Forex Trading Basics
What is Forex
The forex market (foreign exchange market or currency market) is a global decentralized market for currency trading.
The forex market determines the relative values of currencies.
In a typical foreign exchange transaction, a party purchases some quantity of one currency by paying for some quantity of another currency.
Market size and liquidity
Largest and most liquid financial market in the world. (volume of trading)
According to the Bank for International Settlements
In 1998, average daily turnover was 1.7 trillion.
As of April 2007 daily volume was 3.21 trillion.
As of April 2010, average daily turnover was estimated at $3.98 trillion,
$1.490 trillion in spot transactions
$475 billion in outright forwards
$1.765 trillion in foreign exchange swaps
$43 billion currency swaps
$207 billion in options and other products
Trading in forex markets averaged $5.3 trillion per day in April 2013.(Foreign exchange swaps, $2.2 trillion per day; spot trading $2.0 trillion per day in April 2013)
Foreign exchange trading volume by country
Rank in 2010: UK(36.7%),US(17.9%),Japan(6.2%)
Rank in 2013: UK(41%), US(19%),Singapore(5.7%),Japan(5.6%),Hong Kong(4.1%)
Currently The biggest geographic trading center is UK, primarily London.
Trading characteristics
Uniqueness of forex market
24 hours continuous operation except weekends,from 22:00 GMT on Sunday (Sydney) until 22:00 GMT Friday (New York);
Geographical dispersion;
The use of leverage
The low margins of relative profit
Largest asset class in the world with huge trading volume, high liquidity;
The market closest to the ideal of perfect competition
An over-the-counter market where brokers/dealers negotiate directly with one another
No central exchange or clearing house.
very little cross-border regulation.
Major news that affect the exchange rates is released publicly(often on scheduled dates). Traders receive the same news at the same time.
Forex spot market & futures market
Forex spot market or forex cash market means the exchange rate right now. The trade occurs immediately, on the spot. Suppose you want to buy some foods, the store owner give you foods, right now , on the spot.
Futures market means the exchange rate in the future. Suppose you only need foods next week(future), you enter into a contract with the store owner to deliver foods to you in the future at a specified price.
Currency Pair
Currencies are traded in pairs. Each currency pair constitutes an individual trading product.
Every currency trade involves at least two different currencies. If someone is short USD, then that person must be long some other currencies at the same time. He/she can’t trade only one currency because one currency alone does not fluctuate.
The value of a currency fluctuates constantly when measured against other currencies. The exchange rate of a currency pair is what forex traders trade with.
The first currency of any currency pair is called the base currency. The second member of any currency pair is called the counter currency or quote currency.
In the spot currency market, the order of the currencies in a currency pair is fixed. The ISO (International Organization for Standardization) determines the symbol for a currency and the order of currencies in each pair. For example, EUR/USD is the official order determined by the ISO.
Usually, USD is the base currency (e.g. USDJPY, USDCAD, USDCHF).
The exceptions are GBP, AUD, NZD and EUR where the USD is the counter currency (e.g. GBPUSD, AUDUSD, NZDUSD, EURUSD).
The quotation EUR/USD 1.2366 means 1 EUR = 1.2366 USD, so:
If the EUR/USD quote changes from 1.2366 to 1.2376, EUR has increased in relative value(either USD has weakened or EUR has strengthened, or both)
If the EUR/USD quote changes from 1.2366 to 1.2350, EUR has decreased in relative value(either USD has strengthened or EUR has weakened, or both)
The factors affecting the currency XXX will affect both XXX/YYY and XXX/ZZZ. This causes positive currency correlation between XXX/YYY and XXX/ZZZ.
The most traded pairs are called the Majors(EUR/USD, USD/JPY, GBP/USD, AUD/USD, USD/CHF, NZD/USD and USD/CAD). They constitute the largest share of forex market and have high liquidity.
Widely Traded Currency Pairs(created from the eight major currencies (USD, EUR, GBP, JPY, CHF, CAD, AUD, NZD)
Symbol
Description
EUR/USD
Euro/U.S. Dollar
GBP/USD
British Pound/U.S. Dollar
USD/JPY
U.S. Dollar/Japanese Yen
USD/CHF
U.S. Dollar/Swiss Franc
EUR/JPY
Euro/Japanese Yen
EUR/GBP
Euro/British Pound
EUR/CHF
Euro/Swiss Franc
GBP/JPY
British Pound/Japanese Yen
GBP/CHF
British Pound/Swiss Franc
NZD/USD
New Zealand Dollar/U.S. Dollar
AUD/USD
Australian Dollar/U.S. Dollar
USD/CAD
U.S. Dollar/Canadian Dollar
AUD/JPY
Australian Dollar/Japanese Yen
NZD/JPY
New Zealand Dollar/Japanese Yen
Less Widely Traded Currency Pairs
Symbol
Description
EUR/DKK
Euro/Danish Krone
USD/SEK
U.S. Dollar/Swedish Krone
USD/SGD
U.S. Dollar/Singapore Dollar
EUR/RUB
Euro/Russian Ruble
EUR/SEK
Euro/Swedish Krone
CAD/CHF
Canadian Dollar/Swiss Franc
NZD/CAD
New Zealand Dollar/Canadian Dollar
USD/HKD
U.S. Dollar/Hong Kong Dollar
USD/CNY
U.S. Dollar/Chinese Yuan
USD/DKK
U.S. Dollar/Danish Krone
USD/BRL
U.S. Dollar/Brazilian Real
USD/MXN
U.S. Dollar/Mexican Peso
USD/RUB
U.S. Dollar/Russian Ruble
GBP/NZD
British Pound/New Zealand Dollar
Major Currencies, Corresponding Central Banks & Nicknames
Currency
Symbol
Central Bank
nickname
Euro
EUR
European Central Bank, ECB
Single Currency
U.S. Dollar
USD
Federal Reserve, Fed
Greenback, Buck
Swiss Franc
CHF
Swiss National Bank, SNB
Swissy, Chef
Japanese Yen
JPY
Bank of Japan, BoJ
Yen
British Pound
GBP
Bank of England, BoE
Sterling
Canadian Dollar
CAD
Bank of Canada, BoC
Loonie
Australian Dollar
AUD
Reserve Bank of Australia, RBA
Aussie
New Zealand Dollar
NZD
Reserve Bank of New Zealand, RBNZ
Kiwi
Less Widely Traded Currencies. Don’t ignore these currencies, sometimes there are great opportunities. table->page 34
The chart track the base currency
The direction of the exchange rate is based on the base currency. If the base currency is gaining vs. the quote or counter currency, the chart will moving up,vice versa. The chart below illustrates the EUR/USD currency pair.
left side: The exchange rate is moving higher. This means that EUR (base currency) is rising vs. USD or USD (counter currency) is falling vs. EUR.
right side: The exchange rate is moving lower. This means that EUR (base currency) is falling vs. USD or USD (counter currency) is rising vs. EUR.
Lot size
Currencies are traded in fixed contract sizes(lot sizes). One lot is the unit of measurement (in terms of size) for a currency pair.
One Standard Lot = 100,000 Units of the Base Currency
One Mini Lot = 10,000 Units of Currency
One Micro Lot = 1,000 Units of Currency
One Nano Lot = 100 Units of Currency
Pip value
One pip is the unit of measurement (in terms of price or value) for a currency pair.
One pip EUR/USD (Standard Account) = $10 USD
One pip EUR/USD (Mini Account) = $1 USD
One pip EUR/USD (Micro Account) = 10 cents USD
One pip EUR/USD (Nano Account) = 1 cent USD
Pip calculation
The value of a pip is determined by the counter or quote currency(the second member of the currency pair), and has a fixed value in that currency. For example:
The value of 1 pip of EUR/USD:
In a standard account: EUR/USD pip = 0.0001 × 100,000 = USD $10.00 per pip
In a mini account: EUR/USD pip = 0.0001 × 10,000 = USD $1.00 per pip
In a micro account: EUR/USD pip = 0.0001 × 1,000 = USD $0.10 per pip
In a nano account: EUR/USD pip = 0.0001 × 100 = USD $0.01 per pip
The value of 1 pip of USD/CHF
In a standard account: USD/CHF pip = 0.0001 × 100,000 = CHF 10.00 per pip (One pip of USD/CHF is worth 10 CHF)
In a mini account: USD/CHF pip = 0.0001 × 10,000 = CHF 1.00 per pip
In a micro account: USD/CHF pip = 0.0001 × 1,000 = CHF 0.10 per pip
In a nano account: USD/CHF pip = 0.0001 × 100 = CHF 0.01 per pip
First currency = 1 Think of base currency as the number 1. For example, if the quote for EUR/USD is 1.5675, it means that 1 euro equals 1.5675 U.S. dollars.
If EUR/CHF exchange rate is 1.4000, then 1 EUR = 1.4 CHF
If GBP/USD exchange rate is 1.6160, then 1 GBP = 1.616 USD
If AUD/NZD exchange rate is 1.3650, then 1 AUD = 1.365 NZD
If USD/JPY exchange rate is 107.90, then 1 USD = 107.9 JPY
The pip value of USD/CHF fluctuates when it is calculated in terms of the base currency (the first member of the currency pair). For example,
One pip of USD/CHF is worth 10 CHF (fixed value)
If the USD/CHF exchange rate is 1.1400, then 1 USD=1.1400 CHF. 10 CHF= 10 divided by 1.1400 = $8.771 USD. One pip of USD/CHF is worth $8.771 USD.
If the USD/CHF exchange rate is 1.1100, then 1 USD=1.1100 CHF. 10CHF= 10 divided by 1.1100 = $9.009 USD. One pip of USD/CHF is worth $9.009 USD
Position: Long, Short, Flat
Long = a position that will benefit if the exchange rate rises Short = a position that will benefit if the exchange rate falls Flat = absence of a long or short position
Position vs Trade Your current position(long, short, or flat) is the result of the trades you have placed. For example,suppose you place a trade to buy 5 lots of EUR/USD, and 30 minutes later, you place another trade to buy 2 lots of EUR/USD. In this case, you had 2 trades, and a long position of 7 lots of EUR/USD.
Long and Short vs Buy and Sell
Long and short are more precise than buy and sell.
Long only means a position that will benefit if the exchange rate rises
Short only means a position that will benefit if the exchange rate falls
Buy can mean different things. Suppose you want to buy EUR/USD.This could mean
You want to open a long position because you think the EUR/USD will move higher.
You’ve short EUR/USD and you’re buying to close that position.
Sell can mean different things. Suppose you want to sell EUR/USD.This could mean
You want to open a short position because you think the EUR/USD will move lower.
You’ve long EUR/USD and you’re selling to close that position.
Long one, short the other
When a Forex trader long a currency pair, he/she is long the base currency and short counter or quote currency:
Long USD/CAD -> long the USD and short the CAD
Long NZD/USD -> long the NZD and short the USD
Long EUR/USD -> long the EUR and short the USD
Conversely, when a trader shorts a currency pair, he/she is short the base currency and long the counter or quote currency:
Short USD/CHF -> short the USD and long the CHF
Short GBP/CHF -> short the GBP and long the CHF
Short AUD/JPY -> short the AUD and long the JPY
As traders, we usually think of each currency pair as a single unit, just like a stock.For example, When we believe the price of a currency pair or a stock is going to rise, we would open a long position, vice versa.
In fact, we are trading the exchange rate between currencies because an individual currency can not rise and fall, it can only fluctuates in relation to other currencies. We often call the exchange rate the price of the currency pair.
Margin Requirement and Leverage
Margin: the deposit that’s required to open or maintain a position.
Used margin: the amount that’s being used to maintain or open a position
Usable margin: the amount available to open new positions or add to existing positions
Leverage. e.g. 100:1 leverage. With a $1,000 margin balance in your account and a 1 percent margin requirement, you can buy or sell a position worth $100,000.
Note that most forex brokers will close all open trades automatically when the margin balance falls below the amount required to keep the positions open. If not, traders might lose more than the money they have in their account because of leverage.
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