What is Forex?
It may be easily noticed that the value of currencies fluctuates on a regular basis. However, many don’t realize that this a foreign exchange market (Forex), whereby potential profit can be made from fluctuations of these currencies. The most famous example who made a billion dollars in a day by trading currencies is George Soros. However, currency trading involves significant risks and individuals can lose a substantial part of their investment. As era of technological advancements has emerged, Forex market has become more affordable and as a result led to inevitable growth of online trading. One of absolute advantages in currencies trading nowadays is that there is no longer need to be a big money manager to trade currencies; small traders and investors can trade this market.
Who trades Forex?
Anyone can trade Forex regardless of level of experience and geographical location. Because Forex trading has no centralized market place, it operates 24 hours a day from Monday to Friday and all trading is carried out via online trading platforms.
Trading on the Forex market is one of the most worthy investments available.
Buying and selling of currency is conducted in currencies pairs. For example, if you buy the EUR/USD at lower price and you sell it at a higher price, profit is made on such a price movement.
If, again, a trader purchased 1000 USD (US dollars) last year and the equivalent at the time was 800 Euros, this year the value of the USD may be 900 or 700 Euros (EUR). If you decide to sell now, you will lose or earn 100€ accordingly.
A trader can trade Forex via online trading platform and these are provided by Forex brokers. The platforms offered by FX brokers differ in features and styles, and the brokers are responsible for providing brokerage services to traders that will allow them to trade. The trader is usually offered a choice of different types of accounts, trading platforms, trading tools along with other specific trading conditions. The Broker company is responsible to assist clients with trading strategies available and provide the best prices in the market to facilitate trading process
How do I manage risk in FX Trading ?
The most widespread risk management tools in Forex trading include “limit” order and “stop loss” order.
A “limit” order sets the maximum price to be paid or the minimum price to be received.
A “stop loss” order ensures that a specific trading position is liquidated at a predetermined price so to limit possible losses in case that the market moves against the trader’s opened position.
Contingent orders may not limit the risk for potential losses.
Spread is the price difference between buying and selling when opening a position in the Forex market. Spread is the commission of the intermediary company against the services it provides and the prices provided by the international banks supplied with liquidity. The spread is determined based on the supply and demand of a pair of currency pairs traded. When the trader or trader in the Forex market buys a pair of currency pairs, in this case he buys the price offered by the bank (Ask) and if he wants to open the sale transaction will sell or open the deal at the sale price (Bid) The difference between the two prices is the spread The commission obtained by TFX Markets as an intermediary between the client and the liquidity provider.
The pip or spot in the Forex market is the smallest unit to be used to measure the currency price in open positions through which we can calculate profit or loss. The pip or point in the forex market is the fourth decimal if the broker is a market maker but if the broker without a trading room such as TFX Markets passes the transactions directly to the bank STP / ECN, in this case the point or The pip is the fifth decimal number. In this case, each price action is calculated in detail, giving more transparency between TFX Markets and our clients. Almost all currency pairs consist of five digits and most pairs have a decimal point immediately after the first figure, Equals 1.3510. In this example, one point equals the smallest change in the fourth decimal place - 0.0001. Therefore, if the currency of the offer in any pair is the dollar, if one point is always equal to 1 / 100th of a cent. One notable exception is USD / JPY where the point is $ 0.01.
For example, EUR / USD, which is priced at four decimal places, can be bought at 1.3530 and sold later at 1.3542. The difference will be +12 points, or 0.0012. However, the USD / JPY pair is priced at just two decimal places. If you buy USD / JPY at 110.51 and then retreated to 110.31 and you sold it, the difference would be -20 pips, or -0.20. Point difference will determine the profit / loss account in the trade.
What Influences Currency Price ?
1. Inflation :
The simplest way to explain the meaning of inflation is that if the inflation in any given country is relatively less than anywhere else, in this case the exports of this country will become more attractive and attractive and there will be an increase in the demand for its currency to buy goods. Competition for the purchase of foreign goods and the purchase of fewer imports will also be reduced.
So countries with lower inflation tend to devalue their local currency.
2. Interest Rates :
The interest rate is that the return on the capital of the investor through the price obtained by one of the waiver of the disposal of funds that lend to a specific period of time, and the price varies depending on the period, whether monthly or annual and the amount borrowed, the longer the duration of borrowing increased the risk. Interest rates in a country relative to other places, will become more attractive to deposit funds in the country. And thus the demand for this currency will rise.
3. Speculation :
Expectations in trading or speculation on the stock market are "risk buying and selling based on the expectation of price fluctuations in order to obtain the price difference", and this may lead to the expectation if he made a mistake to pay the difference in prices rather than to catch.
If the speculator or trader in the Forex market believes that a pair of currencies will rise in the future and will increase the demand for this currency pair, it will buy in the hope of making a profit. The increase in the demand for a commodity or currency leads to an increase in value to the upside. Therefore, movements in the exchange rate do not always reflect economic fundamentals, but are often driven by the feelings of the financial markets.
For example, if there is an important news in the Forex market such as changing the interest rate to the increase and this change occurs, it will affect the market movement and may lead to market movement, increase demand and the value of this currency.
4.Change in Competitiveness
If country’s goods become more attractive and competitive this will also cause the value of the Exchange Rate to rise. This is important for determining the long run value of the currency. This is similar factor to low inflation.
5. Relative strength of other currencies
In 2010 and 2011, the value of the Japanese Yen and Swiss Franc has gone up because markets were worried about all the other major economies – US and EU. Therefore, despite of low interest rates and low growth in Japan, the Yen kept increasing its value.
6. Balance of Payments
A deficit on the current account means that the value of imports (goods and services) is bigger than the value of exports. If this is financed by a surplus in the capital account, there is no problem whatsoever. But a country that struggles to attract enough capital inflows to finance its current account deficit will notice a drop in its currency value.
7. Government Debt
Under some circumstances, the value of government debt can influence the exchange rates. If markets expect a government to default on its debt, investors will start selling their bonds, which will cause a decrease in the value of the exchange rate. For example, Iceland financial problems in 2008 provoked instant decrease in the value of its domestic currency.
8. Government Intervention
Some governments try hard to influence the value of their local currency. For example, China tries to keep its currency undervalued to make Chinese exports more competitive. They can do this by buying US dollar assets which increases the value of the US dollar in relation to Chinese Yuan.
9. FX Currency Pairs
The reason for currency pairs to exist is that if we all had one single currency, we would have no way of measuring its relative value. By pairing two currencies against each other, the fluctuating value can be established for one currency against another.
Currency Pairs which don’t contain a US dollar in it are commonly named as “Cross Currency Pairs”. Trading Cross Currencies offers entirely new aspects of foreign exchange market to speculators. There are cross currencies that move very slowly and are quite stable. Other cross currency pairs move rather quickly and are extremely unstable with average movements exceeding 100 pips a day.
10. Major Currency Pairs
Most foreign currency transactions utilize term “Majors”, comprising of the British Pound (GBP), Euro (EUR), Japanese Yen (JPY), Swiss Franc (CHF) and the US Dollar (USD). These are the key five currencies, however Canadian Dollar (CAD) along with the Australian Dollar (AUD) are becoming additional ‘major’ currencies.
When a foreign currency transaction is executed, one currency is being borrowed while another one is being lent. This borrowing and lending is treated like a common banking transaction and therefore is a subject to interest rates on the borrowing and lending that are taking place. The interest is usually related to “SWAP” rate in the currency market. The Swap is a credit or debit as an effect of daily interest rates. When traders keep positions overnight, they are either credited or debited interest based on the rates at a given time.
12. Free Margin and Used Margin
In our example, we will have a $500 account balance. In order to open the position we are required to have initial margin of $100. This is referred to as “used margin”. The remaining $400 is considered to be as “free margin”. All things being equal, the free margin is always available for trading.
Current trading platforms are capable of calculating these figures in real time so there is no need to calculate them manually.
13. What is “Leverage”?
Forex trader should always be aware what level of risk they are willing to take. It is quite understandable desire to risk more in a pursuit to profit more, however it should also be mentioned that a slight movement in the market can result in a much higher loss in an over- leveraged account.
Currency traders always have a choice of using a lower level of leverage to an account or a trade. Choosing lower leverage may help reduce risk, but it is worth noting that a lower level of leverage requires a larger margin deposit in order to manage the same size contracts.
14. Concept of Forex Risk
For successful trading, one must fully be aware of all risks involved. Each trader will view the market rather differently, considering the fact that there is no right or wrong way to trade in the market. Essentially, each Forex trader must evaluate the risk that they can comfortably afford.
Determining which type of trader you are is much more important than it might first appear. One might be a systematic trader while the other would prefer trading during highly volatile periods. Are you capitalizing on short-term or long-term profits?
15. What is Risk?
Risk referred to “variability of returns from an investment or the chance that an investment’s actual return will be different than expected. This includes the possibility of losing some or all of the original investment. It is usually measured using the historical returns or average returns for a specific investment. The greater the variability of an investment (i.e. fluctuation in price or interest), the greater the risk.”
The instability of prices can be seen in every day coupled with mentioned leverage available in “off-the-market” foreign currency (Forex) compared to other financial instruments (e.g.bonds). That’s why Forex industry is viewed as highly risky. As traders usually tend to be risk averse, investments with greater risk must promise higher expected returns to justify accepting additional risk. As a rule higher risk promises greater returns or a higher risk for loss. Though higher return doesn’t always mean a higher degree of risk.