How to trade forex?
The Forex market
The Foreign exchange market (Forex or FX) is the market in which a currency is exchanged or traded against another currency.
The Forex market is the largest and most liquid financial market in the world. It is an exchange on which financial institutions, central banks, multinational corporations, governments, and currency speculators and investors all trade foreign currencies.
The Forex market has no physical location and no central exchange. It operates through a global network of banks, corporations and individuals trading one currency for another. The lack of a physical exchange enables the Forex market to operate on a 24-hour basis, spanning from one zone to another in all the major financial centers.
Forex Trading – Trading of currency pairs
How is Forex traded? The price of a currency, such as the euro, fluctuates relative to another currency, such as the US dollar - currency pairs are always priced and traded in pairs. A Forex trade or transaction consists of buying a currency and selling another currency at the same.
For example, you believe that the US economy is strengthening compared to the Japanese economy? You can buy USD/JPY (i.e. buying the US dollar and sell the Japanese yen). If you however believe that the US economy is weakening compared to the Japanese one, you can sell USD/JPY (i.e. sell the US dollar and buy the Japanese yen).
Major currency pairs are currency pairs that have the US dollar crossed with one of the following: Euro; Japanese yen; British pound; Swiss franc; Canadian dollar; Australian dollar; New Zealand dollar. Over 80% of the Forex trading market consists of trading of the major currency pairs.
| Currency pair | Base currency | Counter currency |
|---|---|---|
| EUR/USD | Euro | US dollar |
| USD/JPY | US dollar | Japanese yen |
| GBP/USD | British pound | US dollar |
| USD/CHF | US dollar | Swiss franc |
| USD/CAD | US dollar | Canadian dollar |
| AUD/USD | Australian dollar | US dollar |
| NZD/USD | New Zealand dollar | US dollar |
Exotic currency pairs are currency pairs that include the US dollar with any other currencies other than the major currencies mentioned above, for example, Swedish krona, Singapore dollar, or the Mexican dollar. Other examples of exotic currency pairs (MPO).
Currency Crosses are currency pairs that include currencies other that US dollar, for example, the euro with the British pound (EUR/GBP). Examples of cross currency pairs(MPO).
Why do currencies move ?
The potential of making money in Forex trading arises when prices of currency prices move up or down.
Since the market is always moving, there are always trading opportunities, whether a currency is strengthening or weakening in relation to another currency. A trader has the ability to sell short a currency with the expectation that it will weaken versus another and buy it back more cheaply later and make a profit.
It is important for a trader to have an understanding of why currencies move. Currencies are a reflection of a country's economic performance. If investors believe that the euro zone economy is strengthening at a faster pace than the U.S. economy, they will buy the euro and sell the US dollar. In fact, if the euro zone economy is strengthening, euro interest rates may raise which in turn increases the attractiveness of the euro, the demand for euro, and the price of euro in relation to other currencies. It is such demand and supply of currencies created by investors that make currencies move up and down.
There are multiple signs of a strengthening or weakening economy such as the rate of consumer price inflation, interest rates, or the rate of growth of GDP. Economic indicators (summarized list in MOP) are such economic data that reflect the fundamentals of an economy. Forex traders follow these data closely as they impact currency prices and create opportunities for traders. Fundamental analysis is the analysis of such economic factors that impact a specific economy and is explained separately.
BASICS OF FOREX TRADING
How is a currency pair quoted ?
The first currency (in this case the euro) is referred to as the base currency and the second one is referred to as the counter currency (in this case the US dollar).
Currency pairs always have 2 prices: the sell price (or bid) and the buy price (or ask). If you are selling the pair, you are selling the base currency and buying the counter currency. If you are buying the pair, you are buying the base currency and selling the counter currency.
The price of a pair is the value of the base currency quoted in the counter currency. So in this case, the value of 1 euro is 1.36701 US dollar if you Sell EUR/USD and 1.36715 if you buy EUR/USD.
The difference between the buy and sell price is the spread – in this case it is 1.4 pips (1.36715 – 1.36701).
Pips; Fractional pips; Spread
A pip stands for "percentage in points". A pip is the 4th number after the decimal point. It is 1/100 of 1% or 1/10'000. For all Japanese yen pairs, such as USD/JPY or EUR/JPY, a pip is the 2nd number after the decimal point. In table below, pips have been marked in red.
| Currency pair | Sell (Bid) | Buy (Ask) | Spread | Value of a pip for a 10'000 position | Cost of spread |
|---|---|---|---|---|---|
| EUR/USD | 1.36701 | 1.36715 | 1.4 pips | 10'000 x 0.0001 = 1 USD | 1.4 USD |
| GBP/USD | 1.51160 | 1.51182 | 2.2 pips | 10'000 x 0.0001 = 1 USD | 2.2 USD |
| USD/CHF | 1.05950 | 1.05965 | 1.5 pips | 10'000 x 0.0001 = 1 CHF | 1.5 CHF |
| USD/CAD | 1.02228 | 1.02250 | 2.2 pips | 10'000 x 0.0001 = 1 CAD | 2.2 CAD |
| USD/JPY | 90.429 | 90.441 | 1.2 pips | 10'000 x 0.01 = 100 JPY | 120 JPY |
Fractional pips is pricing or quotes in 1/10th of a pip – an extra digit added to the quote. Under the fractional pips setup, every tick change in a quote is 1/10th of a pip and has 1/10th of value of a pip.
Exto Capital offers fractional pips in order to provide more precise pricing and lower spreads which increases the profit potential for its clients.
Spread is the difference between the buy and sell (or bid/ask) price. When you open a position of let's say USD/CAD 10'000 at prices indicated in the table above, if you close the position immediately (before any price movements), you pay CAD 2.20 for the spread.
Leverage and margin – Forex trading on margin
In the Forex market you can use leverage to multiply the potential of your investment. By using leverage you can hold much larger positions than your deposit in your trading account. The deposit acts as a guarantee or collateral against the trades you make.
Margin is the amount or collateral necessary to open and maintain a position. It is a percentage of the position. For example a 1% margin requirement means that you need to maintain as collateral 1% of the Forex trade position you have opened.
Let's say you open a position, buy or sell, of USD/CAD of 100'000. With a 1% margin requirement, you control 100'000 USD/CAD but have blocked as collateral only USD 1'000 of your funds for this transaction. With a 0.5% margin requirement, only USD 500 would be blocked for the same USD/CAD 100'000 position.
Please note that using a high level of leverage can increase your potential for profits but can also increase your risks for losses. You should always consider using stop-loss orders or other tools available to reduce your risks.
An example of a Forex trade
You believe the US dollar is going to rise against the Canadian dollar and would like to buy 100'000 USD/CAD. Your account with Exto Capital has a balance of US dollar 5'000. The account is set to 1:200 leverage or 0.5% margin requirement.
- You open a buy position of 100'000 USD/CAD at price 1.01927
- The margin blocked for this transaction is US$ 500 (0.5% of 100'000)
- Your account balance is still US$ 5'000
- Your account equity is US$ 5'000 – the spread = US$ 4'982.34
- The Sell price of USD/CAD moves to 1.02246 and you decide to close the position.
- Your profit is USD 228.07 (100'000 x (sell price 1.02160 – buy price 1.01927))
- When you close the position, the US$ 500 is released
- Your account balance is now US$ 5'228.07
- Your account equity is also US$ 5'228.07
Practice
One of the best ways to become more familiar with the Forex market is to open a risk-free $100'000 practice account on the Exto Capital demo trading platform. Over a 30 day period, with full and risk-free access to the trading platform using live market data, you can familiarize yourself with the trading platform and test your strategies.
