What is forex?
The Foreign Exchange Market, which is often referred to as the "FOREX" or "FX" market is the largest, most liquid and most transparent financial market in the world. Daily average turnover has now exceeded 4 trillion USD.
Unlike other financial markets, where for the most part you can only profit in rising markets, in the FX market profits are made by accurately predicting shifts in the relative values of any two currencies. So the cyclical changes that affect other markets are meaningless to the FX market. The constant fluctuations of exchange rates offer a continuous opportunity for profit.
how does forex market work?
The term Foreign Exchange means selling one currency and buying another simultaneously. Since currencies are traded in pairs, to profit from an exchange rate move you need to buy the currency that you expect will strengthen and sell the other.
For example if you believed that the dollar (USD) was going to appreciate against the yen (JPY) you would buy the USD/JPY; or in other words buy the USD and sell the JPY. Alternatively, if you believed that the USD was going to depreciate against the JPY then you would sell the USD/JPY; or sell the USD and buy the JPY.
There is no need to wait for a bullish market to profit, for at any given moment, one currency will be strengthening against another. The FX market is therefore constantly producing opportunities to invest.
Who Trades in the FX Market?
Foreign exchange traders can be separated into two groups, hedgers and speculators.
Hedgers: Governments, companies (exporters and importers) and some investors have foreign exchange exposure. Adverse movements between their local or domestic currency and the foreign currency of the group they are either doing business with (for the exchange of goods and services) or investing in will affect their bottom line. This is the core of all foreign exchange trading; however it only makes up approximately 5% of the actual market.
Speculators: This groups, which includes banks, funds, corporations and individuals creates artificial rate exposure in order to profit from the variations or movements in the price.
How to read currency pairs?
Each currency is recognized by a three-letter code.
For example, EUR is the EURO and refers to the European currency, USD is the United States Dollar. The worlds leading currencies (the majors) are the EUR, USD, JPY (Japanese Yen), GBP (the British Pound or Sterling
Currencies are traded in pairs and are displayed as such. There is always the three-letter currency code a slash and another three-letter currency code. The first currency displayed refers to the "base", "leading" or "primary currency"; the second currency refers to the "secondary currency".
For instance when looking at the EUR/USD the EUR is the leading currency and the USD is the secondary currency. The "currency pair" or "currency cross" is then followed by a number; this is typically a five digit number with a decimal point after the first, for instance 1.2660.
The number represents the ratio of one currency against the other, and can be read as "the amount of the secondary currency needed in order to have one unit of the major currency". In the example just given, EUR/USD 1.2660, one would require 1 Dollar and 26.6 cents to exchange for 1 Euro.
what is the meaning of Buy and Sell?
There are always two numbers given after the currency pair, the first always has a smaller numerical value then the second. For example, (EUR/USD 1.2660 1.2663). The first number is known as the "Bid" or "Sell" and the second number is known as the "Ask", the "Offer" or "Buy".
The Bid (Sell) number represents that price where one can sell the major currency and buy the secondary currency, in this case the price at which one can sell the EUR and buy the USD.
The Ask (Buy) number represents the price where one can buy the major currency and sell the secondary , in this example the price at which one can buy the EUR and sell the USD.
what does Pip mean?
PIP is the term. It measures the smallest price change in the market. Since most major currency pairs are priced to four decimal places, the smallest change is that of the last decimal point - for most pairs this is the equivalent of 1/100 of one percent, or one basis point.
For EUR/USD pair, calculation as follows 1.2820-1.2760=0.0060 (price difference is 60 pip) ; therefore 1 pip=0.0001 and if we trade 100,000 EUR/USD position 1 pip is worth $10 and if we trade 10,000 EUR/USD position 1 pip is worth $1.
Therefore, most traders use the term of “pip”. The value of PIP depends on your trade position.
For another example, USD/JPY position where the market rate is 118.30 one pip is 0.01. We can therefore see that a pip is equal to the last decimal point shown on a rate. The value of 1 pip in USD/JPY for a 100,000 position can be calculated as follows: 100,000*0.01= 1,000 JPY. In USD terms this is equal to 1,000/118.30= $8.45 (rounded to the nearest cent).
how to Calculate your Profit & loss?
As discussed above the foreign exchange rate represents the value of one unit in the major currency in the terms of a secondary currency. Since when opening a trade you exercise the trade in a set amount of the major currency and when closing the trade you do so in the same amount, the profit or loss generated by the round trip (open and close) trade will be in the secondary currency.
For example if a trader sells 100,000 EUR/USD at 1.2820 and then buys 100,000 EUR/USD at 1.2760, his net position in EUR is zero (100,000-100,000) however his USD is not. The USD position is calculated as follows 100,000*1.2820= $128,200 buy and -100,000*1.2760= -$127,600 sell. The profit or loss is always in the second currency. For simplicity’s sake the P&L statements often show the P&L in USD terms. In this case the profit on the trade is $600.