Forex. What do you need to know?

Transcription

1 Forex What do you need to know?

2 Published by: Agencija za trg vrednostnih papirjev, Poljanski nasip 6, 1000 Ljubljana, Slovenia Published at: Year of publication: 2010

3 WHAT IS FOREX? The abbreviation FOREX (or shorter FX) literally means international exchange (FOReign EXchange). Initially, this term was used for interbank trading in foreign currencies. Such trading was at first carried out via telephone and fax connections between banks. With the spreading of information technology, the market started using a programme that gives immediate insight into developments on the currencies market. This programme is not a regulated market, but is merely intended for obtaining information on the supply and demand for currencies. It enables the users to see information for more than one hundred currency pairs. High-value transactions are performed on the interbank currency market (one standard trading lot equals the value of USD 1 million). This means that even minor changes in the exchange rate can result in significant gains or losses for the investor. As a rule, exchange rates are expressed with a figure rounded to four decimal places. In practice, this means that the return in the case of a change in exchange rate by , an investment of EUR 1 million would yield a return of EUR 100. These transactions always involve the exchange of one currency for another. A specific characteristic of the interbank foreign exchange market is that only banks and their intermediaries can participate. The interbank foreign exchange market is not a central market but a network of banks and their intermediaries. Interbank foreign exchange market transactions are transactions of exchanging one currency for another. Large companies, risk capital funds, pension and mutual funds and other entities able to trade in large quantities also access the interbank foreign exchange market through large intermediaries.

4 FOREX TRADING FOR SMALL INVESTORS With the growth of the Internet, the possibility of trading in foreign currencies also became available to small investors. Some banks or intermediaries have set up their own forex trading platforms in which small investors can trade in currency pairs (some platform managers also use the term FX crosses). The permissibility of trading, types of transactions and entities that these services can offer are regulated by national legislation. Even though forex market trading is advertised, a small investor shall, as a rule, only conclude deals with the managers of the forex trading platform. A trustworthy entity should be selected for dealing in FX instruments. The Securities Market Agency therefore advises investors not to give money to natural persons or transfer it to unknown bank accounts! Prudence is required so much more if they are dealing with suspicious websites or possibly even non-existent persons or entities. The virtual world is so much more convenient for fraud, since it only takes a few minutes to set up a website and then another few to erase it; it is often not possible to identify the owner of the website. TYPES OF FX DEALS The providers of forex trading platforms advertise forex deals for small investors, such as the so-called spot transactions, which are settled within two business days. It needs to be said that this expression covers all types of FX deals specified in the table below. A combination of different FX deals may give the impression that these are spot transactions.

5 FOREX DEALS: SPOT deals FORWARD deals (futures, forward) OPTION deals SWAP deals actual currency-for-currency exchange collateralisation against the FX risk FUTURES standardised forward contracts FORWARD non-standardised forward contracts collateralisation against the FX risk Swap contracts WHAT DOES FOREX FOR SMALL INVESTORS INCLUDE? Today, primarily the following services are offered to small investors under the term FOREX deal: - foreign exchange deals; - derivative FX instruments (swap and forward deals); - money chains (Ponzi schemes); 1 - collection of small investors funds with the aim of joint venture; - and other possible forms. WHAT DO WE HAVE TO PAY ATTENTION TO IN FOREX DEALS? Making contracts Officially, banks and intermediaries trading in currencies must have adequate authorisations for performing these deals. The Securities Market Agency recommends that the investor should only make business with those banks and intermediaries with adequate authorisations. 1 The essence of the money chains or Ponzi schemes is that money is generated within the chain and not through investments. In practice, new entrants in such chains finance others, higher in the chain, with their investments. Americans summarise the essence of these chains as rob one to pay out the other.

6 Financial leverage In the framework of forex deals, financial leverage deals are also offered that guarantee high profits on small amounts, but may also result in high losses for the investors. Leverage 100 means that we actually trade with 100 units if we subscribe 1 unit. The change in the price of the underlying financial instrument to which the derivative is linked is multiplied with the leverage. Thus, a seemingly minor change in the underlying instrument means a major loss in the event of large leverage. Deals involving financial leverage are high-risk deals and should be avoided by non-experienced investors, in spite of the high promised returns. Concluding FOREX deals The Securities Market Agency recommends that the investor obtain the following information prior to concluding forex deals 2 : I. Regarding the provider of services: - identity and principal activity of the provider, address of registered office or address at which the provider actually provides services, or contact address; - identity of the representative in the state of the investor, if such representative exists; - whether the investor actually does business with another entity than the provider, the identity of such entity, its activity, the legal position and address; - whether the investor is registered, the name of the register and its identification number; - whether the provider is subject to a system of authorisations, and the details of supervisory body. 2 This means that the provider must publish this information or deliver it to the investor.

7 II. Regarding financial services: - description of the main features of financial service; - the full price of the service to be paid by the investor and the method of calculating the price; - warning that the investments involve high risks and that data on past returns are not indicators of future returns; - whether there any other possible obligations to pay taxes and duties; - time limit of information validity; - activities related to settlement and execution of deals. III. Regarding the agreement: - notice of the investor s right to terminate the agreement with legal consequences and costs; - deadline for termination of agreement; - the right to terminate the agreement with the consequences of such termination; - practical information on the method of exercising the right to terminate the agreement; - provisions on the applicable law; - language of the agreement and communication during the term of the agreement. IV. Regarding damage compensation: - method of claiming compensation; - existence of potential guarantee schemes or funds. The Securities Market Agency recommends that investors should not conclude such deals if they do not understand the provider s explanations.

8 When concluding Forex deals, investors should in particular pay attention to: - the highest legally permissible leverage under the legislation applicable to the agreement; - who the actual party to this agreement is; - whether trading involves standardised instruments on the regulated market or the MTF 3 (for both, the operator needs the authorisation of the national supervisory body); - whether the underlying financial instrument actually exists and what the procedure for determining the value of this instrument for the needs of individual trading platforms is; - whether the actual payment represents the payment of the premium (for the insurance of trading range) or merely the payment of the bet; - who manages the settlement system through which the deal is to be settled and how this is done; - the method of netting deals. Some legal systems only enable netting between the same parties and not between different parties (important if one of the parties declares bankruptcy); - who supervises the operation of the trading platform. 3 MTF means Multilateral Trading Facility. It designates a system that combines the interests concerning the sale and purchase of financial instruments of many third parties in accordance with the predefined rules, by concluding legal transactions concerning the financial instrument. It comprises all organised automated systems of trading in financial instruments.

9 CONCLUSION In view of the complexity of forex deals and in particular the high risk arising from such deals, the Securities Market Agency recommends that investors be very prudent about the selection of contracting parties as well as the type of forex deals. INSTRUCTIONS FOR INVESTORS REGARDING FOREX INVESTMENTS: - obtain as much information as possible, including that on potential risks, - obtain as much information on the providers as possible, including past performance results and other investors experience, - demand written information and certificates from the provider, - do not invest more than you can afford to lose, - check the instrument you are actually trading in, - do not pledge your assets and savings for currency trading, - do not take out loans for high-risk investments. In view of the above, doing business with entities that hold a valid licence of the supervisory body is recommended. The list of entities authorised to provide investment services and deals in the Republic of Slovenia is published on the websites of the Securities Market Agency or the Bank of Slovenia. Avoid products you do not know, that seem to be complicated or are not traded on the regulated markets.