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forex training. INTRODUCTION TO FOREX
FOREIGN EXCHANGE RATES DEFINED:
A foreign exchange rate is the relative value between two currencies. More
specifically it is the required quantity of one currency to buy or sell one unit
of another currency. This is also called a pairing; EUR/USD at 1.3250 means that
one Euro can be exchanged for 1.3250 US dollars.
The pairing of currencies can also be reversed. In this case the rate expresses
how much one US dollar is worth in a foreign currency. For example, USD/JPY at
103.00, means that one US dollar buys 103.00 Japanese Yens.
A cross rate is the expression of an exchange rate that does not involve the US
dollar. The pairing EUR/JPY at 136.50 signifies that one Euro can be exchanged
for 136.50 Japanese yens.
DIFFERENT FOREIGN EXCHANGE SYSTEMS:
Flexible Exchange Rate System:
In a flexible exchange rate system the monetary authority - the central bank -
adjusts the exchange rate to affect the supply and demand for foreign
currencies.
Fixed Exchange Rate System:
In a fixed exchange rate system, the currencies are not fluctuating, instead
they are fixed to each other at a particular rate. This requires the central
bank to have a large reserve of both the domestic and the foreign currency.
Whenever there is a tendency for the market price of the foreign currency to
increase, the central bank must sell that foreign currency in amounts that can
prevent the price increase. Conversely, if the tendency of the foreign currency
is down, the central bank will have to buy the foreign currency in quantities
that will prevent the price drop. Therefore, in a fixed exchange rate system the
central bank must be ready to buy and sell its domestic currency at a fixed
price relative to the foreign currency.
AN OTC MARKET:
The Foreign Exchange Market, or "Forex" market, is the largest financial market
in the world with an average daily turnover exceeding 2 trillion US dollars
(2,000,000,000,000).
The Forex market is the arena where currencies are exchanged and traded.
Investors around the world purchase or sell one currency for another in the hope
of making a profit when the value of the currencies changes in response to
market news and events or as a result of market speculation.
It is an 'over the counter market' (OTC), which means that there is no physical
location and no central exchange and clearing hours where orders are matched.
Instead it operates 24 hours a day through an electronic network of banks,
corporations and individuals trading one currency for another.
FX traders constantly negotiate prices between one another and the resulting
market bid/ask prices are then fed into computers and displayed on official
quote screens. Forex exchange rates quoted between banks are referred to as
Inter-bank Rates.
THE DIFFERENT PARTICIPANTS OF THE FOREX MARKET
In the following we have organized the different participants of the Forex
market in a hierarchy:
The Inter-bank market accounts for the most significant portion of Forex
volumes. In this market, the largest banks deal with each other directly via
Inter-bank brokers or through electronic broking systems like Reuters. These
banks both trade as a service to their customers and for their own benefits.
The Central Banks control their countries’ money supply and they act to affect
or maintain financial stability.
International corporations are important players in the Forex market, as they
exchange big amounts of currencies.
The many travelers who need to exchange their currencies to pay for goods and
services when abroad.
Investors and speculators are becoming increasingly aware of the opportunities
within the Forex market.
FOREIGN EXCHANGE SPREADS
Exchange rates in the Forex market are quoted as 'bid/ask' rates. The difference
between the purchase (ask) and the sale (bid) rates is called the 'spread'. For
example, GBP/USD = 1.8281/84 means that the bid price of GBP is 1.8281 USD and
the ask price is 1.8284 USD. In this case the spread is 3 pips.
There may be great differences in the spread from one currency pair to the
other, depending on whether it is a weak or a strong currency as well as its
past and anticipated volatility.
Different ways to trade forex
The spot market
Forwards and Futures
Options
Spread betting
SPOT FOREX VERSUS CURRENCY FUTURES
There is a tendency for more and more traders to change from currency futures to
spot Forex. There are several reasons for this. First, spot Forex provides
better liquidity and in general lower trading costs than currency futures. In
addition, banks and brokers in spot Forex give quotes 24 hours a day. Moreover,
the spot Forex is not incurred with exchange and NFA ("National Futures
Association") fees, which are generally passed on to the customer in the form of
high commissions.
The mechanism of trading spot Forex is similar to trading currency futures.
However, an important difference is the way currency pairs are quoted. Currency
futures are always quoted as the currency versus the US dollar. For spot Forex
some currencies are also quoted as the currency versus the US dollar, while
others are quoted as the US dollar versus the currency. Forex EUR/USD is for
instance quoted the same way as Euro futures. This means that if the Euro is
strengthening relative to the US dollar, the EUR/USD will rise just as Euro
futures will climb.
However, in spot Forex the Japanese Yen is quoted as the US dollar versus the
Japanese Yen, whereas the opposite is the case for Japanese Yen futures.
Therefore, if the Japanese Yen strengthens relative to the US dollar, the spot
USD/JPY will fall, while Japanese Yen futures will rise.
The rule in spot Forex is that the first currency is always the one being quoted
in terms of direction. For example, "EUR" in EUR/USD and "USD" in USD/JPY are
the currencies being quoted. The table below shows the spot currencies that are
moving parallel to the futures and the ones moving in the inverse direction:
|
Forex
Symbol |
Currency Pair |
Futures
Symbol |
Directional
Relationship |
|
GBPUSD |
British Pound / US Dollar |
BP |
Parallel |
|
EURUSD |
Euro / US Dollar |
EU |
Parallel |
|
USDJPY |
US Dollar / Japanese Yen |
JY |
Inverse |
|
USDCHF |
US Dollar / Swiss Franc |
SF |
Inverse |
|
USDCAD |
US Dollar / Canadian Dollar |
CD |
Inverse |
|
AUDUSD |
Australian Dollar / US Dollar |
AD |
Parallel |
|
NZDUSD |
New Zealand Dollar / US Dollar |
ND |
Parallel |
ADVANTAGES OF TRADING FOREX:
Forex trading is one of the most popular and fastest growing trading methods
available. When it comes to active trading, it is hard to beat currencies and
Forex.
In the following are listed some of the benefits of currency trading:
24 hour market
The Forex market is active 24 hours a day because of the overlap between the
major markets in Europe, Asia, and the United States and in the dealing rooms
dealers are working in three shifts. Clients have the possibility to place
take-profit and stop-loss orders with brokers for overnight execution. The Forex
market opens Sunday 23:00 CET through Friday 23:00 CET, which gives traders the
opportunity to react immediately to market news and hereby determine their own
trading hours.
Liquidity
Forex trading has become increasingly popular over the past thirty years. With
an average daily volume of $ 1.5 trillion, Forex is 46 times larger than all the
futures markets combined, which makes it the world's most liquid market.
In the past, Forex trading was largely limited to huge money central banks and
other institutional traders. But over the past few years, technological
innovations and the development of online trading platforms, has also made it
possible for small traders to take advantage of the significant benefits of
trading Forex.
Leverage
Margin ratios associated with trading currencies are typically higher than those
associated with trading equities. This is primarily due to the higher levels of
liquidity within the currency market. Margin trading allows FX market
participants to trade much larger amounts than they have deposited. For example,
with a margin ratio of 20:1 and a deposit of 10,000 USD, an investor can trade
amounts of up to 200,000 USD. Trading in large volumes allows investors to take
advantage of even small price movements.
Low spreads
Currency trading offers spreads that are much lower than the ones in the
equities market (especially in after-hour markets). Historically, tight currency
spreads of 2 pips have only been available for transaction sizes of 1 million
USD or higher, but today these tighter spreads are also available for investors
trading smaller transaction sizes.
No commissions or transaction costs
A currency transaction typically incurs no commission or transaction fee besides
the quoted spread. This is in stark contrast to the equity market, where
commissions for stock trades range from 8 to 70 USD or even higher, in addition
to the quoted spread.
Profit potential regardless of market direction
An investor with an open position is by definition long one currency and short
another. If a trader believes a currency is about to depreciate, he/she sells
that currency short and goes long another currency. In the currency markets,
selling or shorting is a necessary component of completing a trade. Profit
potential exists in the FX market regardless of whether a trader is buying or
selling and regardless of whether the market is moving up or down. In the US
equity markets, short-selling is less common and more difficult to transact due
to different regulations and market rules. This makes it more difficult to make
a profit when the stock market and/or the share price for a particular stock is
going down.
Equal access to market information
Professional traders and analysts in the equity market have an important
competitive advantage in comparison with the individual trader as they have
access to important corporate information, such as earning estimates and press
releases, before it is released to the general public. This is in stark contrast
to the Forex market, where pertinent information is equally accessible to
everybody, ensuring that all market participants can take advantage of market
moving news as soon as it becomes available.
No Restrictions
No restrictions apply to the Forex market and there are very low account
balances. This means that traders can enjoy profit opportunities in all market
conditions.
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