Traders can generate profits (or losses) whether a currency is rising or falling by buying one currency, which is anticipated to gain value against another currency or selling one currency, which is anticipated to lose value against another currency. Taking a long position is one in which a trader buys a currency at one price and aims to sell it later at a higher price. Alternatively, a short position is one in which the trader sells a currency that he anticipates to depreciate and aims to buy the currency back later at a lower price.
Understanding some basics in forex
Leverage, Margin
You have access to leverage in the forex market. Leverage gives you the ability to trade a position larger than the amount of money in your account. For example, using leverage, you could place a $100,000 trade by only using $1,000 of your own money in your account.
Word of caution: leverage is a tremendous tool for traders. It allows you to make more money on trades than you normally would if you were using only your own money. However, it also allows you to lose more money on trades than you normally would if you were using only your own money.
When you trade with leverage, you have to post margin. Margin is the amount of money you have to set aside in your account when you enter a trade. For example, if you are using 100:1 leverage and you buy 1 mini lot—which is worth $10,000—you must set aside $100 as margin ($10,000 ÷ 100 = $100).
Pip
You will be using pips to determine your profits and losses in the forex market. A pip (percentage in point) or point is the smallest unit of measurement in the Forex market. Most currency pair quotes are carried out four decimal places—i.e. 1.4500. The last decimal place is called a pip. For example, if the exchange rate of a currency pair moved from 1.4500 to 1.4510, we would say that the price moved up 10 pips. You make money when the pips move your way in a trade.
There is an exception: Any exchange rate that contains the Japanese yen or the Thai baht as one of the currencies will only be carried out two decimal places. According to the International Organization for Standardization (ISO).
Currency Pair
We wouldn’t have a Forex market if we weren’t able to compare the value of one currency against the value of another currency. It is this comparison that drives prices. Forex contracts are always quoted in pairs.
One distinction you do need to make when looking at a currency pair is which currency is the base currency and which currency is the quote currency. The base currency is the first currency listed in the pairing. For example, the base currency in the EUR/USD pair is the euro because it is listed first.
The base currency is important because it is the strength or weakness of this currency that is illustrated on the chart. For example, as the chart of the EUR/USD moves higher, it means the value of the euro is getting stronger as compared to the U.S. dollar.
The quote currency is the second currency listed in the pairing. For example, the quote currency in the GBP/USD pair is the U.S. dollar because it is listed second. The quote currency is important because it is the currency in which the exchange rate is quoted.
For example: when you say the exchange rate between the British Pound and the U.S. dollar is 1.7533, you are saying it costs $1.7533 to purchase ₤1. The same principle applies to the USD/CHF pair or any other currency pair. The Swiss franc is the quote currency in the USD/CHF pair. So when you say the exchange rate between the U.S. dollar and the Swiss franc is 1.2468, you are saying it costs 1.2468 Swiss francs to purchase $1.
Bid and Ask
Each currency quote consists of two components: bid and ask, with bid always quoted first and appears on the left side of the price. For example, EURUSD is given as 1.5794/1.5796, where 1.5794 is the bid.
If you want to buy the base currency, you would trade at the ask price quoted to you. If you want to sell the base currency, you will trade at the bid price.
Stop-loss
Stop-loss function is exactly what it is – it is used to limit potential losses on your open position if the market moved against you. For example, if you opened a buy order, you can set a stop loss 20 pips less than the price of your open position. In that case, if the price of the currency pair moves down by 20 pips your position will be closed automatically.
It is recommended to trade 4 main currency pairs:
The individual trader attempts to determine trends in the price movements of currencies, and by buying or selling currency pairs, attempts to gain profits. The most often traded currencies, the major currencies, are those of countries with stable governments and respected central banks that target low inflation. Currencies that often trade along with the U.S. Dollar include the European Euro, the Japanese Yen, and the British Pound as they are the most liquid. A trader can trade these currencies in any combination.
The Euro was created on 1st January 1999 by uniting national currencies of 12 European countries. Other countries soon joined and adopted the Euro. Today the daily turnover of the EURUSD pair is 3 times larger than all equity markets (the stock exchanges) of the world combined. This makes the pair a particularly attractive trading instrument. The other 3 major pairs are:
GBP/USD, USD/JPY, USD/CHF
Another term you are likely to hear in relation to currencies is “cross”. Traditionally cross means a pair which does not include the domestic currency. However, it also means simply any pair which does not include the USD.
Depending on which time zone you are in, you may find that some regional currencies are more popular in your region then others. For example, the North American market hours usually see activity in Canadian dollar and Mexican peso, where the Asian market may concentrate on Australian dollar, New Zealand dollar and Japanese yen. In recent years, due to economic development in these countries, the Russian ruble, Chinese yuan, Indian rupee and Brazilian real became very popular among some traders.
However, let’s not forget that approximately 80% of the forex market turnover usually falls on the EURUSD pair. Especially if you are a trader with limited trading experience, you are highly recommended to concentrate on the four major pairs discussed above.
Close
Commercial banks, Central banks, Investment funds, financial institutions and individual Forex traders – each member is interested in buying at lower price and selling at a higher price. Each member has his own function in the forex market.
Central banks are responsible for the monetary policies, such as effecting currency intervention, change of the discount rates and reservation standards. Other market participants rapidly react to such measures and therefore influence the currency rates.
Commercial banks provide liquidity for their own funds and execute clients’ orders.
Brokerage companies allow individual traders to effect operations in the currency, stock and commodities markets.
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