Forex Trading Guide
Trading Currencies on the Foreign Exchange Buying and Selling Currencies Interest Rates Dealing Spread Margin Trading Stop Loss (If it all goes wrong!) Types of Analysis Summary|
Trading Currencies on the Foreign Exchange |
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The Foreign Exchange, Forex or FX are names used when buying and selling different currencies from around the world.
The Forex market is the biggest market of all with a turnover of more than a trillion US dollars a day (That’s a lot of dollars!) There is no central location for the Forex market, it is an OTC (Over the Counter) market and the trade is between the two counterparts required to make the trade. The Forex trading market starts in Sydney and moves around the world via other trading centers – Tokyo – London – Frankfurt – New York (24 hour trading)
| Buying and Selling Currencies | Top |
When you trade in currencies, you buy one currency and sell another at the same time. The two types of currencies used in the trade are called a cross (GB Pound/ US Dollar for example). The most traded currencies e.g. GBP/USD: EUR/USD:USD/JPY:USD/CHF are called “majors”
Major currencies are traded on the “spot” market. This is the most important forex market because it has the largest volume of trade. The market is called the spot market because all trades are settled straight away (on the spot). In reality this means two working/banking days. Time for an example: Having read the news you have decided that the Euro will rise against the US Dollar and therefore you want to buy the Euro and sell the US Dollar (EUR/USD). The first currency of the pair (EUR/USD) is known as the base currency and the second currency of the pair is the quote currency.
Your broker or dealer will quote a bid/ask price. The ask price is the price your broker will sell at (so you buy at this price). The bid price is the price your broker will buy at (so you sell at this price).
E.g. your broker quotes you a price for EUR/USD of 1.4686-90. Which means you can sell one USD at 1.4686 to buy one Euro.
Day 1 You buy 100,000 Euros at 1.4690 US Dollars Total US Dollars 146,900.00. 7 days later the Euro has risen against the US Dollar to 1.4805 (You were right!) Once again you contact your broker who quotes you a price for EUR/USD of 1.4905-09. Which means you can buy one Euro at 1.4905 US Dollars.
You sell 100,000 Euros at 1.4905 US Dollars Total US Dollars 149,050.00 Your Euro account over the 7 days shows a credit and a debit of 100,000 Euros (No Change) whereas your US Dollar account shows a debit of USD 146900.00 and a credit of USD 149050.00 a profit of 2,150 US Dollars. Time to read the news again and it is bad news for the Euro (maybe good news for you). So you decide to sell the Euro and buy the US Dollar. Your broker quotes you a price for EUR/USD of 1.4450-55. Which means you can sell one USD at 1.4450 to buy one Euro. Day 1 you sell 100,000 Euros at 1.4455 USD. Total US Dollars 144550.00 Day 7 and the Euro has fallen to 1.4200 against the US Dollar (Great!) Once again you contact your broker who quotes you a price for EUR/USD of 1.4200-05. Which means you can buy one Euro at 1.4205 US Dollars
You buy 100,000 Euros at 1.4205 US Dollars Total US Dollars 142,050.00 Your Euro account over the 7 days shows a credit and a debit of 100,000 Euros (No Change) whereas your US Dollar account shows a credit of USD 144,550.00 and a debit of USD 142,050.00, a profit of 2,500 US Dollars.
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Interest Rates |
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Different currencies pay different interest rates and whilst this is not shown in the examples, it can be a very relevant factor when trading over longer periods of time, especially if margins are used (see Margin Trading).
As with all trading due diligence is required to research why a certain currency has a high or low interest rate. There is no guarantee that just because a currency has a high interest rate, it is strong.
| Dealing Spread | Top |
Your broker or dealer will always quote you a buy price and a sell price and the difference between the two is known as the “spread”. There are usually 3-5 points (or pips).
The dealer/broker makes his/her money (We all have to earn a crust) on the spread and therefore there are no additional commissions, costs, or exchange fees.
This speeds up the whole process of trading on the forex market and as many traders are active intra-day traders, getting in an out of trades quickly is very important as EUR/USD price differential can swing 160 – 190 points in a day
| Margin Trading | Top |
The examples shown bought and sold 100,000 Euros (A lot of money for some)
However the good news is that in the Forex market you only need a margin deposit, the remainder will be allowed by your dealer.
The gearing or leverage usually offered brokers is 100:1, but some offer higher leverage.
So to trade 100,000 Euros would require a 1% margin deposit or 1,000 Euros.
This sounds very good, but beware, as a 3% change in your trade will mean a 300% profit or loss in your account and as you can see this creates both large profit opportunities and large potential risks.
It is not a good idea to take up a position with very limited funds, and always research thoroughly before embarking on any trade. Begin with the basic concept before advancing to more complex trading strategies such as Forex trading systems, trading patterns and risk management.
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Stop Loss! (if it all goes wrong) |
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The forex markets offer great potential for significant profits to be made, but as with most things also exposes the trader to substantial risks.
The more active traders can experience profit/loss swings of 25-35% daily. So it is vital that you cover yourself with some protection i.e. a STOP LOSS.
Because the forex markets trade 24 hours a day except weekends, there is always time to react to market moves before getting too badly burned. For currency speculators a stop loss position is essential, although while a stop loss can limit your losses, it is not a cast iron guarantee that you will close your position at the level you want.
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Types of Analysis |
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Fundamental Analysis: This form of analysis looks at the economic situation of the country whose currency you are thinking of trading on the forex market.
A number of factors are evaluated and analyzed to determine the health of the currency against other currencies. The Political climate of the country concerned, the social situation, present economic policy, manufacturing output etc.
All this will help decide whether the currency is overvalued or undervalued and therefore assist the trader in making the decision to buy or sell.
Technical Analysis: This form of analysis uses patterns or charts to predict future movements in particular currencies based on past trends.
There are a number of patterns that constantly appear in forex market trends and if the latest patterns can be identified before they become complete, traders can anticipate the forex market and act accordingly.
Technical analysts study charts to find certain patterns such as the head and shoulders, wedges, triangles and many more. This gives the trader an entry and exit point to open and close a trade on the forex market.
Many brokers offer online charting with a host of indicators and tools.
To understand the basis of both Fundamental and Technical analysis, it is advisable to obtain one of the hundreds of publications offering advice and instruction on analyzing the possible futures moves of the market. Alternatively the information required can be found by searching the web.
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Summary |
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Some of the biggest multinational corporations in the world, along with central and major banks, financial institutions, governments, and traders large and small, all participate in trading on the Forex markets either directly or indirectly.
Many commercial enterprises trade on the Forex Market because of their currency exposure due to their import and export activities. However the main portion of the turnover of the Forex market belongs to the financial institutions.
Investing in foreign exchange fluctuations is still for the most part carried out by the major players in the market, i.e. investment funds, banks, and brokers.
With the advent of online brokers and dealers plus the ability to monitor movement of the Forex markets any investor can take advantage of the benefits associated with currency trading. By investigating and studying the mechanisms and workings of the Forex market the small investor can arm himself/herself with enough information to start trading.
As with all trading Due Diligence must be carried before parting with any money.
It may even be wise to paper trade (No money invested) on the Forex market for awhile so that experience is gained before embarking on the real thing.
