Forex

What is Forex ?

Have you ever exchanged your currency to go on a trip? If you did, whether you knew it or not you were trading forex. Due to easily available, high speed interned forex trading, for speculation purposes, is becoming significantly more and more popular to the retail crowd. There are many names for forex trading, here are just a few examples so you don’t get confused as you read along. Forex Trading is also known as Foreign Exchange Trading, Currency Trading, FX Trading and the list goes on and on.

The simple definition of forex trading is the simultaneous selling of one currency and the buying of another. Forex Trading can be done for both business and speculation purposes. For example of a business forex transaction is a company buying a resources in a foreign country exchanging their currency into the other country’s currency.

An example of speculation is an individual expecting a particular currency to appreciate relative to another therefore buying one and selling the other simultaneously. To take this example one step further you may think that the Euro will appreciate relative to the US Dollar, thus you will buy Euros and sell US Dollars. If the value of the Euro goes up you can sell your Euros back for the US Dollars and lock in your profit. If the value goes down you will incur a loss.

To sum it up, the retail forex market allows you to speculate on the price movements of various currency pairs around the world. The Forex market is the largest market in the world. The average daily volume in the forex market is around $5 trillion per day. Over 90% of this volume is traded for speculation purposes. There are many participants in the forex market including: banks, commercial companies, central banks, investment management firms, hedge funds, retail Forex brokers and individual traders.

Until the late 90’s it was difficult for retail traders to speculate in the forex markets. Minimum investments were typically as high as $10 million. Through the development of retail Forex brokers and the internet retail spot FX now makes up over 10% of the Forex market. You can trade forex online for speculation purposes with as little as $200 in your account from you home computer.

Forex specifications incorporate the individual contract details and the conditions under which they can be traded.

Margins – the amount of your equity required to open a trading position.

Spreads – the difference between the bid and ask price for a currency pair.

Swaps – the interest rate calculation representing the cost or reward of holding open positions overnight.

Levarage – Buying Power

Majors, Minors and Exotics pairs

Majors are currency pairs that are primarily traded in the Forex market. Often they are quoted against the USD as is market convention; in these terms, the USD is the base currency. Liquidity is deep and spreads are tight, giving excellent short-, medium- and long-term trading opportunities. The trading volume of majors exceeds two thirds of the total estimated volume in Forex.

Minors are less frequently traded or secondary currency pairs. Generally these instruments have less liquidity but are still traded heavily in the financial markets. They will also include crosses, a term for currency pairs that include major traded currencies against each other but without the USD as the base.

Exotics are currency pairs that are not widely traded or are derived from emerging markets. Exotics still provide trading opportunity, but spreads are often wider and therefore less attractive to high-frequency intraday traders. Interest rate differentials can be greater and will often attract trading based around favourable swaps.

Pip Values

A pip is the value of the fourth decimal in the exchange rate of a currency pair; this does not apply to JPY and HUF currency pairs (for these pairs a pip is the value of the second decimal). At AzTrades, the smallest incremental movement equals to 0.1 pip.

Calculating Profit and Loss

AZtrades platforms will calculate your profit or loss and display it for each open and closed trade reflected in the currency in which you hold your account. It is important to be able to work out your own projected profit and loss which can be relatively easy to do.

Leverage

One key aspect of forex trading is the leverage involved. Many forex dealers offer 1:100* leverage, some dealers offer leverage as high as 1:400 (please note: The maximum leverage allowed in AZtrades is1:400). What this means is that for every dollar you put in you are actually controlling $400 dollars worth of currency.

Currency pairs are traded in lots and the lots allow for you to take leveraged positions to speculate on the value of various currency pairs. There are typically 3 types of lots; standard lots, mini lots and micro lots.

With a standard lot you are taking on a position where every pip is roughly $10, with a mini lot every pip is roughly $1 and with a micro every pip is roughly 10 cents.

Leveraged trades case study

Assume You have €10,000 equity in your trading account and you anticipate the EUR will depreciate against the USD. To reflect this opinion you need to open a trade where you sell EUR against USD, consider the current quote is 1.4848/1.4850. You consider that you are fairly confident in this prediction and will use a trade amount of 1 Lot (€100,000) and so you Sell 1 Lot EURUSD at the bid price of 1.4848. The maximum permitted leverage for your account value is 1:400, or expressed as margin is 0.25%. The margin requirement for the trade is therefore €250.

Later in the day and as you predicted, the EURUSD price falls to 1.4798/1.4800 and to close the position you Buy back 1 lot EURUSD at 1.4800. The trade has made a profit of 48 pips, that’s $480 or €324.30.

Swap Rates

Another important component to remember when trading forex is the SWAP (Also known as rollover) rates. As mentioned before when trading a currency pair you are borrowing the bottom pair and purchasing and holding the top pair. So if you are trading the GBP/JPY you are actually purchasing the GBP and borrowing the Yen.

As you know, when holding a currency in an account you are receiving interest and when borrowing a currency you are paying interest. Because forex trading is highly leveraged and you are theoretically controlling large amounts of money, the SWAP rates accumulate and need to be accounted for in your trading. Typically forex dealers either pay or charge you the SWAP rate depending on the position you are holding.

Let’s look at the GBP/JPY example. When taking a position in the GBP/JPY you are borrowing the Japanese Yen at a low interest rate and using it to purchase the Sterling which pays a higher interest; so when you are long this pair you will receive daily interest from AZtrades and when you are short you will be paying daily interest. AZtrades will always charge a little more than they pay when it comes to rollover rates in exchange for facilitating the process.

Available trading Currency pairs at AZtrades.