has put a greater focus on currencies. At the same time heightened volatility has increased their attraction as an asset class.
Over the last 12 months, the euro has risen by some 17 per cent against the dollar with swings of 2-3 per cent along the way. Within emerging markets the moves can be even more extreme.
Global Market
More than £1.8 trillion is traded in the global foreign exchange markets every day, making it the largest financial market in the world and dwarfing the volumes on the equity and commodity markets. More than a third of that volume comes through London, which in turn has encouraged innovation among existing players and start-ups offering trading platforms. Unsurprisingly retail investors make up a tiny proportion of this vast daily flow of cash – less than 2 per cent according to one estimate.
But 2 per cent of £1.8 trillion is still £18bn a day and enough to attract competition. While there are specialists who are involved in forex trading between banks, such as Schneider, major banks such as Deutsche Bank via dbFX and Barclays Capital with BARX have a major presence in the retail market, while specialists include CMC Markets and Saxobank.
Because the forex market is an over-the-counter market with no centralised exchange, online brokers have been able to set up internet platforms, often without any dealing desk.
Competitive Market
The result has been a highly competitive market for both price and service. So called “newbie” traders need to shop around carefully as the package offered by each platform is made up of different elements.
The first is commission – and here is the first piece of good news. Unlike trades through stockbrokers, there are no dealing commission charges, exchange fees or other hidden fees.
Brokers make their profit out of a small percentage of the bid/ask spread – the difference between the buy and sell price. On the major currency pairs -euro/dollar, sterling/dollar, sterling/euro, dollar/yen and dollar/Swiss franc – the spread can be as low as one “pip”, where a pip is 0.0001 of the exchange rate.
For minors such as the Australian versus the New Zealand dollars the spread will be around 4 pips while for pairs including “exotics” such as the South African rand it can be much higher
This means that the smaller the spread, the smaller the gain in the exchange rate needed to pay back the charge, making it a good idea to go for brokers that offer the tightest spreads.
Tiny Margins
Another key feature of the forex market is leverage. Most brokers require only tiny margins to make a trade because the profit margins can be so small. If a broker requires only a 2 per cent margin, that means an investor needs to put up just £200 to open a position of £10,000.
FXSolutions, an online US broker that was bought by Britain’s City Index in February of this year, requires a margin of just 0.25 per cent, or 400 times leverage.
dbFX, Deutsche Bank’s online FX platform and one of the world’s largest foreign exchange banks, operates margins as low as 1 per cent with a minimum funding account of $5,000 (£2,565). It offers 34 major currency pairs with the bid/ask spread ranging from two pips for euro/dollar to 75 pips for a dollar/rand contract.
BARX, the forex platform run by Barclays Capital, offers trades in more than 50 currencies and 300 currency pairs. It separates itself from others by offering prices in a fifth decimal place or a tenth of a pip.
Saxobank offers 38 currencies and 150 pairs or crosses, which it says is more than any other online provider. Its spreads start at two pips. Meanwhile Oanda, a US-based platform, differentiates itself by allowing trades from as little as a dollar.
CMC Markets addresses that issue by running two platforms, for small and large investors. Spot FX trading using its contract for difference (CFD) platform is aimed at the semi-professional forex trader, looking to trade larger positions with a minimum of $10,000
The smaller investor can use its Spreadbet Forex facility, which requires a minimum of just £1 and which is denominated in sterling, even for trades such as the dollar/yen, so removing exchange rate risk, it says.
Investors also have to think about the execution system, which will determine how quickly the trade is settled. This can be particularly important on days when a piece of major economic news can move markets.
An important but technical aspect of a platform is what Tony Celentano, head of UK sales at E*TRADE Securities calls “order functionality”. These are tools such as stop loss, trailing stops (which lock in profit levels) and a limit order (to buy or sell at a certain price).
One-Click Trading
Celentano says it is vital that the system enables a trader to link all their positions. “You don’t want to worry about an order being filled but that another order has been left open”,” he says. “It should be one click trading.” Any investor new to a market should research it closely before risking their money. With FX this means understanding the foreign exchange market, which are the key currency pairs and what moves markets.
It is also important that the platform provider provides research and charting programmes to enable traders to track the market in real time. The one feature that most online platforms share is the ability to use a free trial version of its trading system using virtual money.
Betsy Waters, global director at dbFX, says that new investors should practice trading on a demo platform and get comfortable with the system and their own trading strategy before committing real money.
“Could you imagine an athlete going to the Olympic Games without preparation and training?” she asks.
Phil Thornton is lead consultant at research house Clarity Economics