What is Forex?
It may be easily noticed that the value of currencies fluctuates on a regular basis. However, many don’t realize that this a foreign exchange market (Forex), whereby potential profit can be made from fluctuations of these currencies. The most famous example who made a billion dollars in a day by trading currencies is George Soros. However, currency trading involves significant risks and individuals can lose a substantial part of their investment. As era of technological advancements has emerged, Forex market has become more affordable and as a result led to inevitable growth of online trading. One of absolute advantages in currencies trading nowadays is that there is no longer need to be a big money manager to trade currencies; small traders and investors can trade this market.
Who trades Forex?
Anyone can trade Forex regardless of level of experience and geographical location. Because Forex trading has no centralized market place, it operates 24 hours a day from Monday to Friday and all trading is carried out via online trading platforms. Trading on the Forex market is one of the most worthy investments available. Buying and selling of currency is conducted in currencies pairs. For example, if you buy the EUR/USD at lower price and you sell it at a higher price, profit is made on such a price movement. If, again, a trader purchased 1000 USD (US dollars) last year and the equivalent at the time was 800 Euros, this year the value of the USD may be 900 or 700 Euros (EUR). If you decide to sell now, you will lose or earn 100€ accordingly. A trader can trade Forex via online trading platform and these are provided by Forex brokers. The platforms offered by FX brokers differ in features and styles, and the brokers are responsible for providing brokerage services to traders that will allow them to trade. The trader is usually offered a choice of different types of accounts, trading platforms, trading tools along with other specific trading conditions. The Broker company is responsible to assist clients with trading strategies available and provide the best prices in the market to facilitate trading process.
How do I manage risk in FX Trading ?
The most widespread risk management tools in Forex trading include “limit” order and “stop loss” order. A “limit” order sets the maximum price to be paid or the minimum price to be received. A “stop loss” order ensures that a specific trading position is liquidated at a predetermined price so to limit possible losses in case that the market moves against the trader’s opened position. Contingent orders may not limit the risk for potential losses.
FX Currency prices are always presented in the form of a Bid/Ask spread. The spread is the difference between the Bid and the Ask. The Bid is the price which a trader is able to sell a currency pair for. The Bid price (“Sell”) in a given currency pair is always the lower price in a quote. The Ask price (“Offer”) in a given currency pair, is the price which traders are able to buy a currency pair for.
“PIP” stands for “Point In Percentage”. More simply, a pip in the currency market is referred to the “point” for calculating profits and losses. In a standard (10k) account, each pip is worth approximately one unit of currency in which trader’s account is denominated. If trading account is denominated in USD, each pip (depending on the currency pair) is worth about $1. In a micro account, each pip is worth somewhere 1/10th the amount it would be worth in a standard account (about $0.10). In all currency pairs which have the Japanese Yen (JPY), a pip is the 1/100th place (2 places to the right of the decimal). In all other currency pairs, a pip is the 1/10,000 the place (4 places to the right of the decimal).
How to read Price Quotes?
When a currency is quoted, it is done so in relation to another currency, so that the value of one is reflected through the value of another. Therefore, if you are trying to calculate the exchange rate between the U.S. dollar (USD) and the Japanese yen (JPY), the quote would look like this: USD/JPY=118.49 This is referred to as a currency pair. The currency to the left of the slash is often referred to the “base currency”, while the currency on the right is called the “quote” or “counter currency”. The base currency (in this case, the U.S. dollar) is always equal to one unit (in this case, US$1), and the quoted currency (in this case, the Japanese yen) is what that one base unit is equivalent to in the other currency. The quote means that US$1 = 118.49 Japanese yen. In other words, US$1 can buy 118.49 Japanese yen. So, two things to remember: The first currency listed is the “base currency”. The value of the “base currency” is always 1 (one).
If inflation of any given country is relatively lower than elsewhere, then this country’s exports will become more attractive and there will be an increase in demand for its currency to buy goods. Also foreign goods will be less competitive and so its citizens will buy fewer imports. Therefore countries with lower inflation rates tend to see an appreciation in the value of their currency.
If a country’s interest rates rise relative to elsewhere, it will become more attractive to deposit money in such a country. Therefore demand for this currency will rise. Higher interest rates cause an appreciation.
If speculators believe that a currency will rise in the future, they will demand more now to be able to make a profit. This increase in demand will cause the value to rise. Therefore movements in the exchange rate do not always reflect economic fundamentals, but are often driven by the sentiments of the financial markets. For example, if markets see news which makes an interest rate increase more likely, the value of this currency will probably rise in anticipation.
Change in Competitiveness
If country’s goods become more attractive and competitive this will also cause the value of the Exchange Rate to rise. This is important for determining the long run value of the currency. This is similar factor to low inflation.
. Relative strength of other currencies
In 2010 and 2011, the value of the Japanese Yen and Swiss Franc has gone up because markets were worried about all the other major economies – US and EU. Therefore, despite of low interest rates and low growth in Japan, the Yen kept increasing its value.
Balance of Payments
A deficit on the current account means that the value of imports (goods and services) is bigger than the value of exports. If this is financed by a surplus in the capital account, there is no problem whatsoever. But a country that struggles to attract enough capital inflows to finance its current account deficit will notice a drop in its currency value.
Under some circumstances, the value of government debt can influence the exchange rates. If markets expect a government to default on its debt, investors will start selling their bonds, which will cause a decrease in the value of the exchange rate. For example, Iceland financial problems in 2008 provoked instant decrease in the value of its domestic currency.
FX Currency Pairs
The reason for currency pairs to exist is that if we all had one single currency, we would have no way of measuring its relative value. By pairing two currencies against each other, the fluctuating value can be established for one currency against another. Currency Pairs which don’t contain a US dollar in it are commonly named as “Cross Currency Pairs”. Trading Cross Currencies offers entirely new aspects of foreign exchange market to speculators. There are cross currencies that move very slowly and are quite stable. Other cross currency pairs move rather quickly and are extremely unstable with average movements exceeding 100 pips a day.