How did foreign currency exchange come about? The foreign exchange market that the retail currency trader knows today, has been shaped by a long history of global historical events. Consequently, studying the history of foreign currency exchange can be a lengthy and time consuming process. Although important for cultural and historical reasons, a detailed study of specific historical events like the Bretton Woods accord and the Smithsonian Agreement is not very useful for the modern foreign currency exchange trader. It is more important for a trader that is considering foreign currencies, to understand the logic behind foreign exchange as an efficient medium of exchange for goods and service.

The barter system was originally used by our ancestors as a means of exchange. Bartering was inefficient as an exchange mechanism because it required that a lot of time be spent in negotiation to strike a deal. Also, much time was needed to search for the goods required for bartering. The barter exchange system was eventually enhanced by the public acceptance of standardized sizes and grades of metals like gold, silver and bronze for the exchange of merchandise. This metal currency for exchange had many advantages including durability and storage. During the middle ages, a variety of paper IOU’s started gaining popularity as a medium of exchange.

Throughout the years, people began to realize that carrying around paper currency was a lot more advantageous than carrying heavy bags of precious metals. Consequently, stable governments eventually adopted paper currency and backed its value with gold reserves. This led to the birth of the gold standard. On July of 1944, the Bretton Woods Accord pegged the US Dollar to gold at a price of $35 per ounce. The Bretton Woods Accord also fixed other foreign currencies to the dollar. It lasted until 1971, when US president Nixon let the dollar “float” freely against other foreign currencies and suspended the conversion to gold.

As we fast forward to the present, the foreign currency exchange market has grown into the largest financial market in the world, with an aggregate daily volume of 1.5 trillion dollars or greater. Even though foreign exchange has traditionally been an institutional (Inter-Bank) market, the growth of the Internet has propelled online currency trading among private individuals to the stratosphere, widening the retail currency trading market considerably.

24-hour currency trading

Foreign exchange market trading occurs over a 24 hour period picking up in Asia around 23:00 GMT (6:00 PM EST) Sunday evening and coming to an end in the United States on Friday around 22:00 GMT (5:00 PM EST). So, whether it’s 6 PM or 6 AM, somewhere in the world there are buyers and sellers actively trading foreign currencies. Traders involved in currency trading can always respond to breaking news immediately.

Although after-hours trading in stocks can be achieved via ECNs (electronic communications networks) and in futures via electronic systems like Globex, the prices can be uncompetitive since the liquidity is often low. For foreign currency trading this is not the case. The currency trader can get tight spreads around the clock and can thus pick and choose whatever trading hours are the most convenient for him.

FREE Currency Trading Training

Register online with us and get free live training over the Internet. The training is conducted by professionals. Find out more about our free currency trading training.

Little money needed to start day trading currencies

Day trading currencies requires a lot less starting capital than day trading stocks. To day trade stocks a day trader needs at least $25,000 by US law, otherwise he is restricted in the number of daily transactions he can make. This restriction does not exist in the online currency trading market. You could open an account with us with $2,500 or more and get free online training live.

No Commissions

Online discount brokers typically charge anywhere from $5 to $30 a stock trade. Full-service brokers usually charge $100 or more for each stock transaction. Futures trades can be from $10 to $30 a round turn. Forex trading with Currency Trading USA is commission free. Thus, investors involved in foreign currency trading could limit the cost associated with trading. Currency Trading USA is compensated through the Bid/Ask spread..

Lower operation fees

To be a serious stock day trader, a person needs a direct access trading system. These systems can cost from about $250 to $400 or more a month. Currency trading can be done through a sophisticated online system for free. Our Currency Trading USA trading platform is top-of-the-line and has the same (or more) features that quality stock trading systems provide. The main difference is that our currency trading system is free.

Tighter Bid/Ask Spreads

If we compare our currency trading platform’s typical spread of 3 pips on a the EUR/USD currency pair to a stock transaction, we could see how online currency trading could offer tighter spreads than stocks. A 3 pip spread (0.0003) on 1 lot (100,000 per lot) is $30. If a stock trader trades a stock with an average price of $25 a share, he would have to trade 4,000 shares to reach the 100,000 value of one currency lot. Assuming the stock is very liquid, the spread would vary between 0.01 to 0.02 or more per share throughout the day. This is equivalent to $40 to $80 per transaction, much higher than for our currency trading example.

Low Margin Requirements

Our 100:1 margin (1%) requirement for foreign currency trading allows a trader to control $100,000 worth of currency for only $1,000. This is much higher than the requirement for stocks and futures. The typical requirement for stock trading is 2:1 and 15:1 for futures trading (Increasing leverage increases risk).

The substantial leverage available in the foreign currency market is essential because the average daily move of a major currency is less than 1%. While certainly not for everyone, the substantial leverage available from online currency trading may be useful to traders that employ a disciplined trading style with strict money management principles (High Leverage and low margin can magnify or lead to both substantial profits and losses).

Superior liquidity in the currency markets

The foreign currency trading market has a daily trading volume that is larger than that of all the world stock markets put together. This means that there are always currency broker/dealers willing to buy or sell currencies in the forex markets. Consequently, price stability is assured, especially for the major the major currencies. Currency traders can almost always open or close a position at a fair market price; a key advantage of currency trading.

Because the stock market and other exchange-traded markets only have a fraction of the volume of the currency market, these investors run a greater risk of having wide dealing spreads or large price fluctuations while trading.

No Limit up / limit down in the currency spot market

Under certain price conditions, the number and types of transactions that a futures trader can make are limited. The futures market restricts a trader from initiating new positions and only liquidating existing ones, if the price of a specific currency rises or falls beyond a specific predetermined daily level. This is an artificial way to control daily price volatility. This mechanism is meant to control daily price volatility, but since the futures currency market follows the spot currency market anyway, the next day the futures price can gap up or gap down to readjust to the spot price. In the foreign currency spot market these artificial restrictions are nonexistent, so the trader can trade freely without limitations, applying his trading strategy with stop losses to protect himself from unexpected price fluctuations caused by high volatility.

No short-selling restrictions in currency trading

There are no restrictions to sell currencies short, unlike stocks which have to be sold short on an Uptick rule. This means that with currency trading you can make money just as easily in rising and falling markets. This advantages is especially attractive to currency day traders who want might want to sell a currency short quickly, without any possibility of the trade being delayed by artificial means.

All of these advantages make currency trading superior to stock and futures trading in may ways.

24-hour currency trading

Foreign exchange market trading occurs over a 24 hour period picking up in Asia around 23:00 GMT (6:00 PM EST) Sunday evening and coming to an end in the United States on Friday around 22:00 GMT (5:00 PM EST). So, whether it’s 6 PM or 6 AM, somewhere in the world there are buyers and sellers actively trading foreign currencies. Traders involved in currency trading can always respond to breaking news immediately.

Although after-hours trading in stocks can be achieved via ECNs (electronic communications networks) and in futures via electronic systems like Globex, the prices can be uncompetitive since the liquidity is often low. For foreign currency trading this is not the case. The currency trader can get tight spreads around the clock and can thus pick and choose whatever trading hours are the most convenient for him.

FREE Currency Trading Training

Register online with us and get free live training over the Internet. The training is conducted by professionals. Find out more about our free currency trading training.

Little money needed to start day trading currencies

Day trading currencies requires a lot less starting capital than day trading stocks. To day trade stocks a day trader needs at least $25,000 by US law, otherwise he is restricted in the number of daily transactions he can make. This restriction does not exist in the online currency trading market. You could open an account with us with $2,500 or more and get free online training live.

No Commissions

Online discount brokers typically charge anywhere from $5 to $30 a stock trade. Full-service brokers usually charge $100 or more for each stock transaction. Futures trades can be from $10 to $30 a round turn. Forex trading with Currency Trading USA is commission free. Thus, investors involved in foreign currency trading could limit the cost associated with trading. Currency Trading USA is compensated through the Bid/Ask spread..

Lower operation fees

To be a serious stock day trader, a person needs a direct access trading system. These systems can cost from about $250 to $400 or more a month. Currency trading can be done through a sophisticated online system for free. Our Currency Trading USA trading platform is top-of-the-line and has the same (or more) features that quality stock trading systems provide. The main difference is that our currency trading system is free.

Tighter Bid/Ask Spreads

If we compare our currency trading platform’s typical spread of 3 pips on a the EUR/USD currency pair to a stock transaction, we could see how online currency trading could offer tighter spreads than stocks. A 3 pip spread (0.0003) on 1 lot (100,000 per lot) is $30. If a stock trader trades a stock with an average price of $25 a share, he would have to trade 4,000 shares to reach the 100,000 value of one currency lot. Assuming the stock is very liquid, the spread would vary between 0.01 to 0.02 or more per share throughout the day. This is equivalent to $40 to $80 per transaction, much higher than for our currency trading example.

Low Margin Requirements

Our 100:1 margin (1%) requirement for foreign currency trading allows a trader to control $100,000 worth of currency for only $1,000. This is much higher than the requirement for stocks and futures. The typical requirement for stock trading is 2:1 and 15:1 for futures trading (Increasing leverage increases risk).

The substantial leverage available in the foreign currency market is essential because the average daily move of a major currency is less than 1%. While certainly not for everyone, the substantial leverage available from online currency trading may be useful to traders that employ a disciplined trading style with strict money management principles (High Leverage and low margin can magnify or lead to both substantial profits and losses).

Superior liquidity in the currency markets

The foreign currency trading market has a daily trading volume that is larger than that of all the world stock markets put together. This means that there are always currency broker/dealers willing to buy or sell currencies in the forex markets. Consequently, price stability is assured, especially for the major the major currencies. Currency traders can almost always open or close a position at a fair market price; a key advantage of currency trading.

Because the stock market and other exchange-traded markets only have a fraction of the volume of the currency market, these investors run a greater risk of having wide dealing spreads or large price fluctuations while trading.

No Limit up / limit down in the currency spot market

Under certain price conditions, the number and types of transactions that a futures trader can make are limited. The futures market restricts a trader from initiating new positions and only liquidating existing ones, if the price of a specific currency rises or falls beyond a specific predetermined daily level. This is an artificial way to control daily price volatility. This mechanism is meant to control daily price volatility, but since the futures currency market follows the spot currency market anyway, the next day the futures price can gap up or gap down to readjust to the spot price. In the foreign currency spot market these artificial restrictions are nonexistent, so the trader can trade freely without limitations, applying his trading strategy with stop losses to protect himself from unexpected price fluctuations caused by high volatility.

No short-selling restrictions in currency trading

There are no restrictions to sell currencies short, unlike stocks which have to be sold short on an Uptick rule. This means that with currency trading you can make money just as easily in rising and falling markets. This advantages is especially attractive to currency day traders who want might want to sell a currency short quickly, without any possibility of the trade being delayed by artificial means.

All of these advantages make currency trading superior to stock and futures trading in may ways.

Granville said it best in his book, A Strategy of Daily Stock Market Timing:

“When it’s obvious to the public, it’s obviously wrong.”

Since we talk a lot about sentiment and contrarian sentiment, lets step back and review where this idea came from and how it developed from its origins.

Charles H. Dow
The main principle behind contrarian analysis and sentiment (two sides of the same coin) comes from Charles H. Dow’s work on distribution and accumulation. The same ideas that underpin the Dow Theory. I’m sure you’ll also notice the similarity between these ideas and Weinstein’s stage analysis which breaks up a movement of a security into four parts.

According to Dow Theory, major market movements start with an “accumulation” phase where insiders, and other knowledgeable traders or investors start to buy shares. Since at this point the average public sentiment towards the market is negative, they are able to accumulate shares without significantly pushing prices higher.

Eventually the general sentiment starts to tip as more and more people start to realize that something has changed. This is the stage at which trend followers jump on and start to push up prices further. The trend continues and feeds on itself, perpetuating until it reaches a crescendo.

At this point we reach “distribution”, the final phase of the trend where the reverse happens: insiders, institutions, or if you will, “smart” market participants begin to sell their holdings into a frenzy of indiscriminate public buying. Since a smaller number of players are in the know, their holdings must need be several magnitudes higher than the average retail participant.

This is why we see lopsided sentiment metrics. Since for every trade to occur, we need to have an equal number of shares bought and sold, if the minority are selling, then they must have the ability to supply the demand of the many who are buying (in a distribution phase). If we imagine, for instance, that 90% are bullish, then the average seller must be selling 10 times as large as the average buyer.

Garfield Albee Drew
In the 1940’s, Drew started to gather and study trading statistics from retail brokerage accounts and noticed that small traders or “odd lot” traders tended to sell when the market was bottoming and buy when it was topping. So he started to track odd lot trades on the NYSE and this now familiar metric was born.

I’ve mentioned this sentiment measure a few times before (Climbing the Wall of Worry). There is also the flip side: odd lot short sales ratio. But I suspect that the change in the market structure has eroded the usefulness of odd lot data. When Drew did his studies, odd lot volume was 15% of the NYSE, now it is less than 1%.

Drew garnered attention when he published “New Methods for Profit in the Stock Market” and later started an institutional service (for $95 a year back in the 1960’s) gaining thousands of clients.

Humphrey B. Neil

In 1954, Neil was arguably the first to introduce the concept of contrarian sentiment in his book: The Art of Contrary Thinking. Unfortunately, he didn’t really explain exactly what he meant, other than just doing the opposite of what others are doing.

Neither did he provide any quantitative methods for measuring sentiment to be able to not only put the ideas to the test, but to also come up with a framework that others could follow.

A. W. Cohen
The task of quantification began in 1963 when Cohen started to compile statistics on a number of market newsletters to aggregate their recommendations. It was Cohen who laid the groundwork for moving sentiment and contrarian analysis from vague generalities to hard numbers and metrics. He established a famous sentiment measure that is now known as Investor’s Ingelligence (by ChartCraft) – along with the AAII, the most watched weekly sentiment data.

Cohen began to compile the sentiment data monthly in January 1963. A year later it was measured twice a month and in 1969 it changed to the now familiar weekly frequency. Cohen’s work is now carried on by Michael Burke. Cohen, you may also remember, was the major force behind the popularization of point and figure charting (which has nebulous origins somewhere in the early 1900’s).

R. Earl Hadady
Hadady refined much of the previous work already mentioned, as well as that of his one time partner, J. H. Sibbet – whose most important contribution was weighing each newsletter according to its reach and audience. Hadady delineated methods for both quantitative and qualitative measure of contrary sentiment in his book. He is also the developer of a sentiment measure you’re probably familiar with: Bullish Consensus (now provided by Market Vane).

Although Bullish Consensus is known for its weekly sentiment data on the US equity market, they also track 36 commodity futures markets. Hadady has written other books (both on the market and other subjects) but “Contrary Opinion” remains his masterpiece.

Before becoming Market Vane, Hadady Corp. used to publish charts which plotted sentiment below the major market index. The chart for the S&P 500 Index for 1987 is a great example: on August 25th 1987, Bullish Consensus reached 70% – the critical optimistic level for the first time in the year. On October 20th 1987, Bullish Consensus fell to the critical pessimism level of 25%. Between those two dates, the market provided one of the blackest swans we have ever seen.

The shocking volatility of the 1987 market crash lead Hadady to conclude that weekly numbers were not enough so in late 1988 his company started to compile and disseminate daily Bullish Consensus data.

Granville said it best in his book, A Strategy of Daily Stock Market Timing:

“When it’s obvious to the public, it’s obviously wrong.”

Since we talk a lot about sentiment and contrarian sentiment, lets step back and review where this idea came from and how it developed from its origins.

Charles H. Dow
The main principle behind contrarian analysis and sentiment (two sides of the same coin) comes from Charles H. Dow’s work on distribution and accumulation. The same ideas that underpin the Dow Theory. I’m sure you’ll also notice the similarity between these ideas and Weinstein’s stage analysis which breaks up a movement of a security into four parts.

According to Dow Theory, major market movements start with an “accumulation” phase where insiders, and other knowledgeable traders or investors start to buy shares. Since at this point the average public sentiment towards the market is negative, they are able to accumulate shares without significantly pushing prices higher.

Eventually the general sentiment starts to tip as more and more people start to realize that something has changed. This is the stage at which trend followers jump on and start to push up prices further. The trend continues and feeds on itself, perpetuating until it reaches a crescendo.

At this point we reach “distribution”, the final phase of the trend where the reverse happens: insiders, institutions, or if you will, “smart” market participants begin to sell their holdings into a frenzy of indiscriminate public buying. Since a smaller number of players are in the know, their holdings must need be several magnitudes higher than the average retail participant.

This is why we see lopsided sentiment metrics. Since for every trade to occur, we need to have an equal number of shares bought and sold, if the minority are selling, then they must have the ability to supply the demand of the many who are buying (in a distribution phase). If we imagine, for instance, that 90% are bullish, then the average seller must be selling 10 times as large as the average buyer.

Garfield Albee Drew
In the 1940’s, Drew started to gather and study trading statistics from retail brokerage accounts and noticed that small traders or “odd lot” traders tended to sell when the market was bottoming and buy when it was topping. So he started to track odd lot trades on the NYSE and this now familiar metric was born.

I’ve mentioned this sentiment measure a few times before (Climbing the Wall of Worry). There is also the flip side: odd lot short sales ratio. But I suspect that the change in the market structure has eroded the usefulness of odd lot data. When Drew did his studies, odd lot volume was 15% of the NYSE, now it is less than 1%.

Drew garnered attention when he published “New Methods for Profit in the Stock Market” and later started an institutional service (for $95 a year back in the 1960’s) gaining thousands of clients.

Humphrey B. Neil

In 1954, Neil was arguably the first to introduce the concept of contrarian sentiment in his book: The Art of Contrary Thinking. Unfortunately, he didn’t really explain exactly what he meant, other than just doing the opposite of what others are doing.

Neither did he provide any quantitative methods for measuring sentiment to be able to not only put the ideas to the test, but to also come up with a framework that others could follow.

A. W. Cohen
The task of quantification began in 1963 when Cohen started to compile statistics on a number of market newsletters to aggregate their recommendations. It was Cohen who laid the groundwork for moving sentiment and contrarian analysis from vague generalities to hard numbers and metrics. He established a famous sentiment measure that is now known as Investor’s Ingelligence (by ChartCraft) – along with the AAII, the most watched weekly sentiment data.

Cohen began to compile the sentiment data monthly in January 1963. A year later it was measured twice a month and in 1969 it changed to the now familiar weekly frequency. Cohen’s work is now carried on by Michael Burke. Cohen, you may also remember, was the major force behind the popularization of point and figure charting (which has nebulous origins somewhere in the early 1900’s).

R. Earl Hadady
Hadady refined much of the previous work already mentioned, as well as that of his one time partner, J. H. Sibbet – whose most important contribution was weighing each newsletter according to its reach and audience. Hadady delineated methods for both quantitative and qualitative measure of contrary sentiment in his book. He is also the developer of a sentiment measure you’re probably familiar with: Bullish Consensus (now provided by Market Vane).

Although Bullish Consensus is known for its weekly sentiment data on the US equity market, they also track 36 commodity futures markets. Hadady has written other books (both on the market and other subjects) but “Contrary Opinion” remains his masterpiece.

Before becoming Market Vane, Hadady Corp. used to publish charts which plotted sentiment below the major market index. The chart for the S&P 500 Index for 1987 is a great example: on August 25th 1987, Bullish Consensus reached 70% – the critical optimistic level for the first time in the year. On October 20th 1987, Bullish Consensus fell to the critical pessimism level of 25%. Between those two dates, the market provided one of the blackest swans we have ever seen.

The shocking volatility of the 1987 market crash lead Hadady to conclude that weekly numbers were not enough so in late 1988 his company started to compile and disseminate daily Bullish Consensus data.