What is Forex?
The off-exchange retail foreign currency market (“FOREX”) describes the
purchase of a particular currency from an individual or institution and the
simultaneous sale of another currency at the equivalent value or current
exchange rate. Essentially, the process of exchanging one currency for
another is a simple trade based on the current rates of the two currencies
involved.At the core level of the world’s need for money exchange is the
international traveler. When traveling from the US to England, for example,
you will of course need the local currency to pay for transportation, food,
and so on. Upon arrival at the airport you will surrender (sell) your USD in
order to receive (buy) the equivalent in GBP. In this example, you sold the
USD and bought the GBP. Conversely, the FOREX counter bought the USD
and sold the GBP. The prices at which you buy and sell currencies are known
as exchange rates. This rate or price fluctuates based on demand and on
political and economic events surrounding each country’s currency.
Forex Market Hours?
Unlike other financial markets, the FOREX market operates 24 hours a day,
5.5 days a week, through an electronic network of banks, corporations and
individual traders exchange currencies. Though as the market is primarily
used as a means for speculative investing, actual physical delivery of
currencies is almost never intended. FOREX trading begins every day in
Sydney, moves to Tokyo, followed by Europe and finally the Americas.
Bid vs. Ask
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FOREX prices, or quotes,
include a “Bid” and “Ask”
.similar to other financial products.
Bid is the price at which a trader
is able to sell a currency pair.
The Bid price or sell price of a currency pair is always the lower price in a quote.
Ask, sometimes referred to as “Offer”, is then the price at which traders are able to
buy a currency pair. In other words, FOREX traders always buy at the high and sell
at the low of a price quote. The difference between the Bid and Ask is called the
“Spread,” which is the Trader’s cost per trade or per transaction. There are typically
no additional broker commissions involved in trading the FOREX market, as there
might be when trading other investment markets.
Why Do Currencies Move?
FOREX markets and prices are mainly influenced by international trade and investment
flows. The FOREX market is also influenced, but to a lesser extent, by the same factors
that influence the equity and bond markets: economic and political conditions, especially
interest rates, inflation, and political stability, or as if often the case, political instability.
Though economic factors do have long term affects, it is often the immediate reaction
that causes daily price volatility, which makes FOREX trading very attractive to intra-day
traders. Currency trading can offer investors another layer of diversification from
traditional investments. You should bear in mind that trading in the off-exchange foreign
currency market is one of the riskiest forms of trading and you should only invest risk
capital in this market.
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The Majors
Most currency transactions involve the “Majors” consisting of the British Pound (GBP),
Euro (EUR), Japanese Yen (JPY), Swiss Franc (CHF) and the US Dollar (USD). Many
traders are beginning to add the Canadian Dollar (CAD) and the Australian Dollar
(AUD) to this category as well.
Why Are There Two Currency Pairs?
Often new traders struggle to grasp the concept of trading currencies in pairs. “Why
not just buy the Euro?” they might ask. Why does it have to be paired with the US
Dollar? The reason is that the currency on the right side of the pair is there to
establish a comparative value. Without it how could the base currency (currency
on the left side of the pair) have any certain value? In other words, if currencies
were not paired, what would a single currency gain or lose value against? By pairing
two currencies against each other a fluctuating value can be established for the one
versus the other. So, how is the Euro doing against the Dollar, or how many Dollars
does it taketo buy one Euro?
What is Margin?
In the FOREX market the term margin is most often referring to the amount of money
required to open a leveraged position, or a contract in the market. It may also be used
to describe the type of account, i.e. margin account; meaning that an account is being
traded on borrowed funds.It is generally safe to assume that all off-exchange retail
FOREX traders are trading within margined accounts.Without leverage, or the ability
to trade on borrowed funds, a trader placing a standard lot trade in the market would
need to post the full contract value of $100,000 in order to have his or her trade
executed. Trading with a margined account allows traders to utilize leverage, meaning
that the same $100,000 contract can be placed for an amount of margin determined
by the set level of leverage. An account at 100:1 leverage would require $1,000 of
margin to place a $100,000 trade. *100:1 is the entry leverage value. Since most
brokerages will have margin calls set at different level, exact leverage may vary.
Simply stated, trading FOREX on margin increases your buying power.
As an example: a trader with $10,000 in a margin account that allows 100:1 leverage,
would be able to purchase a maximum of $1,000,000 in currency contracts
(10 standard lots). At 100:1 leverage 1% of the contract value is required as collateral.
By trading on margin, traders can potentially increase their total return on investment
with less cash outlay. Trading on margin should be used wisely as it magnifies both
your potential profits AND potential losses. A good rule of thumb to follow is the higher
the margin, the greater the risk.
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Contract Size
Understanding contract sizes (lots) is a necessary precursor to understanding the
need for high leverage in the FOREX market. Each standard lot traded in the FOREX
market is a $100,000 contract. In other words, when trading one lot in a standard account,
a trader is essentially placing a $100,000 trade in the market. Without leverage, most
investors would not be able to afford such a transaction. Leverage of (100–1) would
allow a trader to place the same one lot ($100,000) trade with the post of $1,000 in
margin. $100,000 divided by 100 equals $1,000, thus (100–1) leverage means that
$1,000 of margin is able to control a $100,000 position.
Many retail FOREX traders today begin their trading in a Mini account. Because standard
contracts in the FOREX market are rather large, even with (100–1) leverage, $1,000
of margin per contract traded is still expensive for some investors. For this reason most
retail brokers offer the option of a Mini account.
Forex is the largest market in the world, trading in excess of $3 trillionper day. Currencies are traded worldwide, around the clock, and in a
variety of pairings. Trading Forex gives traders flexibility, and a large
product pool to draw from, making it one of the fastest growing industries.
