Basics of Currency Trading

Currencies are quotes in pairs and are always quoted in buy and sell prices. The difference between the buy and sell price is referred to as the spread. The buy and sell prices are also referred to as the bid (sell) and ask (buy). The BID price is the price at which the price provider is buying at – and the trader sells at while the ASK price is the price at which the price provider is selling at – and the trader buys at. From a client’s perspective, the BID is the sell price, and the ASK is the buy price.

Each currency has a code, designated by the International Standardization Organization in Geneva, Switzerland. For the USD/JPY, the USD is the base currency and JPY is the counter currency.

Major Currencies:

EUR = Euro

GBP = Great British Pound, also named Cable or Sterling

USD = U.S. Dollar

JPY = Japanese Yen

CHF = Swiss Franc, also named Swissi

CAD = Canadian Dollar

AUD = Australian Dollar, named Auzzie

NZD = New Zealand Dollar, named Kiwi.

Exotic Currencies:

TRY = Turkish Lira

SEK = Swedish Kroc

NOK = Norwegian Kroner

DKK = Danish Kroner

MXN = Mexican Peso

ZAR = South African Rand

SGD = Singapore Dollar

HKD = Hong Kong Dollar

Prices for currencies come down to the same factors that affect all financial instruments: Supply and demand. When there are many buyers and not very many sellers, the price for this instrument or currency is very high. When there are more sellers than there are buyers, the price for this instrument or currency is very low. One of the main characteristics with the FX market is its vast flexibility, where there are many buyers and many sellers. This provides a level of liquidity not found in any other market, helping to make FX the premier trading market.

Like all financial markets, there exists a terminology traders are required to know. The following is a brief list of the more basic terms commonly used:

Basic Terminology:

Long: Holding a buy position. “I am currently long EUR/USD”.

Short: Holding a sell position. “I am shorting USD/JPY; I think it is going down.”

Flat: To have neither a long nor short position.

Floating P/L: A Profit or Loss that is not yet realized. The position is still open.

Base Currency: The first currency listed in the pair. For example, the Euro is the base currency in EUR/USD.

Counter Currency: The second currency in the pair. USD is the counter currency in EUR/USD.

Lots: The trading size in the FX market.

Pips: These are the smallest digits in the currency pair. For example, if the EUR/USD was to move from 1.3501 to 1.3502, that is an increase of 1 pip.

All currencies are traded in pairs. Consequently, when trading FX, you are always long one currency and short the other. For example, when you buy EUR/USD, you are buying Euros and selling USD. In this example, you are long EUR/USD, hoping that the Euro’s value against the USD will rise. Your profit or loss from this trade is determined by:

1) The position you have taken
2) The direction the market has moved in
3) The spread for this particular currency pair

The size of the position is determined by the number of lots traded.

Leverage

The currency market is one of the most popular markets for speculation in part due to the high degree of liquidity available. Liquidity is the term used to describe how easily trades can be entered and exited. A liquid market is where participants can execute large volume transactions rapidly with little impact on prices.

Leverage is a tool which allows clients to magnify potential returns and generate greater profits while trading in the foreign exchange market. It is a means of enhancing the value of an investment without increasing the size of the investment.

The leverage offered in the FX market is higher than in any other market. You may ask yourself, “How can the FX market offer such a high degree of leverage?”

The FX market can offer such a high degree of leverage due to the vast liquidity of the FX market, the relatively low volatility of the major currency pairs, and the security of a 24-hour trading market.

Leverage can lead to swings between profits and losses and thus should be viewed as a double-edged sword. Without proper risk management, this high degree of leverage can lead to a large loss as well as a gain.

Margin

Margin can be thought of as a good faith deposit required maintaining open positions. This is not a fee or a transaction cost, it is simply a portion of your account equity set aside and allocated as a margin deposit. Margin requirements (per 10K lot) at FXCM are determined by taking a percentage of the notional trade size plus a small cushion. A cushion is added to help alleviate daily/weekly fluctuations.

Why trade on margin?

Trading on Margin (Trading with Leverage*) is a common attraction of the Forex market. It allows you to open trades that are larger than the capital in your account.

Rollover

A unique feature of the currency market is that currencies allow you to earn profit/interest in addition to earning from the capital appreciation of the currency. When trading in the spot FX market, it is not a derivative being traded as it is with a futures contract; it is the actual underlying instrument. Accordingly, as each currency has an interest rate associated with it, each position is debited / credited when rolled over.

If the interest rate on the currency you bought is higher than the interest rate of the currency you sold, then you will earn rollover (positive roll). If the interest rate on the currency you bought is lower than the interest rate on the currency you sold, then you will pay rollover (negative roll). Rollover can add a significant extra cost or profit to your trade.

When you buy the EUR/USD pair, you are buying the euro, and selling the U.S. dollar to pay for it. If the euro interest rate is 4.00%, and the U.S. rate is 2.25%, you are buying the currency with the higher interest rate, and you will earn rollover -- about 1.75% on an annual basis. If you sell the EUR/USD pair, you are selling the currency with the lower interest rate, and you will pay rollover -- about 1.75% on an annual basis, since you are paying the euro interest rate and earning the U.S. interest rate.

When is rollover booked?

5 p.m. in New York is considered the beginning and end of the Forex trading day. Any positions that are open at 5 p.m. sharp are considered to be held overnight, and are subject to rollover. A position opened at 5:01 p.m. is not subject to rollover until the next day, while a position opened at 4:59 p.m. is subject to rollover at 5 p.m.

A credit or debit for each position open at 5 p.m. appears on your account within an hour, and is applied directly to your accounts balance.

Weekends and Holidays

Most banks across the globe are closed on Saturdays and Sundays, so there is no rollover on these days, but most banks still apply interest for those two days. To account for that, the Forex market books three days of rollover on Wednesdays, which makes a typical Wednesday rollover three times the amount on Tuesday. There is no rollover on holidays, but an extra days worth of rollover two business days before the holiday. Typically, holiday rollover happens if any of the currencies traded has a major holiday. Therefore, Independence Day in the USA, July 4, closes American banks, and an extra day of rollover is added at 5 p.m. on July 1 for all U.S. dollar pairs.

Currency Movements

Forex trading necessitates the use of fundamental as well as technical analyses. Using such analytical tools will help a trader in attempting to forecast currency trends and market changes and eventually to make profits.

Fundamental analysis is a technique used to analyze the value of a state’s currency with the help of its economic indicators, quality markets and political events and associations. Political stability is also one of the influencers of exchange rates in the Forex market. Basically, Forex trading is not merely intuitive, it’s also quite technical.

Technical analysis allows traders to understand price trends and movements, hence facilitating his/her decision-making process. The primary data in technical analysis are values: The highest or lowest values, the price for opening and closing in a definite period of time and the amount of transactions taking place. Other factors, be it economical or political, have already been measured by the market to be included in the price.