Foreign Exchange - Forex

Forex- the overview

For active traders and investors, foreign exchange should be no different than other investment products such as equities, commodities or fixed-income. Due to globalization in the economic world and consolidation of whole economic regions (i.e., the European Union), including currencies in a portfolio helps to diversify assets and can reduce risk.

Just like other investment alternatives, foreign exchange offers traders/investors a market where they can buy or sell an investment product. In this case it is a specific Currency Pair. The currency pair may be the Euro versus the US Dollar, the US Dollar versus the Japanese Yen, the British Pound versus the US Dollar, the Euro versus British Pound, or a number of other currency combinations.

The different currency combinations represent nothing more than the value of one currency versus the value of another. That relationship is represented by a single price. In foreign exchange, the price of a currency pair is the market's expectations at the given time of the value of that currency measured against another currency given the current and expected economic and political situation in the two economies. In equity terms, which individuals are more familiar with it is the price of the stock.

Similar to equities there are other factors that determine the short term value of a currency product including technical analysis, short term supply and demand, seasonal capital flow patterns, the current price of the instrument and so on. It is these universal dynamics and topics that will move a currency's value up or down. By analyzing the pricing dynamics and combining that with sound money management and discipline, the investor can ensure greater success in his or her forex trading.


Forex - Pricing

The base currency is ALWAYS equal to one of the currency's monetary unit of exchange (i.e., 1 Euro, 1 Pound, and 1 Dollar). When an investor buys 100,000 EUR/USD, he is said to be buying (or receiving) the EURO or the Base Currency and selling (or paying for) the USD or Counter Currency. The amount of the Base Currency he is buying is equal to 100,000 Euros. Note that this is true no matter the current exchange rate at the time. The base currency amount remains constant.

The Counter Currency equivalent amount that the investor is selling (or paying), on the other hand, will fluctuate with the exchange rate for the Currency Pair. It is equal to:

(Amount of Base Currency x Market Foreign Exchange Rate)
Since the Counter Currency is the part of the currency pair that fluctuates higher or lower, it determines the strength or weakness of both currencies in a currency pair. As one currency goes up, the other must go down.
Currencies trade in fractions of a full unit. The smallest fraction is called a "pip" (click and get a little pop up page 6). Currencies trade in pips because exchanges of currencies for speculative reasons are generally for large amounts. This is because of the leverage that is available when trading Foreign Exchange.

HY Markets provides a Maximum Trading Leverage Ratio of 260:1 for mini accounts. At that ratio, a 100,000 EUR position would require $500 of Margin at an exchange rate of 1.3000. This is calculated by taking the US$ equivalent of 100,000 EUR or US$130,000 and dividing by the 260:1 leverage ratio.
Margin Required = $130,000 / 260 = $500

To determine the value of a pip for the deal above the following calculation would be made:

Value in US$ = 1.30 x Par Amount of Base Currency = $130,000
Value in US$ - a pip = (1.30 -.0001) x Par Amount of Base Currency = $129,990
The value of a pip in dollars is equal to $130,000 - $129,990 or $10.

When a currency pair goes from a low price to a higher price, the Base Currency is said to have strengthened or gotten stronger. The converse is true for the Counter Currency. That is, it has weakened or gotten weaker as the Base Currency has gotten stronger.

Since Exchange Rates represent what a fixed amount of currency is equal to in terms of another currency, we have seen there is just one price for the Currency Pair. The movement of that price determines whether a currency is getting stronger or weaker.

If the EUR/USD exchange rate goes from 1.2000 to 1.2024, we have concluded that the EUR got stronger, the USD weaker. Why?

When looking at Foreign Exchange Rates (or prices) an action to Buy the Currency Pair implies buying the Base Currency, or EUR, and selling the Counter Currency, or USD. If the EUR/USD exchange rate moves higher, as expected, the trader can now sell the EUR/USD at a dearer/higher price. The difference represents a Profit to the trader that was Long, or who bought the EUR/USD Currency Pair.
Another way of looking at it is at 1.2000, an investor/trader could exchange 1 EUR for $1.20. At 1.2100, however, that same single EUR can now be exchanged for a higher amount of USD, in this case $1.21 USD. The EUR has strengthened or gotten stronger.

One currency in a currency pair is always dominant. It is called the Base Currency. The base currency is identified as the first currency in a currency pair. It also is the currency that remains constant when determining a currency pair's price.

The Euro is the dominant base currency against all other global currencies. As a result, currency pairs against the EUR will be identified as EUR/USD, EUR/GBP, EUR/CHF, EUR/JPY, EUR/CAD, etc. All have the EUR acronym as the first in the sequence.

The British Pound is next in the hierarchy of currency name domination. The major currency pairs versus the GBP would, therefore be identified as GBP/USD, GBP/CHF, GBP/JPY, GBP/CAD. Apart from the EUR/GBP, expect to see GBP as the first currency in a currency pair.

The USD is the next dominant base currency. USD/CAD, USD/JPY, USD/CHF would be the normal currency pair convention for the major currencies. Since the EUR and the GBP are more dominant in terms of base currencies, the dollar is quoted as EUR/USD and GBP/USD.

Knowing the base currency is important as it determines the values of currencies (notional or real) exchanged when a foreign exchange deal is transacted. The Counter Currency is the second currency in a Currency Pair notation.

Advantage trading Forex

The forex trading market is an international market in which money is bought and sold freely and with no outside intervention. The prices of one currency against the other is decided solely by the participants of the market, by the laws of supply and demand. In this sense the forex market is indeed perfect in that it is a completely free market. It is also a relatively safe market, since, if anyone would want to manipulate the market or corner it, they would have to operate with tens of millions of dollars, which would be absurd.

The forex market has several advantages, which make it an ideal trading market for many people who do or do not have any knowledge of other markets. It takes only a short tutorial to have you playing like a pro. In addition, the forex market is fast. The prices can go up and down several times a day, and there is no end to the combinations that you can get. In addition, in time, with the proper training, you can become a professional Forex trader and even help other people come into the exciting world of Forex. What is best of all is that the Forex trading market is today the biggest market in the world, and there is no end to the number of trades and transactions that you can make.

Advantage of the Online Forex Spot Transactions

The Forex spot market has a huge advantage because after you see a price of a certain currency on your computer screen, you can immediately buy or sell that currency and get the current price for your trade. This gives you a spot on connection to the online Forex market, and you are sure that you are not missing anything, because it's real time.

The fact that the online Forex spot market is concurrent, allows for the many trades to take place each day, and eventually is one of the reasons why the online Forex market is a very quick option to make money. Unlike the regular stock market, the Forex market is much more dynamic, so you don't have to sit and wait for changes in your stock. You can view your currency on the spot, and if you don't like it from one minute to the next, you can go and sell it immediately and not suffer any unnecessary losses.

Accordingly, once you have noticed that the currency you invested in has risen enough, and is saturated, you can decide to sell it and reap the profits. The Forex spot market is seen in it's real time glory through the charts offered by technical analysis, so you can view the dynamics by yourself.