Foreign Exchange Market (Forex) is the arena where a nation's currency is exchanged for that of another at a mutually agreed rate. It was created in the 70's when international trade transitioned from fixed to floating exchange rates, and nowadays is considered to be the largest financial market in the world because of its tremendous turnover.
Introduction to Forex
All currencies are traded in pairs and each is assigned with an abbreviation.
Here are some of them (Table 1):
EUR Euro
USD US Dollar
GBP British Pound
JPY Japanese Yen
CHF Swiss Franc
AUD Australian Dollar
CAD Canadian Dollar
NZD New Zealand Dollar
SGD Singapore Dollar
Base currency is the first currency in the pair. Quote currency is the second currency in the pair.
USD / JPY = 120.25
Base currency Quote currency Rate
This abbreviation specifies how much you have to pay in quote currency to obtain one unit of the base currency (in this example, 120.25 Japanese Yen for one US Dollar). The minimum rate fluctuation is called a point or pip.
Most currencies, except USD/JPY, EUR/JPY, CHF/JPY and GBP/JPY where a pip is 0.01, have 4 digits after the period (a pip is 0.0001), and sometimes they are abbreviated to the last two digits. For example, if EURUSD is traded at 1.2389/1.2394 the quote may be abbreviated to 89/94.
The currency pairs on Forex are quoted as the Bid and Ask (or Offer) prices:
Bid Ask
USD / JPY = 120.25 / 120.30
Bid is the rate at which you can sell the base currency, in our case it's US dollar, and buy the quote currency, i.e Japanese Yen.
Ask ( or Offer) is the rate at which you can buy the base currency, in our case US dollars, and sell the quote currency, i.e. Japanese Yen.
Spread is the difference between the Bid and the Ask price.
Pip is the smallest price increment a currency can make. Also known as a point. e.g. 1 pip = 0.0001 for EUR/USD, and 0.01 for USD/JPY.
Currency Rate is the value of one currency expressed in terms of another. The rate depends on the supply and demand on the market or restrictions by a government or by a central bank.
1.0 lot size for different currency pairs (Table 2)
Currency 1.0 lot size 1 pip
EURUSD EUR 100,000 0.0001
USDCHF USD 100,000 0.0001
EURUSD EUR 100,000 0.0001
GBPUSD GBP 70,000 0.0001
USDJPY USD 100,000 0.01
AUDUSD AUD 200,000 0.0001
USDCAD USD 100,000 0.0001
EURCHF EUR 100,000 0.0001
EURJPY EUR 100,000 0.01
EURGBP EUR 100,000 0.0001
GBPJPY GBP 70,000 0.01
GBPCHF GBP 70,000 0.0001
EURCAD EUR 100,000 0.0001
NZDUSD NZD 200,000 0.0001
USDSEK USD 100,000 0.0001
USDDKK USD 100,000 0.0001
USDNOK USD 100,000 0.0001
USDSGD USD 100,000 0.0001
USDZAR USD 100,000 0.0001
CHFJPY CHF 100,000 0.01
Spreads & Margins
Margin is the collateral required to open and maintain a position:
* 1% of transaction size for account balances below $ 100,000
* 2% of transaction size for account balances up to $ 250,000
* 4% of transaction size for account balances above $ 250,000
Balance is the total financial result of all completed transactions and deposits/withdrawals on the trading account.
Floating Profit/Loss is current profit/loss on open positions calculated at the current prices.
Equity is calculated as balance + floating profit - floating loss.
Free margin means funds on the trading account, which may be used to open a position. It is calculated as equity less necessary margin.
Calculating profit/loss
For example, EUR/USD exchange rate is 1.2505/1.2509 and your leverage is 1:100. You believe that EUR/USD will go up and buy 0.1 lot of EUR/USD at 1.2509 (Ask price) - for the contract size refer to Table 2. As we can see from Table 2, 1.0 lot of EUR/USD is 100,000 EUR, which means that 0.1 lot (our example deal size) is 10,000 EUR.
So, you buy 10,000 EUR and sell 10,000*1.2509=12,509 USD. In fact to fund this position you do not have to have 12,509 USD but only 125.09 USD. The rest of the money (in our example 12,383.91 USD) is leveraged to you by Alpari (UK).
Leverage (or gearing) mechanism allows you to open and hold a position much larger than your trading account value. 1:100 leverage means that when you wish to open a new position, then you need to support a deposit 100 times less than the value of the contract you are interested in.
For example, you believe that EUR/USD is moving higher and buy 10,000 EUR and sell 12,509 USD. Assuming you are right and EUR/USD goes up to 1.2599/1.2603 and you decide to close the position: when you close a long position you sell the base currency (10,000 EUR in our example) and buy the quote currency (10,000*1.2599 = 12,599 USD):
Transaction EUR USD
Open a position: buy EUR and sell USD + 10,000 - 12,509
Close a position: sell EUR and buy USD - 10,000 + 12,599
Total: 0 + 90
NB: When you close a short position you buy the base currency and sell the quote currency.
To fund this position you only need 100 EUR (approximately 125 USD) not 10,000 EUR. The profit on this position is 90 pips (1.2599-1.2509=0.0090). A pip or point is a minimal rate fluctuation. For EUR/USD 1 pip is 0.0001 of the price (see Table 2).
This example shows a favourable outcome. If EUR/USD had fallen you would realise a loss not a profit and with leverage this loss will be magnified. For example, if you close the position at 1.2419, your loss would be $90. Should you have doubts about your understanding of risks, please consult your financial adviser.
Lot Size is the number of base currency, underlying asset or shares in one lot defined in the contract specifications. For details refer to the Table 2.
Lot is an abstract notion of the number of base currency, shares or other underlying asset in the trading platform.
Transaction (or deal) size is lot size multiplied by number of lots.
Long Position is a buy position whereby you profit from an increase in price. In respect of currency pairs: buying the base currency against the quote currency.
Short Position is a sell position whereby you profit from a decrease in price. For currency pairs: selling the base currency against the quote currency.
Completed Transaction consists of two counter deals of the same size (open and close a position): buy then sell or vice versa.
Leverage is the term used to describe margin requirements: the ratio between the collateral and the value of the contract. 1:100 leverage means that you can control $100,000 with only $1,000 (1%).
As a result, positions are subject to a swap charge or credit based on the "Rollover/Interest Policy" webpage.
The cost of rollover is based on the interest rate differential of the two currencies. Let’s assume that the interest rates in the EU and USA are 4.25% p.a and 3.5% p.a respectively. Every currency trade involves borrowing one currency to buy another. If you have a buy position of 1.0 lot in EUR/USD, then you earn 4.25% on your Euros and borrow USD at 3.5% per year.
In other words:
* If you have a long position (i.e. bought) and the first currency in the currency pair has a higher overnight interest rate than the second currency, then you receive a gain.
* If you have a short position (i.e. sold) and the first currency in the currency pair has a higher overnight interest rate than the second currency, then you lose the difference.
* If you have a long position (i.e. bought) and the first currency in the currency pair has a lower overnight interest rate than the second currency, then you lose the difference.
* If you have a short position (i.e. sold) and the first currency in the currency pair has a lower overnight interest rate than the second currency, then you receive a gain.
Please note that if you open and close a position before 10:59:45 p.m. (London time) you will not be subject to a rollover.
The act of rolling the currency pair over is known as tom.next, which stands for tomorrow and the next day.
Why trade Forex?
Unlike other financial markets Forex has no physical location, like stock exchanges, for example. It operates through the electronic network of banks, computer terminals or via telephone. The lack of a physical exchange enables Forex to operate on a 24-hour basis, spanning from one time zone to another across the major financial centres (Sydney, Tokyo, Hong Kong, Frankfurt, London, New York etc). In every financial centre there are many dealers, who buy and sell currencies 24 hours a day during the whole business week. Trading begins in the Far East, New Zealand (Wellington), then Sydney, Tokyo, Hong Kong, Singapore, Moscow, Frankfurt-on-Maine, London and ends in New York and Los Angeles. Below there are approximate trading hours for regional markets (London time):
Japan 00:00-06:30
Continental Europe 06:30-13:00
Great Britain 8:30-15:30
USA 14:30-21:30
Forex has some advantages which make it very popular among investors:
* Liquidity. Forex is the largest financial market in the world, with the equivalent of over $3-4 trillion changing hands daily whereas traded volume on the stock markets equates to only 500 billion US dollars.
* Flexibility. Forex is a 24-hour market, which offers a major advantage over other markets, for example, stock exchanges which are only open during regional business hours. You can respond to breaking news immediately if the situation requires it and customise your trading schedule.
* Lower transaction costs. Traditionally there are no commissions or charges on Forex, except for the spread.
* Margin. Our 1:100 leverage (only for deposits below $ 100,000) is a powerful tool. You need to support a deposit of 1,000 US dollars to make a deal with $100,000. Such high leverage combined with rapid rate fluctuations can make this market profitable but at the same time risky: please see Risk Warning below.
Risk Warning
Under margin trading conditions even small market movements may have a great impact on the customer's trading account. You must consider that if the market moves against you, you may sustain a total loss greater than the funds deposited. You are responsible for all the risks, financial resources you use and for the chosen trading strategy.
This information was provided by 2004-2007 Alpari (UK) Limited
