Forex Trading Education

What is FX?


Foreign Exchange is one of the most liquid markets in the world. It is also know as “FX” or “Forex.” Spot FX involves trading one currency against another currency. Currencies can also change against other assets like gold.

What is FX Trading?


One currency is sold in exchange for another currency in an FX transaction. The rate expresses the relative value between the two currencies. For example a EUR/USD rate of 1.25 means that 1 EURO is worth $1.25. Codes such as EUR/USD are called currency pairs.

FX Prices


There are many factors that help determine a free floating currency’s worth. These include economic conditions, political conditions, trade flow, supply and demand among others.

Market Participants


There are many types of market participants in the FX markets including banks, market makers, hedge funds, CTA’s, and retail traders. FX is a zero sum game where what one trader makes is equal in theory to what another trader lost.

OTC Marketplace


The FX market is traded over the counter (OTC). This means that there is not a physical location, clearing hours, or exchange where orders are matched up. FX is instead traded OTC 24 hours per day via an electronic network of corporations, banks, and individuals trading one currency for another. The electronic price negotiation between traders is referred to as the Bid/Ask spread.

Liquidity


The FX market is one of the largest in the world and is still growing. Daily average volume in FX is well over $3 trillion. The FX markets are extremely liquid.

24 Hour Market


FX is an active marketplace that is traded 24 hours per day and 6 days per week.

Narrow Spreads


Spreads are the difference between a Bid and Ask. The spreads in FX are typically small in comparison to equities.

Ability To Profit In Any Market Direction


FX prices can go up or down. There are no trading restrictions on selling a currency pair. Traders can profit from buying or selling a currency pair if the market moves in correct direction.

Major Pairs


The majority of trading activity in the FX markets is concentrated on six major currency pairs. These are the EUR/USD, USD/JPY, GBP/USD, USD/CHF, USD/CAD, and AUD/USD. One currency is always paired against another in FX. The base currency is typically thought of as the reference point. For example in EUR/USD, the base currency is EURO and the quote refers to how many USD it costs to buy one Euro.

Bid and Ask


The price the market is willing to pay for an FX currency pair is called the Bid. The ask is the price the market will sell at.

What Is a Pip?


A pip is a Price Interest Point. A pip is the smallest fluctuation in the price of a currency pair. A change of 1 pip in the EUR/USD for example is 1.3000 to 1.3001.

What is Basis?


The difference between the cash (spot) price and futures price is the basis. A basis point is one hundredth of a percentage point.

Central Bank


The primary monetary authority of a particular nation that is controlled by that nations government is a central bank. Central banks issue currency, interest rates, control monetary policy, and control exchange rate policy. Central banks also regulate and supervise the banking sector in a particular country.

Currency Devaluation


The lowering of the value of a countries currency compared to other countries is called devaluation. Nations typically devalue their currencies in order to make their exports less expensive. Imports would also become more expensive if a currency gets devalued.

G-7


The G7 includes the leading 7 industrial countries not including China. These include Germany, the United States, Japan, France, Britain, Canada, and Italy.

G-10


The G-10 is the G-7 plust Belgium, Netherlands, and Sweden. The G-10 is normally associated with IMF meetings.

G-20


This is a group that includes the finance ministers and central banks of the following countries: Australia, Argentina, Canada, Brazil, China, France, India, Germany, Indonesia, Italy, Japan, Russia, Mexico, Saudi Arabia, South Korea, Turkey, South Africa, UK, United States, and the European Union. The World Bank and IMF also normally participate.

LIBOR


Libor is the London Inter-Bank Offer Rate. It is the interest rate that banks charge one another for loans. The charges are normally in Eurodollars. The rate applies to the short term international interbank deposit market. The loans are typically large and last from 1 to 5 years. Banks with liquidity requirements can borrow money quickly from other banks that have a surplus of cash which enables banks to avoid holding excessive amounts of their assets as liquid assets. The Libor rate changes daily.

Leverage


Leverage is when an investor or entity is using borrowed money. The use of leverage for traders means that the trader is borrowing money on margin in the hopes of generating a greater return without adding more money to the investment. In other words the notional amount traded far exceeds the margin required for the trade. For example if the notional amount traded is $10,000 and the required margin is $200 then the trader is trading with 50 times leverage (10,000/200). There can be a great deal of risk when trading with leverage.

Margin


Money that customers must deposit as collateral to cover potential losses from their trades. Customers can be required to add funds to their account as collateral in order to stay in a position that is moving against them. This is called a margin call. Margin calls are normally issued by brokers or dealers when a customer needs to increase their equity to a certain level to maintain a position.

Cost of Carry (premium)


The cost of holding an open position from one day to the next. The premium is calculated using the differential in short term interest rates between both currencies in a particular pair.

Rollover


This is where settlement of a trade is moved (rolled) forward to another value date. The cost of rollover is determined by the difference in interest rates between the two currencies. An example is an overnight swap the next business day against the following day. Swaps combine a spot and forward transaction into a single deal.

Revaluation


This is an increase in the value of a currency that is pegged to gold or other currencies.