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Chapter 1: Forex Trading
Tom Hougaard explains the basics of Forex trading, how FX is used in global commerce and essential currency trading terms such as pips, spreads and leverage.
Introduction
Foreign exchange trading is not only the largest market in the world, with a daily turnover in excess of 3 trillion dollars. it's also the fastest growing traded market amongst private traders and speculators.
We'll be looking briefly at the history of FX, how it's used in the world of global commerce and tourism, but most importantly we want to show you how foreign exchange trading works, the terminology behind foreign exchange trading - but most importantly, how you go about placing your trades.
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In September 1992 I was due to start my university education in England. I had saved my money in Danish Kroner and had an idea of how much I would receive in Pound Sterling.
Being young and naive I had little idea of what was going on in the global markets. Almost to the hour, as I walked to the bank to instruct them to convert my life savings from Danish Kroner into Pound Sterling, drama was unfolding with the Bank of England and the legendary George Soros.
The rest is history, as they say, but as the Sterling Pound fell from grace over those hours in September 1992, I made 20% more on my conversion from Danish Kroner to Pound Sterling.
It is true when you hear traders state that timing is everything. Before we cover the area of entries and exit in the FX market, we need to cover the essentials of Foreign Exchange trading.
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The global foreign exchange market is the largest market in the world with in excess of $3 trillion daily turnover. This turnover is the result of numerous trades made between currency pairs. Currency trading involves the exchange of the value of money in one country against the value of money in another country. For example, should I decide to buy Euros, then I can do so by paying in pounds sterling.
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When you trade, you will always trade a combination of two currencies - referred to as a cross or a currency pair - in which one will be a long (bought) and the other, a short (sold) side. There are a number of reasons why people engage in currency trading. Whilst on an individual basis, many transactions are undertaken as a means of acquiring foreign currencies, e.g. for tourism purposes, other transactions are investment orientated. The principles behind these transactions are the same.
When we go on holiday we need to pay for our goods and services, so we need to exchange our own money for the local currency. Similarly, companies who deal with international business partners operate using the same principles, but on a much larger scale. Ultimately, trades that are undertaken in a foreign country need to be carried out using the local currency.
Currency trading produces the opportunity to realize a profit. Rising and falling rates of exchange present opportunities for speculators to trade on market direction. This means an investor is speculating on the prospect of one of the currencies fluctuating in value against the other. The terms trade currency and price currency are used to refer to each currency within a cross. Using EURUSD as an example, Euro is the trade (or base) currency and USD is the price (or variable) currency. The trade currency is often the one with the highest value.
Here is an example of a chart depicting the exchange between GBP and USD. GBP is the Base currency, and USD is the variable. As the USD strengthens, the exchange rate will fall. As it weakens, the exchange rate will rise. This applies at all levels of currency trading. For example, if you are going on holiday and the USD is weak, then you will be able to buy more dollars for your pound sterling.
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We should note that foreign exchange is not traded on a physical exchange as with equities and commodities. It is conducted Over the Counter (OTC). As such, currencies are categorized into three bands; Majors, Minors and Exotics. The following currencies are the most widely traded, and are referred to as the Majors:
- US Dollar (USD)
- Japanese Yen (JPY)
- Euro (EUR)
- British Pound (GBP)
- Canadian Dollar (CAD)
- Australian Dollar (AUD)
- Swiss Franc (CHF)
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Most major currency pairs are priced to four decimal places; hence the incremental movement is that of the last decimal place.
This figure is referred to as either one basis point or a pip. When, for example, you hear the expression ‘the price moved 10 pips today’, you will understand that the fourth decimal place has shown a movement of ten in a given direction.
Spreads are the difference between the buying and selling price of a currency pair or rate of exchange. These are often quoted as bid and offer prices.
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Forex trading with Saxo Bank enables traders to employ trading on margin. Trading on margin allows investors to buy and sell assets of greater value than the capital in their accounts.
For example, if your leverage is 100/1 it means that if you have a $1000 at your disposal on your trading account, you can control $100.000 worth of assets.
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You now know the basics of Foreign Exchange. You should now understand the terminology and mechanics of Forex. This concludes our Introduction to Forex.
07:09 minutes
Tags: currency pairs, currency trading, daytrading, education, forex trading, fx, pips, tom hougaard, trading