Forex (FX) - Basics:
· Forex stands for FOReign Exchange. It is also known as FX
· You buy one currency while simultaneously selling another
· Currencies trade in pairs, like Euro-US dollar (EUR/USD)
· Foreign Exchange market is an over-the-counter market, a decentralized market with no central exchange
· Daily turnover Foreign trade (5%), Speculation for profited (95%)
Most traders focus on the biggest, most liquid currency pairs, known as "The Majors". These include US Dollar, Japanese Yen, Euro, British Pound, Swiss Franc, Canadian Dollar and Australian Dollar. In fact, more than 85% of daily forex trading happens in the major currency pairs.
· 24-hour market Sunday 5pm ET to Friday 5pm ET
· 3.2 trillion average daily turnover
Reading a foreign exchange quote is simple if you remember two things:
The first currency listed is the base currency
The value of the base currency is always 1
The US dollar is usually considered the base currency for quotes. When the base currency is the USD, think of the quote as telling you what a US dollar is worth in that other currency.
When USD is the base currency and the quote goes up, that means USD has strengthened in value and the other currency has weakened. In other words, a rising quote means that the US dollar can buy more of the other currency than before.
Majors are not based on the US dollar.
There are three exceptions when the US Dollar is not the base currency of a pair - these exceptions are the British pound (GBP), the Australian dollar (AUD) and the Euro (EUR).
For these pairs, the quote is based on the other currency, and a rising quote means that the other currency is strengthening, and the US dollar is weakening.
Cross currencies
Currency pairs that don't involve USD at all are called cross currencies.
BID, ASK and the Spread
Just like other markets, forex quotes consist of two sides, the BID and the ASK:
The BID is the price at which you can SELL base currency.
The ASK is the price at which you can BUY base currency.
The spread is the difference between the BID and the ASK, and represents the cost of trading. In forex, spreads are tighter than many other markets, making it cost effective to trade on relatively small price movements.
What's a pip?
Forex prices are generally very liquid, and are usually quoted in very small increments called pips, or "percentage in point". A pip refers to the fourth decimal point out, or 1/100th of 1%.
For Japanese yen, pips refer to the second decimal point. This is the only exception among the major currencies.
Leverage & Margin
Leverage trading, or trading on margin, means you aren't required to put up the full value of the position. As a result, you can open a significantly larger position that you would be able to if you needed to fund your trade in full. Trading on leverage increases your potential for profit, but also increases your risks.
Forex trading offers leverage up to 200:1. This means that for every £1 in your account, you can trade £200 worth of a position.
No debit balances, no margin calls
Your risk is limited to funds on deposit. There are no margin calls in forex trading. You need to maintain sufficient funds on your account to keep your positions open, and you will not be able to open larger positions than can be supported by your account balance. If your account falls below the required level to maintain your position(s), we will automatically close out all positions to ensure that you can't lose more money than you have in your account.
More leverage means more opportunity - and more risk
Trading using leverage offers significantly increased profit potential, but it is important to remember that it also means significantly increased risk. Your risks can be limited by monitoring your account, and by using stop losses to set the maximum loss you are prepared to take on any one position.
Calculating Profit and Loss
Our online trading platform will automatically calculate the P&L of your open positions, but it is useful to understand how this calculation is made to understand your profit and loss potential on each trade.
Example 1:
Let's say that the current bid/ask for EUR/USD is 1.46160/190, meaning you can buy 1 euro for 1.46190 or sell 1 euro for 1.46160.
Suppose you decide that the Euro is undervalued against the US dollar, and you expect it to strengthen. You would buy Euros (simultaneously selling dollars), and then wait for the exchange rate to rise.
To make the trade you buy 100,000 Euros, paying 146,190 dollars (100,000 x 1.46190). At 1% margin, your initial margin deposit would be approximately $1,461 for this trade.
If as you expected, the Euro strengthens you can realize a profit by selling EUR/USD to close your trade. If the Euro had strengthened to 1.462300/260, you would sell 100,000 Euros at the current rate of 1.46230, and receive $146,230
To calculate your profit:
You bought 100,000 Euros at 1.46190, paying $146,190.
You sold 100,000 Euros at 1.46230, receiving $146,230.
That's a difference of 4 pips, or in dollar terms ($146,190 - 146,230 = $40).
Total profit = US $40.
Let's say that we once again buy EUR/USD when trading at 1.46160/190.
You buy 100,000 Euros paying 146,190 dollars (100,000 x 1.46190) - as in example 1.
However, in this example the Euro weakens to 1.46110/140. To minimize your loss you sell 100,000 Euros at 1.46110 and receive $146,110.
To calculate your loss:
You bought 100k Euros at 1.46190, paying $146,190.
You sold 100k Euros at 1.46110, receiving $146,110.
That's a difference of 8 pips, or in dollar terms ($146,190 - $146,110 = $80).
Total loss = US $80.
