Forex - Basics

What is Forex?

Forex is a market that is used for the global exchange of goods and services in different currencies

• The market is used by international banks to balance their reserve capitals, for multi-national companies to repatriate their profits from abroad, and where speculators and hedge funds go to extract the maximum return out of short term holdings and investments
• It is the largest Financial Market in the World, with no peers
• Volume levels in Forex eclipse all global equity, bonds, commodity and treasury markets combined
• Money is traded from one currency to another as a part of necessary daily global trade and that creates a market that speculators can use to follow trends, react to economic news and profit from swings in currency values
• This market has been open to individual traders since the early 1990's and because of the advancements in technology we are able to operate in an electronic market. Anyone has the freedom to access and learn without the restrictions of a limited numbers of trades within a certain time period and without the restriction of having to hold large amounts of money in a brokerage account.

How do traders and investors use the most active, stimulating and highly leveraged Market in the world to diversify their holdings?

• In the Forex Market there are two currencies to any one trade; they are called pairs. Traders chose to buy or sell one or the other of the two currencies that make up that pair
• Trading is done directly through the Inter Bank Market, in other words, electronically via either a broker or directly through an international bank, and as such, fills are instant, trades can be closed at will and the market is guaranteed by the international banking system

Main Currencies

Symbol Country Currency Nickname

USD United States Dollar Buck

EUR Euro members Euro Fiber

JPY Japan Yen Yen

GBP Great Pound Cable

CHF Switzerland Franc Swissy

CAD Canada Dollar Loonie

AUD Australia Dollar Aussie

NZD New Zealand Dollar Kiwi

Majors

The above are referred to as the major currencies which have good daily volume and are easy to buy and sell. Every country around the world has a currency that can be traded, not all however, have decent daily volumes, and some lack liquidity to such a degree that they are used only by specialists for very specific reasons.

A currency pair that has good volume but does not include the US$ on one side of it or the other can be referred to as an exotic pair, they are regularly traded but not to the degree of the major currencies.

Base Currency

The first named currency on any Pair is called the base currency. For example: USD(US$)/CHF(Swiss Franc) has the USD first, that makes it the base currency.

If the quoted price of USD/CHF is 1.2250 it means that $1 is equal to 1.2250 Swiss Francs. If the AUD(Australian$)/USD is quoted as 0.8200 it means that 1 Australian Dollar is equal to $0.82.

Pips

‘Pips’ are Price Interest Points and are the units in which a currency pair moves. On a daily basis the US$ may move 50 Pips up against the Euro, which equates to a move that would look like this: Starting price is $1.3020, finishing price would be $1.3070. You can see that the 50 pips were less than a one cent move on the dollar, in fact 50 pips would equal half of a cent.

Bid & Ask

The bid price is the amount that the market is offering you for your pair that you are holding. A trader will sell their holding at the bid price (as an example going long on a pair). The ask price is what the market is asking you to pay to open a position (as an example going long on a pair). For short trades the bid and ask are reversed. (When going long you buy at the ask to open a position/ When going short you sell at the bid to open a position).

Spread

The spread is the difference between the bid and the ask price. The more daily volume in a Pair, the smaller the spread becomes. Major pairs tend to have a spread of between 3-5 pips.

Lots

Each purchase of foreign exchange pairs is done in lots; it is the unit amount that the market uses to trade currencies. One mini lot is the smallest denomination that a trader can purchase and that will cost about $60 of the money that a trader has in their brokerage account on average, (or only $25 if a trader choses a broker that offers 400:1 leverage). 1 pip of price movement will increase 1 mini lot’s value by $1 on average.

Standard Lots are the equivalent to 10 Mini Lots, 1 Pip of price movement will increase the Standard Lot by $10. One Standard Lot will cost about $600 of the money that a Trader has in their Brokerage account on average.

Leverage

Trading a Commodity that moves less than 1c a day seems worthless as a Trader; that is why the Markets offer leverage of 100:1. Leverage allows a Trader to open a Brokerage account with as little as $500-1000 and to still be able to make potentially worthwhile gains out of such tiny price moves.

Margin

When you open a new Brokerage account with a Forex Broker, you must deposit a minimum amount that is referred to as your Margin Amount. This minimum varies from broker to broker and can be as low as $500 in some cases. Each time you execute a new trade, a certain percentage of the account balance in the Margin Account will be set aside as the initial margin requirement for that new trade. That amount is based upon the underlying currency pair, its current price, and the number of units (or Lots) traded.

As an example, a Trader opens a Mini Account which provides 200:1 leverage or 0.5% Margin. Mini Accounts trade Mini lots. Let’’s say one Mini lot equals $10,000 of currency. If you were to buy one Mini Lot, instead of having to provide the full $10,000, you would only need to provide $50 ($10,000 x .5 = $50). Each currency Pair has a slightly different Margin requirement to purchase 1 Lot, dependent on the current price of the underlying currency. Each Broker will provide differing rates of Margin requirements, the norm is 100 or 200:1.

Interest Earned

Each currency Pair either pays you to hold it or charges you to hold it depending on the overnight Interest Rate that each country has. For example if the US Interest Rate was 4.00%, and the Japanese Interest Rate was 0.5% therefore Buying a USD/JPY Pair will pay you Interest if you hold the position past 5pm each day. Conversely Selling a USD/JPY Pair will charge you Interest for holding it past 5pm each day.

A Forex Trader is very much aware of the Interest Rates that each economy has and therefore is in a position to add the Interest charges into their potential trade plans.

Market Times

The Forex Market opens on a Monday Morning in New Zealand; that is 5pm EDT on Sunday in the US, and closes at 4pm EDT on the following Friday. A continuous flow of activity across the Globe in the exchange of goods, services and currencies allows plenty of opportunity for Traders to operate on their own daily time scale, unlike the Equity, Commodity and Treasury Markets that open and close each day.

The main price movement in the Forex Market happens when London opens for trading. The UK dominates the amount of Forex Trade from the London opening at 02:00 EDT until the US session slowing down at 1pm EDT the following afternoon. It is during this window we see the most price movement.