In this section:
What is forex?
"Forex" stands for foreign exchange; it is also known as FX. In a forex trade, you buy one currency while simultaneously selling another - that is, you exchange the sold currency for the one you are buying. Foreign exchange is essentially an over-the-counter market.
Currencies trade in pairs, like the Euro-US Dollar (EUR/USD) or US Dollar-Japanese Yen (USD/JPY). Unlike stocks or futures, there is no centralised exchange for forex. All transactions happen via phone or electronic network.
Who trades currencies and why?
Daily turnover in the world's currencies comes from two sources:
Foreign trade comprises 5% of total volume. Companies buy and sell products in foreign countries and convert the profits of foreign sales into domestic currency.
Speculation for profit amounts to 95% of total volume. Both Hedge Funds and individuals use the currency market to cover existing positions and take a speculative view on where the market could go.
Most traders focus on the biggest, most liquid currency pairs. "The Majors" include the US Dollar, Japanese Yen, Euro, British Pound, Swiss Franc, Canadian Dollar and Australian Dollar. In fact, more than 85% of daily forex trading happens in the major currency pairs.
Forex is the world’s most traded market, trading 24-hours a day
With an average daily turnover of US$3.2 trillion, forex is the most traded market in the world. It is a true 24-hour market. Forex trading officially begins in Sydney, and moves around the globe as the business day begins, first to Tokyo, then London, and ends in New York. Unlike other financial markets, investors can respond immediately to currency fluctuations, whenever they occur - day or night.
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Understanding forex quotes
Reading a foreign exchange quote is simple, if you remember two things:
The first currency listed is the base currency.
The value of the base currency is always one (1).
At the centre of the forex market is the US Dollar (USD), which is usually considered the base currency for quotes. If the base currency is USD, then the quote will inform you what the US Dollar is worth in the other currency you are considering.
Should USD be the base currency and the quote increases, it means the USD has strengthened in value and the other currency has weakened. Rising quotes mean a US Dollar can buy more of the other currency than before the price was increased.
Majors not based on the US Dollar
The three exceptions to the rule discussed above are the British Pound (GBP), the Australian Dollar (AUD) and the Euro (EUR). For these pairs, where the USD is not the base currency, a rising quote means the US Dollar is weakening and will buy less of the other currency than before.
In other words, if a currency quote increases, it shows that the base currency is strengthening. A lower quote means the base currency is weakening.
Cross currencies
Currency pairs that do not involve the USD are called cross currencies, but the premise covered in the point above remains the same.
Bids, asks and the spread
Just like other markets, forex quotes consist of two sides, the bid and the ask:
The BID is the price at which you can SELL base currency.
The ASK is the price at which you can BUY base currency.
What is a pip?
Forex prices are often so liquid that they are quoted in tiny increments called pips, or "percentage in points". A pip refers to the fourth decimal point out, or 1/100th of 1%.
For Japanese Yen, pips refer to the second decimal point. This is the only exception among the major currencies.
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Leverage and margin
Leverage trading, or trading on margin, means you are not required to put up the full value of the position.
Forex trading offers more leverage than stocks or futures - up to 200 times the value of your account. Keep in mind, however, that increased leverage also increases your risk.
Standard FX Trader has no debit balances and no margin calls
At Standard FX Trader, your risk is only limited to the funds on deposit. Our margin policy eliminates concerns about debit balances by guaranteeing that you will never owe more than you have in your account.
More leverage means more opportunity and more risks
It is crucial to remember that increasing leverage increases risk. To limit downside risk, we recommend that you monitor your account regularly and use stop-loss orders on every open position.
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For convenience, most online trading platforms automatically calculate the Profit and Loss (P&L) of a trader’s open positions. It may be useful for you to understand how this calculation is formulated.
A forex trade is illustrated in the following two examples:
Example 1
Let us assume that the current bid/ask for EUR/USD is 1.46160/190. At this rate, you could buy one (1) Euro for 1.46190 or sell (1) Euro for 1.46160.
If you decide that the Euro is undervalued against the US Dollar, you would execute your strategy by buying Euros (and simultaneously selling dollars), and then waiting for the exchange rate to rise.
You would therefore make the following trade: to buy 100,000 Euros you would pay 146,190 dollars (100,000 x 1.46190). Remember, at a 1% margin, your initial margin deposit would be approximately US$1,461 for this trade.
As you expected, the Euro strengthens to 1.46230/260. In order to realise your profits, you would sell 100,000 Euros at the current rate of 1.46230 and receive US$146,230.
You bought 100 K Euros at 1.46190, paying US$146,190. Then you sold 100 K Euros at 1.46230, receiving US$146,230. This equates to a difference of four (4) pips, or in dollar terms (US$146,190 - 146,230 = US$40).
Your total profit would amount to US$40.
Example 2
Using the same example, let us assume that you once again bought EUR/USD when trading at 1.46160/190. You bought 100,000 Euros and paid 146,190 dollars (100,000 x 1.46190).
However, after your purchase the Euro weakened to 1.46110/140. In order to minimise your losses, you sold 100,000 Euros at 1.46110 and received US$146,110.
You bought 100K Euros at 1.46190, paying US$146,190. You sold 100K Euros at 1.46110, receiving US$146,110. That represents a difference of eight (8) pips, or in dollar terms (US$146,190 - US$146,110 = US$80).
Your total loss in this scenario would have been US$80
