Forex Market Overview

The Market

The foreign exchange market (Forex or FX) is the largest financial market in the world with an estimated daily trading volume of $2 trillion dollars (NYSE’s 2003 total dollar value of reported volume equaled $9.6 trillion and $10.2 trillion for all of 2002). Unlike other financial markets, the Forex market has no physical location and no central exchange. The Forex market operates 24 hours a day through an electronic network of banks, corporations and individual traders. Forex trading begins every day in Sydney , moves to Tokyo , followed by London and then New York . The participants in this market include central banks, commercial banks, investment banks, securities dealers, pension funds, insurance companies, multinational corporations and sophisticated individuals.

Forex Trading vs. Equities and Futures Trading

The buying and selling of foreign exchange provides significant advantages over equities and futures. In addition to these advantages, the seamless 24 hour nature of the trading market gives traders the unique advantages of reacting to news and worldwide developments instantaneously, participating in real-time trading in the largest market in the world.

Ability to Profit in the Rising or Declining Markets

Unlike equity and fixed income managers, Forex traders are able to profit under any market conditions by either buying or selling a particular currency in relationship to another. In the Foreign Exchange market there always be one currency strengthening against another, unlike stock shares that move only up or down.

High Leverage Provides Opportunity to Substantial Return

High leverage is the most attractive feature in Forex Trading. 100:1 Leverage allows the traders to enhance their profit by 100 times. For example; US$1000 deposit guarantees a position of US$100,000; for EURUSD, a change 0f 0.0100 (one cent) in the right direction will gain a profit of US$1000, a 100% return.

Certainly, high leverage can cost high damage to your capital as well; if the position goes in the wrong direction for a 0.0100(one cent), you also suffer lose of US$1000.

As a conclusion, Forex Trading is a performance sport car; it requires skill and training to master the driving. Skill drivers could enjoy the performance while the novices may crash easily.   

From experience of working in the Foreign Exchange markets few individuals tend to have the training, skill, patience or inclination to trade on their own successfully. The basic idea behind this type of trading then is to open or join a Foreign Exchange Fund and let an experienced manager trade funds in the foreign exchange market.

This allows a broader spectrum of the public to participate and also gives them the advantage of portfolio diversification.

There is a compelling argument for the inclusion of currency funds in a traditional investment portfolio. Currency funds can offer enhanced portfolio performance under all market conditions. It is the manager’s flexibility and skill-based strategies that make this investment class inherently attractive. This said, a strong case may be made for the investor to learn as much about the industry as they reasonably can in order to more effectively monitor their situation.

Forex MarginTrading only exists for couple decades. The legislations and regulations on Forex Margin Trading are relatively immature by comparing with equity trading or future trading. Forex Market by its nature also contributes many difficulties and restrictions on legislation and regulation developments. Two major characteristics of Forex market are the major concerns:

1. As Forex Market is a Global Market, legislations and regulations require mutual agreements of many countries involved.

2. Forex Market is an OTC (over-the-counter) market and there is no central exchange to process the transactions clearing.

Due to its nature and other various factors, Forex brokerages are mostly under-regulated or even non-regulated in many countries. However, as Forex trading being more and more popular, some countries have already amended to their regulations or enhanced their existing regulatory systems to govern the Forex Brokerages and Forex MarginTrading.

To secure investors’ fund, many countries’ regulatory authorities raise the Forex brokerage’s operating capital requirements dramatically; some also requires the Forex brokerages to obtain banking licence which means even more operating capital required and extending regulations applied.

Here, we review some of the most popular regulatory authorities who govern the Forex MarginTrading and Forex brokerages of their countries.

United States of America – CFTC/NFA

There are two relevant regulatory authorities in America, one is CFTC (Commodity Futures Trading Commission – CFTC), and the other is NFA (National Futures Association– NFA). CFTC is an independent federal authority which was established by Congress based on the modified “Commodity Trading Act” in 1975. Its major duties are to govern the operation of Futures and Options market and protect the interests of investors. Generally, CFTC is responsible for regulating the market and assigning part of its duties to NFA and the exchange at the same time. NFA is self-regulatory authority of Future and Option industry, its operation expenses are covered by member fees. It is responsible for performing regular auditing on the registered institutions, carrying out the professional ethics standard and protecting investors’ interests and interceding disputes between investors and institutions.

For further regulating financial derivative market, especially the Forex derivative market which including Forex Future and Option margin trading markets), Congress modified the rules in CEA, and extended the regulatory arm. The new Act is called “Commodity Future Modernization Act and it was being implemented in 2001. At the same time, CFTC and NFA were also extending their regulatory arm to cover the regulation on Forex market. According to the Act/rules, if a firm wants to carry out Forex business, it has to register with NFA and become “Future Commodity Merchants” or “Forex Dealer Merchants” and receive strict regular supervision on its financial conditions. If the firm is getting out of line, the authorities have the right to choose to freeze its assets or penalty the brokerage with a fine accordingly. In this way, the investors are protected in a great extent.

Hong Kong - SFC

The Securities and Futures Commission (SFC) is an independent statutory body established by the Securities and Futures Commission Ordinance (SFCO). The SFCO and nine other securities and futures related ordinances were consolidated into the Securities and Futures Ordinance (SFO), which came into operation on 1 April 2003. The statutory regulatory objectives as set out in the SFO are:

In 1994, SFC made a specific ordinance on Forex margin trading which is called “Leverage Foreign Exchange Trading Ordinance under Securities and Futures Ordinance”. The ordinance has clarified the requirements (including quick asset and overall capital) for firms to carry out Forex margin trading business. If a firm wants to do the relevant business, it has to be licensed based on the requirements and under strict SFC regulation. According to code23 of the ordinance, leveraged Forex dealers are required to open and maintain independent trust accounts to deposit clients’ funds, every account should be pointed as the trust account, and they should be open at the regulated/licensed institutions. As the trust accounts are held by third party who is independent from Forex broker dealers, in this case, clients’ funds would be well protected.

Britain - FSA

The Financial Services Authority (FSA) is an independent non-governmental body, given statutory powers by the Financial Services and Markets Act 2000. It is funded entirely by the firms it regulates. The FSA is an open and transparent organization and provides full information for firms, consumers and others about its objectives, plans, policies and rules. It sets industrial standard and requires the regulated financial institutions to obey the standard. If they are getting out of line, FSA has the right to ask them to pay penalty to the clients. The “Financial Services and Markets Act give four statutory objectives:

“Financial Service and Markets Act 2000”prescribes that FSA is the only regulatory authority that regulates securities market, option market, money market and Forex market in The Act regards financial derivatives (including Forex derivatives) as one of the investment business. According to the relevant regulations on investment business, there are 3 key regulatory rules for financial derivatives: 1. Registration/licensing; 2. Performing durative regulations on the firms’ operating capitals, financial statements, clients’ funds; 3. Carrying out internal control regulations on the firms so as to prevent them from money laundering with the tools of financial derivative.

Switzerland - FDF

As being the world’s financial center, Switzerland is famous for its competitive financial system. Currently the world’s largest banks and financial institutions are all found in the country. What’s more, the registered institutions are now managing over 35% of personal asset in the world. The reason why Swiss financial industry can attract investors worldwide is that it has an open, active, mature and strict regulatory environment which benefits the investors to a greater extent.

Federal Department of Finance is a government authority. It regulates the financial intermediaries based on the “Swiss Federal Law”. All the registered financial intermediaries are required to follow a set of strict bylaws and procedures so as to sustain high level of industry standard and credit standing.

There is no specific bylaw in SFL that governs Forex margin trading. However, broker dealers that are doing Forex business are all being regarded as financial intermediaries and govern by FDF based on SFL. All the intermediaries that provide financial products and services must register with FDF and pass through all the strict checking procedures. The authority conducts regular finance auditing to the intermediaries. If their operating capitals are less than 50% of the initial capitals, the authority would terminate their businesses according to the law unless flesh capitals are being injected. Also introduces anti-money laundering Act. The Act requires all the financial intermediaries truly disclosure clients’ detailed information and the sources of funds. Such transparent regulation acts as a safeguard to the clients as well. The self-regulatory authority ARIF performs the duty assigned by Anti-Money Laundering Control Authority; all the ARIF registered members should strictly fulfill the obligation of disclosure.

Recently, FDF requires all Forex brokerage to obtain banking license and operate under the Swiss banking regulations.

In addition to above mentioned countries and areas, Canada and Australia and other countries also have mature and complete financial regulatory systems. However, the regulatory authorities in most of the countries and areas haven’t clearly covered the regulation on Forex margin trading. The brokers who provide relevant business are just being regulated under general rules. Therefore, for better security of your trading capitals, it is wise to choose those Forex brokerages registered in those highly regulated countries.