The Foreign Exchange market, also referred to as the "Forex" or "FX" market is the largest financial market in the world, with a daily average turnover of well over US$1 trillion -- 30 times larger than the combined volume of all U.S. equity markets.
"Foreign Exchange" is the simultaneous buying of one currency and selling of another. Currencies are traded in pairs, for example Euro/US Dollar (EUR/USD) or US Dollar/Japanese Yen (USD/JPY).
There are two reasons to buy and sell currencies. About 5% of daily turnover is from companies and governments that buy or sell products and services in a foreign country or must convert profits made in foreign currencies into their domestic currency.
The other 95% is trading for profit, or speculation.
For speculators, the best trading opportunities are with the most commonly traded (and therefore most liquid) currencies, called "the Majors."
Today, more than 85% of all daily transactions involve trading of the Majors, which include the US Dollar, Japanese Yen, Euro, British Pound, Swiss Franc, Canadian Dollar and Australian Dollar.
A true 24-hour market, Forex trading begins each day in Sydney, and moves around the globe as the business day begins in each financial center, first to Tokyo, London, and New York.
Unlike any other financial market, investors can respond to currency fluctuations caused by economic, social and political events at the time they occur - day or night.
The FX market is considered an Over The Counter (OTC) or 'interbank' market, due to the fact that transactions are conducted between two counterparts over the telephone or via an electronic network.
Trading is not centralized on an exchange, as with the stock and futures markets.
On Monday, October 19, 1987, the Dow Jones Industrial Average declined 22.6% in the largest single-day drop in history.
This one day decline was not confined to the United States, but mirrored all over the world. By the end of October, Australia had fallen 41.8%, Canada 22.5%, Hong Kong 45.8%, and the United Kingdom 26.4%.
Black Monday, as it has become known, was almost twice as bad as the stock market crash of October 29, 1929. The 1929 decline approximated 11.7% and started the Great Depression.
The Securities Exchange Commission, academic professors, financial writers and every financial security firm has analyzed the stock market crash of 1987 in about every way possible.
Some believe the market crash was caused by an irrational behavior on the part of investors. Some analysts believe that excessive stock prices and computerized trading were the cause.
The key finding is that no single news event occurred that could account for the crash!
The stock market was doing quite well for the first nine months of 1987. It was up more than 30%, reaching unprecedented heights. That was after two consecutive years of gains exceeding 20%.
By 1987, interest rates began to climb. Three days before Black Monday, the stock market gains for the year dropped by 11.6%, including the effects of a 9.5% drop on October 16, 1987.
The three day drop was caused by several macroeconomic factors. Long-term bond yields that has started 1987 at 7.6% climbed to approximately 10%. This offered a lucrative alternative to stocks for investors looking for yield.
The merchandise trade deficit soared and the value of the U.S. dollar began to decline. After a speech by Treasury Secretary Jim Baker, investors began to fear that the weak US dollar would cause further inflation.
On Monday, the Dow dropped about 200 points or 9% in the first hour and half. During the day, most institutional investors implemented various computer-based portfolio insurance programs.
Portfolio insurance was destabilizing because it required selling stock as prices declined. The more stocks fell, the more stocks were sold. As the market did not have the liquidity to support the sales, the stock market fell even further.
Buyers waited, knowing the more the market dropped, the more selling would have to take place. By the end of the day, the Dow had lost 508 points.
One important lesson came out of this 1987 stock market crash:
Investors who sold, were taken to the cleaners. Those who held and continued a disciplined and systemic approach received rewards!
In fact, by the end of 1987, total return for the year, including dividends, approximated 5%.
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Buy the Dips!
"The best time to buy stock is when blood is running in the streets."
Nathan Mayer Rothschild (1776 - 1836)
I hope that you have enough courage to enjoy the market's severe ups and downs!
But for most of you these are unsettling times, and you start sweating when you see your holdings decline by double-digit percentages!
But take courage, those movements may actually be good for you!
What should a careful investor do in a market downturn?
How can you avoid panic and make the best use of panic selling by others?
Dramatic dives in the stock market allow you to "Buy the Dips!" And the dips are so frequent these days, you don't even need to know when they will occur!
With stock prices flying up and down, chances are that on your next payday prices will be down, so you'll get more shares for your money.
You'll be enjoying cost averaging!
The more volatile the market and the more extreme the price fluctuations, the better off you'll be in the long run.
It may sound crazy at first, but it makes sense:
When prices swing wildly up and down, you will frequently have the opportunity to buy low.
As the stock market inches up over time, you'll enjoy greater gains than those who plunked all their money into the market when it was high, or who invested in a market that was slowly rising rather than wildly fluctuating!
So when prices dip, open up the champagne ...
You'll be buying stocks on sale!
