We all have to start somewhere and where better than providing some definitions of what foreign exchange trading is commonly known as in trading circles.
First off, foreign exchange is commonly known as Forex, which is an abbreviation of the two words into one.
In simple words Forex is the business of buying and selling currencies. In fact it is also referred to as Currency trading.
Other terms is also known as the FX market but the most common usage is the vernacular phrase of Forex.
Within your local area you can see how prevalent this currency trading business has become. From the malls, the streets, and around the commercial district areas, you can find these small booths that carry the label Foreign Exchange Traded Here.
Currency trading can be an on line activity especially since currencies can be traded 24 hours each day from Monday through Friday.
In Forex trading, you are buying one kind of currency while selling another kind at the same time.
This means that you are exchanging your money for the one that you are purchasing. The basic rule is that every currency has its corresponding value in another currency.
Currency exchange rate is the term used for the value of a certain currency that is being exchanged for another. All forex trades occur between 2 currencies and in fact they are referred to as currency pairs. So trading the US Dollar for the Euro would mean that you are trading the USD/EUR currency pair.
Currency Trading Can Be A Home Business
Like all the other corporations and business entities around the globe, Forex has also been growing and developing over time. Today, trading of currencies has become simpler and easier because of online forex currency trading. Buying and selling currencies by currency trading can even be conducted through your computer at home utilising an online broker platform like meta trader 4.
Currency trading can therefore become a home based business without the need to commute to one of the city centres.
The Foreign Exchange Market
The Foreign Exchange Market (Forex) is a decentralized global market used for the trading currencies from all over the world. The 2 main currencies traded in this market are the United States Dollar (US$) and the EUR, followed by the Japanese YEN, the Great British Pound Sterling, Australian Dollar, Canadian Dollar and Swiss Franc.
As already mentioned, the Forex market is open five days a week and unlike other markets, during these work days, the Forex market is open for twenty-four (24) hours during each of those days. This is because of the time difference between currency countries. New York, Hong Kong, London, Singapore, Sydney, Frankfurt, Zurich and Tokyo are the most prominent world trading centers and these all have different time-zones.
So, for example while the US currency exchange market is closed, the London Market is open and trading. So, yes the Forex Trading Market globally never closes.
During a gold standard, all paper currencies are backed by a physical store of gold, and currency was pegged to the price of an ounce of gold. Currency could be converted into gold at the fixed rate.
More than $1.9 trillion are being traded every single day, as trading is being conducted throughout the entire twenty-four hours.
Foreign currency trading is the market that has the highest financial liquidity. The most common traders in this business are the banks, central banks of every country, investors in big financial institutions, currency speculators, governments, corporations, the small retail investors, and other financial institutions. There is no formal forex market with an exchange like the London Stock Exchange or the New York Stock Exchange and in this informal global financial market there is more money traded than in all those stock exchanges put together.
Who Trades Forex?
There are many people trading in forex all over the world, from Central banks to private individuals and hopefully you too will soon be trading in foreign exchange pairs and hopefully making a living out of it..
Central banks of each country are the main players of this market and they basically control through the forex market the inflation and interest rates.
Hedge Funds managing portfolios of investments also are a big part of the Forex Trading community and billions of dollars traded daily. These tend to be quite aggressive in their dealings.
Commercial Companies also play an important part in the Forex world as they try to diversify their currency holdings for their commercial trade and at the same time try to minimise losses on the necessary currency exchange.
Then obviously there are individual traders like most of you out there who are currently reading this page. You and I are a growing part of the currency exchange market and we can participate either through banks or brokers.
Brokers give us the opportunity to speculate on the market through their Forex online platforms and in return they get a small commission on each trade.
The Foreign Exchange currency market comes with its own technical jargon that could be confusing to the average person. Before going any further, it is important to understand some of the basic terms, terminologies and concepts to better understand the forex markets.
Here is what we will learn in this article
- Basic forex terms;
- Market Terminology;
- Common currency pairs;
- The dynamics between currency pairs
- How the Economy Effects Foreign Exchange values
Basic Forex Terms:
Exchange Rate: The monetary value of one currency expressed in provisions of another currency. Take for example the AUD/USD at 0.89706. That means that one Australian Dollar is worth 89.706 cents in American Dollars.
PIP (Percentage in Point): A pip is a unit of change in the exchange rate of a currency pair. As a general rule, currencies are priced to the fourth decimal place. A pip is then one unit of the fourth decimal place. The 5th decimal place is known as a fractional pip. The Japanese Yen is an exception. Because the Yen is close to one hundredth of the value of other major currencies, it is only measured to the second decimal place. A pip in this case is therefore one point in the second decimal place.
Bid Price: The price at which the market will buy a currency pair from you is known as the bid price.
Ask Price: The price at which the market will sell a specific currency pair to you is known as the ask price.
You buy at the ASK price and sell at the BID price.
In other words, when you want to buy at market you buy the “ask price” (1.67156) and sell at the ” bid price” (1.67105)
Spread: The difference between the bid and ask price of a currency pair. In the example of the GBPUSD above the bid is quoted at 1.67105 and the Ask is quoted at 1.67156. The spread or the difference between the two is 5.1 PIP’s.
Leverage: The borrowed capital used in an account that enables a trader to hold a greater position. It is not uncommon for leverage ratios to be 100:1 or even 200:1. This means that for every $1000 invested into an account, one could hold a position of $100,000 or $200,000 respectively. Increasing leverage increases the potential gains, but also amplifies potential losses.
A simple way to calculate your leverage being used would be to divide the total value of your open positions by the total margin balance in your account. If for illustration purposes, you had funded your trading account with $1,000, and then proceeded to open one standard lot of USD/CAD for $50,000, your leverage ratio would be 50:1 ($50,000/$1,000).
Margin: This is the capital requirement needed to open a position and to hold that position. Margin is considered to be either “used” or “free”. As one would expect, “used” margin is that sum which is in play in the markets. “Free” margin is that which remains at the disposition of the investor to create new open positions. Take for example an investment account with a 100:1 leverage ratio. In this case, a 1% margin level is required to be able invest 100 times that. So, with a $1,000 margin balance, one can hold positions of up to $100,000.
Margin Call: It is important to be aware of the minimum margin amount required to hold an open position. If your account falls below the minimum amount most brokers will automatically close the trade position. They may also prompt for additional funds to be transferred into the trading account. The actual amount/percentage of the account required varies from broker to broker.
Some Basic Market Terminology
Bull Market: Upward bias to the market direction. May also be heard as the “bulls” are in control of the market and driving prices higher.
Bear Market: Downward bias to the market direction. May also be heard as the “bears” are in control of the market and driving the prices lower.
What is great about the Forex market is that profits can be made just as easily in a bull market as in a bear market. Now let us discuss the difference between going Long and going Short.
Long – When a person goes long on a currency pair, they are buying the first currency, the base currency, and selling the second one, the quote currency. So if someone buys the USD/CAD and the American Dollar appreciates in relation to the Loonie, then that person will be in a profitable position.
Short – When a person goes short on a currency pair, they are buying the second currency, the quote currency, and selling the first, the base currency. So if a person sells the USD/CAD and then the American Dollar appreciates in relation to the Loonie, then that person will have suffered a loss in that position.
Below we will review all the possible order types. In the Forex market all trades are called ‘orders’. There are a variety of order types and they can differ between brokers. All brokers have the common basic order types, but then some brokers have some more special types as well.
Market Order – An order that is placed at the price of the market is considered to be a ‘market order’.
Limit Entry Order (Limit Orders) – A limit entry order puts a restriction on the order to the price that the trader decides he is willing to accept. When buying, a limit order can be placed below the market value and when selling a limit order can be placed at a premium to the current market price.
Stop Loss Order – A stop loss order is used in conjunction with an open position in the market. It is tied to the open position and automatically sells off that position once the market reaches a certain predetermined level. In currency trading, this is one of the most important tools available. It restricts the risk you are willing to accept and limits potential losses. In essence, this is your trading insurance policy and should always be used.
Trailing Stop – A trailing stop loss order is similar to the stop loss order. It restricts the level of risk one is willing to accept and sells off the position when the market reaches the determined point. The trailing stop differs however in that it follows the market trend. For example, you can set a trailing stop of 20 pips on the USD/CAD. If the market rises by 25 pips, then the trailing stop will also rise by 5 pips. This enables you to guarantee a certain amount of profit as the market rises.
Good till Cancelled Order (GTC) – A GTC order is self-explanatory. It is an order that will subsist until you manual change it or cancel it. It is important to pay close attention to these types of orders. It is not advisable to have outstanding orders for excessive periods of time.
Good for the Day Order (GFD) – A GFD order is only valid for the day’s trading period. The day end for Forex trading is at 5:00pm EST (New York time). It is important to always check the expiry time of a GFD because it may vary from broker to broker.
One Cancels the Other Order (OCO) – An OCO order is a pair of orders placed simultaneously. If one order gets filled then the other one is automatically cancelled. These orders typically combine a limit order with a stop order. For example, if you buy the USD/CAD currency pair and expect it to rise by 50 pips, then you can place a sell order at the limit of plus 50 pips. If at the same time, you are not willing to lose more than 20 pips, then a stop loss order will be placed at that level. Whichever mark is reached first will fulfill the concurrent order and subsequently the other outstanding order will be cancelled.
One Triggers the Other Order (OTO) – An OTO is the inverse of an OCO. In this case, a second order is contingent upon a first order being fulfilled.
What Are The Major Forex Currencies?
USD = United States Dollar
EUR = Euro
GBP = British Pound
JPY = Japanese Yen
CAD = Canadian Dollar
AUD = Australian Dollar
CHF = Swiss Franc
NZD = New Zealand Dollar
Common Currency Pairs and Their Nicknames
EUR/USD = “Eurodollar”
GBP/USD = “Sterling”
USD/CAD = “Dollar Can” (CAD is also referred to as the “Loonie”)
USD/JPY = “Dollar Yen”
AUD/USD = “Aussie Dollar”
NZD/USD = “Kiwi”
USD/CHF = “Swissy”
Comprehending the Dynamics of a Currency Pair
Before going any further, you must learn how to properly read a currency pair quote.
The exchange rate of a currency is always quoted as a pair of two currencies. The USD/CAD is such an example. When you purchase a currency pair, you are buying one currency and selling another. In this case you would be buying USD and selling CAD.
In this illustration, the USD would also be known as the “Base Currency”. Also known as the domestic currency and the accounting currency, it is the first currency in a pair and is to the left of the slash mark. Our second currency located to the left of the slash mark, the CAD, is also known as the “Quote Currency”. The price is indicative of how much quote currency is required to purchase one unit of the base currency. If you were to sell this pair, you would get 1.11047 CAD for every 1 USD sold.
The whole goal of Forex trading is to buy a currency pair in which you think the Base currency will appreciate in value in relation to the Quote currency. You can also sell a currency pair. In that case you would want the Quote currency to appreciate in value in regards to the Base currency.
Swap rates are determined by the overnight interest rate differential between two currencies involved in the pair.
For instance, if you hold AUD/JPY overnight (usually 0:00 server time) you will be paid a swap because the interest rate in Australia is greater than in Japan. If on the other hand, you were selling AUD/JPY you would be paying the swap.
Be advised, however, that some currency pairs will have negative swaps on both the long and short side. Swap rates differ from broker to broker.
How The Economy Affects Forex – Examining Fundamental Analysis
There are basically two types of currency exchange trading analysis they are forex fundamental analysis and forex technical analysis. There is a lot of debate about which is better. In fact, both are important.
The simplest way of looking at these two methods of analyzing the market is to say that fundamental analysis considers the world economy while technical analysis looks at charts. In this post we will consider the different fundamental or economic factors and how they can affect your trades.
It will be clear to anybody who has even the most rudimentary understanding of the currency markets that a nation’s economic status will have an effect on the value of that nation’s currency. A healthy economy means a strong currency, just as a company’s stocks will rise in value when that company is doing well.
Any time that a major financial or economic report is due from one of the main players in the world economy, you can expect to see an effect on the foreign exchange markets. This includes reports of the country’s Gross Domestic Product, statements of the national debt, inflation, employment levels and trade deficits. Many of these reports are given out regularly at predetermined times and dates, and you will see a lot of volatility in the forex markets around those times.
It is very important to keep track of when these reports are due, not only in your own country but in all of the countries whose currencies you regularly trade. You cannot rely on national newspapers and television for this. They do not carry international economic news at a sufficiently detailed level. You need specialist publications. Many people use the internet for this purpose.
However, it is not only the economy that counts. Social and political forces also have a strong influence on a nation’s currency values. Events such as an election, civil unrest, or a natural disaster can cause fluctuations in values.
Some of these events are difficult or even impossible to predict, but you can still base trades around what is likely to happen after the event. You can use historical analysis to see what happened in the currency markets the last time there was a similar event.
If you want to base your trading around fundamental analysis of the forex markets you will need to be the type of person who enjoys following the financial, political and economic news.
The alternative is to use information about upcoming events to avoid trading at those times. People who prefer to rely mainly on technical analysis will do this. But you still need to know what is happening, in order to keep out of the market. So even for somebody who prefers basing their trades on charts, forex fundamental analysis is important.