Forex Trading Basics ©
The global foreign exchange market is the biggest market in the world. There are many reasons for the popularity of foreign exchange trading, but among the most important are the leverage available, the high liquidity 24 hours a day and the very low dealing costs associated with trading currency.
Of course many commercial organizations participate purely due to the currency exposures created by their import and export activities, but the main part of the turnover is accounted for by financial institutions. Investing in foreign exchange remains predominantly the domain of the big professional players in the market.
In the following, we would like to introduce you to some of the basic concepts of foreign exchange trading. If you would like any further information, we suggest that you sign up for a FREE Membership on any of the web''s currency forex trading sites.
Foreign exchange is normally traded on margin. A relatively small deposit can control much larger positions in the market. For trading the main currencies, a 1% margin deposit is customary. This means that in order to trade one million dollars, you need to place just USD 10,000 by way of security.
In other words, you will have obtained a gearing of up to 100 times. This means that a change of, say 2%, in the underlying value of your trade will result in a 200% profit or loss on your deposit. As you can see, this calls for a very disciplined approach to trading as both profit opportunities and potential risks are very large.
Base Currency and Variable Currency
When you trade, you will always trade a combination of two currencies. For example, you will buy US dollars and sell Euro. Or buy Euro and sell Japanese yen, or any other combination of dozens of widely traded currencies. But there is always a long (bought) and a short (sold) side to a trade, which means that you are speculating on the prospect of one of the currencies strengthening in relation to the other.
The trade currency is normally, but not always, the currency with the highest value. When trading US dollars against German marks, the normal way to trade is buying or selling a fixed amount of US dollars, i.e. USD 1,000,000. When closing the position, the opposite trade is done, again USD 1,000,000. The profit or loss will be apparent in the change of the amount of Euro credited and debited for the two transactions. In other words, your profit or loss will be denominated in Euro, which is known as the price currency.
This way of trading is different to the futures markets, for example, where the marks, francs and yen are the fixed trade currency, resulting in a US dollar denominated profit or loss. You can, however, also choose to trade in this reciprocal manner in foreign exchange markets but it is not the norm.
When trading foreign exchange, you are quoted a dealing spread offering you a buying and a selling level for your trade. Once you accept the offered price and receive confirmation from our dealers, the trade is done. There is no need to call an exchange floor. There are no other time-consuming delays. This is possible due to live streaming prices, which are also a great advantage in times of fast-moving markets: You can see where the market is trading and you know whether your orders are filled or not.
The dealing spread is typically 3-5 points in normal market conditions, e.g. USD/EUR 1.7780-85. This means that you can sell US dollars against the Euro at 1.7780 and buy at 1.7785. There are no further costs, commissions or exchange fees.
This ensures that you can get in and out of your trades at very low slippage and many traders are therefore active intra-day traders, given that a typical day in USD/EUR presents price swings of 150-200 points.
Although a forward trade is for a future date, the position can be clod out at any time - the closing part of the position is then swapped forward to the same future value date.
Different currencies pay different interest rates. This is one of the main driving forces behind foreign exchange trends. It is inherently attractive to be a buyer of a currency that pays a high interest rate while being short a currency that has a low interest rate.
As you can see, there are significant opportunities and risks in foreign exchange markets. Aggressive traders might experience profit/loss swings of 20-30% daily. This calls for strict stop-loss policies in positions that are moving against you.
Fortunately, there are no daily limits on foreign exchange trading and no restrictions on trading hours other than the weekend. This means that there will nearly always be an opportunity to react to moves in the main currency markets and a low risk of getting caught without the opportunity of getting out. Of course, the market can move very fast and a stop-loss order is by no means a guarantee of getting out at the desired level.
For speculative trading, we always recommend the placement of protective stop-loss orders. With currency forex trading sites on the Internet, you can easily place and change such orders while watching market development graphically on your computer screen.