Traders buy and sell currencies with the hope of making a profit when the value of the currencies changes in their favor, whether from market news or events that take place in the world. The forex market is the largest market in the world with daily reported volume of over 1.8 trillion, making it one of the most exciting markets for trading.
The spot FX market is unique to any other market in the world, as trading is available 24-hours a day. Somewhere around the world, a financial center is open for business, and banks and other institutions exchange currencies every hour of the day and night with generally only minor gaps on the weekend. Essentially, foreign exchange markets follow the sun around the world, giving traders the flexibility of determining their trading day.
In this market you may buy or sell currencies. The objective is to earn a profit from your position. Placing a trade in the foreign exchange market is simple: the mechanics of a trade are virtually identical to those found in other markets, so the transition for many traders is often seamless.
Example of How FX Trade Works |
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Traders Action | Euros | US Dollar |
A trader purchases 10,000 euros in the beginning of 2001 when the EUR/USD rate was .9600. | +10,000 | -9,600 |
In May of 2003 the trader exchanges his 10,000 euro back into US dollar at the market rate of 1.1800. | -10,000 | +11,800 |
In this example, the trader earned a gross profit of $2,200 | 0 | +2,200 |
Currency Abbreviations | |
Symbol | Definition |
EUR | Euro |
GBP | Great British Pound |
USD | US Dollar |
CHF | Swiss Franc |
AUD | Australian Dollar |
CAD | Canadian Dollar |
JPY | Japanese Yen |
NZD | New Zealand Dollar |
TRY | Turkish New Lira |
ZAR | South African Rand |
In this example euro is the base currency and thus the “basis” for the buy/sell.
If you believe that the US economy will continue to weaken and this will hurt the US dollar, you would execute a BUY EUR/USD order. By doing so you have bought euros in the expectation that they will appreciate versus the US dollar. If you believe that the US economy is strong and the euro will weaken against the US dollar you would execute a SELL EUR/USD order. By doing so you have sold euros in the expectation that they will depreciate versus the US dollar.
In this example the US dollar is the base currency and thus the “basis” for the buy/sell.
If you think that the Japanese government is going to weaken the yen in order to help its export industry, you would execute a BUY USD/JPY order. By doing so you have bought US dollars in the expectation that they will appreciate versus the Japanese yen. If you believe that Japanese investors are pulling money out of US financial markets and repatriating funds back to Japan, and this will hurt the US dollar, you would execute a SELL USD/JPY order. By doing so you have sold US dollars in the expectation that they will depreciate against the Japanese yen.
In this example the GBP is the base currency and thus the “basis” for the buy/sell. If you think the British economy will continue to be the leading economy among the G8 nations in terms of growth, thus buying the pound, you would execute a BUY GBP/USD order. By doing so you have bought pounds in the expectation that they will appreciate versus the US dollar. If you believe the British are going to adopt the euro and this will weaken pounds as they devalue their currency in anticipation of the merge, you would execute a SELL GBP/USD order. By doing so you have sold pounds in the expectation that they will depreciate against the US dollar.
In this example the USD is the base currency and thus the “basis” for the buy/sell.
If you think the US dollar is undervalued, you would execute a BUY USD/CHF order. By doing so you have bought US dollars in the expectation that they will appreciate versus the Swiss Franc. If you believe that due to instability in the Middle East and in U.S. financial markets the dollar will continue to weaken, you would execute a SELL USD/CHF order. By doing so you have sold US dollars in the expectation that they will depreciate against the Swiss Franc.
Example of How Buying/Selling Works |
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Just like in all markets, there are two prices for every currency pair. The difference between these two prices is the spread, or the cost of the trade. In this example, the spread is three pips. On a mini account, a pip on the EUR/USD currency pair is worth $1. |
The margin deposit is not a down payment on a purchase of equity, as many perceive margins to be in the stock markets. Rather, the margin is a performance bond, or good faith deposit. The margin requirement allows traders to hold a position much larger than the account value.
Since the trader opened 1 lot of the EUR/USD, his margin requirement or Used Margin is $1000. Usable Margin is the funds available to open new positions or sustain trading losses. If the equity (the value of his account) falls below his Used Margin due to trading losses, his position will automatically be closed. As a result, the trader can never lose more than he/she deposits.
For positions open at 5pm EST, there is a daily rollover interest rate that a trader either pays or earns, depending on your established margin and position in the market. If you do not want to earn or pay interest on your positions, simply make sure it is closed at 5pm EST, the established end of the market day. Since every currency trade involves borrowing one currency to buy another, interest rollover charges are an inherent part of FX trading. Interest is paid on the currency that is borrowed, and earned on the one that is purchased. If a client is buying a currency with a higher interest rate than the one he/she is borrowing, the net differential will be positive – and the client will earn funds as a result. Please note that clients must be on 2% margin in order to earn funds.
Unlike the equity market, there is no restriction on short selling in the currency market. Trading opportunities exist in the currency market regardless of whether a trader is long or short, or which way the market is moving. Since currency trading always involves buying one currency and selling another, there is no structural bias to the market. Hence, a trader has an equal access to trade in a rising or falling market.
Equity markets can be used as a key indicator for movement in the Forex market. As technology has enabled greater ease with respect to transportation of capital, investing in global equity markets has become far more feasible. Accordingly, a rallying equity market in any part of the world serves as an ideal opportunity for all, regardless of geographic location. The result of this has become a strong correlation between a country’s equity markets and its currency: if the equity market is rising, investment dollars are coming in to seize the opportunity. Alternatively, falling equity markets will have domestic investors selling their shares of local publicly traded firms only to seize investment opportunities abroad.