What is Forex Trading?
Forex or Foreign Exchange is the simultaneous buying of one currency and the selling of another. Currencies are traded in pairs.
The Forex Market has more buyers and sellers and daily volume than any other market in the world and takes place in major financial institutions across the globe. The forex market is open 24 hours a day five days a week
Buying/SellingIn the forex market, currencies are always priced in pairs and all trades result in the simultaneous buying of one currency and the selling of another. The objective of currency trading is to buy the currency that increases in value relative to the one you sold. If you have bought a currency and the price appreciates in value, then you must sell the currency back in order to lock in the profit.
Quoting ConventionsCurrencies are quoted in pairs. The first listed currency is known as the base currency and the second is called the counter or quote currency.
Currencies are quoted using five significant numbers, with the last placeholder called a point or a pip For example a EUR/USD quote 1.1345/1.1350
Like all financial products, forex quotes include a "bid" and "ask" or a "sell" and a "buy" price. By quoting both the bid and ask in real time, brokers ensure that traders always receive a fair price on all transactions. As in any traded instrument, there is an immediate cost in establishing a position. This cost will vary between the different brokers and is sometimes called "spread".
For example, USD/JPY may bid at 131.40 and ask at 131.45, this five-pip spread defines the trader's cost, which can be recovered with a favourable currency move in the market
MarginThe margin is a performance bond, or good faith deposit, to ensure against the total loss of your account. Trade stations have margin management capabilities. In the event that funds in the account fall below margin requirements, the broker's dealing desk will close all open positions. This prevents clients' accounts from falling into a negative balance, even in a highly volatile, fast moving market.
The new NFA rule requires a minimum 1% margin at all time to maintain an open trade. (Note this may change from time to time so although we use 1% as the example at some stage in the future the margin maybe different. However using similar calculations one can easily calculate the new margins) Some deal stations automatically calculate this according to the formula and hence the margin requirements are continually varying.
Based on a 1% margin requirement
Example 1: GBP/USD
rate: 1.7442/1.7447
account type: 100 000/lot account
1% leverage: 100 000x0.01 (1%) =1000units
When you are long (buy) GBP/USD, the margin required is:
1.7447 (GBP/USD) xlOOO (units of base currency GBP) = USD1744 for each lot. Some brokers require $1,800 margin for GBP pairs.
Example 2: EUR/USD
rate: 1.2326/1.2331
account type: 100 000/lot account
1% leverage: 100 000x0.01 (1%) =1000units
When you are long (buy) EUR/USD, the margin required is:
1.2331 (EUR/USD) xlOOO (units of base currency EUR) = USD1233 for each lot.
Some brokers require $ 1,300 per lot in margin for EUR based pairs. In general, a margin of $ 1,300 allows you to control a $100,000 spot currency position. This is an efficient use of trading capital as the leverage in futures and stock markets is much less.
Example 3: Where the USD is the BASE currency, the margin requirement is USD 1000 (iel%oflOOOOO)
When you are long (buy) USD/CAD, USD/CHF etc the margin required is: = USD1000 for each lot.
Forex Market and LocationsThe forex market is a seamless 24 hour market and is open 5 days a week.
At 5 pm Sunday, New York time, trading begins as markets open in Sydney and Singapore.
At 7 pm the Tokyo market opens, followed by London at 2 am,
and finally New York at 8 am. (Time is based on New York time)
As a trader, this allows you to react to favourable/unfavourable news by trading immediately.
The trading of forex takes place all over the world and is not located in any one central location. Deals are done between a variety of traders, from banks to managed funds to individual traders
Size of the Forex MarketForex trades approximately US$1.85 trillion a day and is by far the most liquid market in the world. It takes the NY Stock Exchange THREE MONTHS to trade the same USD value as the forex trades each and every day making it the largest and most liquid market in the world. This market can absorb trading volume and transaction sizes that dwarf the capacity of any other market. If you compare this to the US$30 billion per day futures market, it becomes clear that the futures markets provide only limited liquidity. The forex market is always liquid, meaning positions can be liquidated and stop orders executed without slippage.
Brokers and Market MakersMarket Maker - One that consistently makes two way prices, providing both a bid and an offer. Unlike brokers, market makers trade their capital
Broker - An individual who matches buy and sell orders in return for a commission. The bid and offer prices are those of the market participants and not of the broker.
Currency PairsTraders can trade a variety of currency pairs, limited only by which pairs each broker provides. Major currency pairs are typically the USD pairs for example
EURUSD
GBPUSD
AUDUSD
USDJPY
USDCHF Cross currency pairs are pairs which do not involve the USD for example
EURGBP
EURJPY
GBPJPY
EURCHF EUR= Euro, GBP= Pound, CHF= Swiss Franc, JPY=Yen, AUD= Aussie $
Point/Pip ValuesPoint/Pip values is the US$ value for each Point/Pip (these are typical values and can vary between the different Brokers and Market Makers)
Regular Mini
Euro = $10 ($1)
Pound = $10 ($1)
Australian Dollar = $10 ($1)
Swiss Franc CHF = $7.60 ($0.76)
Canadian Dollar CAD = $7.30 ($0.73)
Japanese Yen = $8.45 ($0.85)
Major Market Participants
Traders include Governments, Reserve Banks, Large Mutual Funds, Banks, Companies, Hedge Funds, Individual Traders.
Fundamental or TechnicalThe two basic approaches to analysing the currency market are Fundamental Analysis and Technical Analysis. The fundamental analyst concentrates on the underlying causes of price movements, while the technical analyst studies the price movements themselves.
Fundamental Analysis
Fundamental analysis focuses on the
economic social political geopolitical forces
These drive supply and demand.
Fundamental analysts look at various macroeconomic indicators such as
economic growth rates, interest rates, inflation, unemployment, etc.
