GBHJ GLOBAL: Forex Trading 101

Friday 26 June 2015

Forex Trading 101

The Forex is the foreign currency exchange market. This market functions like any other, only the commodity is the actual currency of different countries. The same basic rules apply: buy low (when a currency is depreciating), sell high (when it is appreciating). It is a 24-hour market that runs from Sunday 5 p.m. E.T. to Friday 5 p.m. E.T., starting in Sydney, Australia, and moving across the planet.

The main reason people trade on the Forex market is speculation – to make a profit. A small percentage of Forex transactions come from foreign trade between nations and conversion of trade profits into domestic currency.

How to Read Codes and Rates

To begin, you need to know the currency code for each country. As 85 percent of all Forex trading happens among the major currency pairs, the most important currency codes are the USD (United States Dollar), GBP (Great Britain Pound), JPY (Japanese Yen), EUR (the Euro), CHF (the Swiss Franc), CAD (the Canadian Dollar), and AUD (the Australian Dollar).

A currency pair consists of two country codes. The first currency listed is the base and the second is the counter or quote. In the example GBPUSD, the British Pound is the base and the American Dollar the counter.

The base currency always has a value of 1. If the quote increases or goes up, the base currency strengthens in value, the other currency weakens, and the base can now buy more of the other currency. Many complex factors affect the price fluctuations.

Rates are five digit ratios of currency units. For example, GBPUSD= 1.7546 shows the number of American Dollars you would have to pay for one British Pound. In this case, one pound costs about $1.75 American Dollars.

Understanding PIP

PIP is short for the Price Interest Point or Percentage In Point. It is the fourth decimal place out (1/100th of 1 percent) in the increment of movement. The only exception to this rule involves the Japanese Yen, which is only reported to two decimal places.

Take the example GBPUSD= 1.7546 once again. If the number increases to 1.7547, it has moved one point. When the number increases, the first currency appreciates by one point and the second depreciates by one point; so here, the GBP appreciated and the USD depreciated

Bid/Ask

The bid price is the price at which the broker or buyer is willing to buy. The ask is the price at which the broker or seller is willing to sell. The bid is always lower than the ask.

Currency pairs will usually be listed with a bid and an ask price. Here are two ways the listing may appear: GBPUSD 1.7546/49 or GBPUSD 1.7546/9. Both mean the bid is 1.7546 and the ask is 1.7549.

If, for example, you believe the USD is losing value, you can choose to buy GBP/USD. As one currency falls in value, it takes more of that currency to equal the other. If a currency is low and expected to appreciate in value, an investor can buy that currency while it is low and sell it high later, once it appreciates, for a profit.

When you execute a buy, you have opened a position. When you sell, you close that position.

Margin Trading

Margin trading uses leverage provided by a broker. This can be extremely dangerous and risky. Leverage works like a loan and only a margin deposit is required. You will not need to put up the full value of the position you want to take.

In Forex trading, 100:1 is the most common (with brokers offering from 50:1 to 400:1), so your margin deposit of $1,000 (initial balance) is capable of trading with $100,000.

Margin Call

If you use an account with no debit balance, you will experience margin calls if you owe more than is in your account. A margin call occurs when your position experiences losses that equal your actual account balance (the $1,000 intial balance above, for example). A margin call is issued, the position is closed, and the brokerage liquidates your account. The more leverage you work with, the greater possible gains and the greater the risk.

Choosing a Brokerage

U.S. firms undergo more scrutiny and are subject to more laws than some foreign brokers, which usually make them a far safer choice when searching for a brokerage firm. Look to make the best deal for yourself by comparing account details. Ideally, you want a better spread – the difference between the value of the currency pair and what the brokerage charges (instead of a commission), lower account minimums, varying leverage, and the most convenient type of funding the firm will accept for the account.

Practice trading accounts are usually available and it is advisable to use one for extensive practice before investing real money.