Introduction to Forex trading

When trading Forex one operates currency trading account in order to capitalize on the currency exchange rate fluctuations. No surprise there is the specific terminology one has to familiarize yourself with not to mention the overall trading logics before taking any practical steps.

This section defines and gives decribtion of the key elements of the trading process:

Currencies and Abbreviations

 

In Forex currencies are exchanged for one another. Each currency has its own ISO currency code (ISO 4217). Under specific symbols there are also other investment vehicles available in Forex such as Commodities and CFDs (Contracts for Difference) on Shares, Stock Indices and Commodities.

 

Abbreviation	Name, nickname
EUR	Euro
USD	US dollar
CAD	Canadian dollar
AUD	Australian dollar
NZD	New Zealandian dollar
GBP	British pound
CHF	Swiss franc
JPY	Japanese yen
DKK	Danish krone
NOK	Norwegian krone
SEK	Swedish krona
SGD	Singapore dollar
XAU	Gold
XAG	Silver
OIL	Oil
CAC40	Index of the top 40 French companies
FTSE100	Index of top 100 companies included in the list of London Stock Exchange
ND100	Index of 100 US and international non-financial companies
DAX	Index of the largest German companies
DJI	Dow Jones industrial index
SP500	Index of 500 selected US companies

 

Currencies are traded in pairs in order to express the relative value of one currency against the value of another. The first currency in the pair is refferred to as the base currency while the second currency in the pair is the quote one. The relation of the two values is the quotation of the currency pair.

 

EUR/USD 1.4120

 

This quotation means that 1 Euro can be exchanged for 1.4120 US dollars. In this currency pair Euro (EUR) is the base currency and US dollar (USD) is the quote one.

 

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Major currency pairs

 

Being the World's Reserve Currency US Dollar is the most traded currency in the World. Up to 85 % of all trades in Forex in 2010 included US dollar. No wonder why currency pairs including US Dollar are referred to as Major currency pairs and are the most traded currency pairs in Forex

 

Symbol	Currencies
EURUSD	Euro vs US dollar
GBPUSD	British pound vs US dollar
USDJPY	US dollar vs Japanese yen
USDCHF	US dollar vs Swiss frank
AUDUSD	Australian dollar vs US dollar
USDCAD	US dollar vs Canadian dollar
NZDUSD	New Zealandian dollar vs US dollar

 

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Major currency cross pairs

 

Currency pairs that do not include US Dollar are reffered to as Major currency cross pairs. These are subsequent from the individual major pairs but are quoted independently from each other.

 

Symbol	Currencies
AUDCAD	Australian dollar vs Canadian dollar
AUDCHF	Australian dollar vs Swiss franc
AUDJPY	Australian dollar vs Japanese yen
AUDNZD	Australian dollar vs New Zealandian dollar
CADCHF	Canadian dollar vs Swiss franc
CADJPY	Canadian dollar vs Japanese yen
CHFJPY	Swiss franc vs Japanese yen
EURAUD	Euro vs Australian dollar
EURCAD	Euro vs Canadian dollar
EURCHF	Euro vs Swiss franc
EURGBP	Euro vs British pound
EURJPY	Euro vs Japanese yen
EURNZD	Euro vs New Zealandian dollar
GBPAUD	British pound vs Australian dollar
GBPCAD	British pound vs Canadian dollar
GBPCHF	British pound vs Swiss franc
GBPJPY	British pound vs Japanese yen
GBPNZD	British pound vs New Zealandian dollar
NZDCAD	New Zealandian dollar vs Canadian dollar
NZDCHF	New Zealandian dollar vs Swiss franc
NZDJPY	New Zealandian dollar vs Japanese yen

 

Minor currency cross pairs

 

Symbol	Currencies
EURSEK	Euro vs Swedish krona
GBPSEK	British pound vs Swedish krona
USDNOK	US dollar vs Norwegian krone
USDSEK	US dollar vs Swedish krona
USDSGD	US dollar vs Singapore dollar

 

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Trading a Pair

 

In Forex you capitalize on currency rate fluctuations. The more the rate changes the bigger your profit or loss is.

 

It is important to understand that a decreasing rate may be just as benefitial as the rising one.

 

1. When the rate is increasing, you are buying the base currency for the quoted one, so that to sell it later on for a profit at a higher price (trading volume is always expressed in the quoted currency).
   
   
2. When the rate is decreasing, you are selling the base currency for the quoted one, so that to buy it later on for a profit at a lower price (trading volume is always expressed in the quoted currency).

Such actions in both cases constitute a complete trading operation in which you first open a trading position by whatever action you take and then subsequently close your open position by taking an action that is offset to the original one and at a newer price.

 

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Bid/Ask Prices and Spread

 

At every moment of time a currency pair is always quoted double price: Bid for sale and and Ask for purchase of a base currency in a pair for the quote one.

 

 

This quotation means we may immediately:

• Sell 1 EUR for 1.4110 USD (at the Bid price)
• Buy 1 EUR for 1.4112 USD (at the Ask price)

The complete trading operation involves both prices Bid and Ask because opening and closing a position means carrying out trasnactions that are offset to one another:

• Opening a Buy position means buying while closing a Buy position means selling,
• Opening a Sell position means selling while closing a Sell position means buying.

IMPORTANT Do not forget that charts are only constructed using the Bid price. Ask price is always spread-distance higher than what the chart shows.

 

Spread is the difference between Bid and Ask prices. It is the size of the transaction cost which varies from pair to pair. Spread volume is measured in pips. In our case the EURUSD spread is 2 pips.

 

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Pip and Its Value

 

Pip (percentage in point) is a volume unit and equals the smallest currency rate increment (0.0001 for most currency pairs that are quoted to the fourth decimal point). Pips are used to measure rate fluctuations and spreads.

 

The monetary value of a pip depends on the volume involved and expressed in units of quote currency.

 

Example A: 1 pip volume in EUR/USD is 0.0001

 

Trading position volume	Calculation	1 pip value
100,000 EUR	100,000 * 0.0001	10 USD
10,000 EUR	10,000 * 0.0001	1 USD
1,000 EUR	1,000 * 0.0001	0.1 USD
100 EUR	100 * 0.0001	0.01 USD

 

Example B: 1 pip volume in USD/JPY is 0.01

 

Trading position volume	Calculation	1 pip value
100,000 USD	100,000 * 0.01	1000 JPY
10,000 USD	10,000 * 0.01	100 JPY
1,000 USD	1,000 * 0.01	10 JPY
100 USD	100 * 0.01	1 JPY

 

As you can see, a pip value (price) goes down as a position (trade) volume decreases and is nominated in a second currency in a pair (Quoted Currency).

 

A concept of pip value allows to measure the monetary value of the smallest possible rate change in relation to the volume of a specific trading operation.

 

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Profit/Loss Calculation

 

Once completed a trading operation always results in either profit or loss.

 

Buy 200,000 USD/JPY:

• We opened a Buy position: bought 200,000 USD at an Ask rate 95.650 paying 95.650 x 200,000 = 19,130,000 JPY
• then we closed our Buy position by selling 200,000 USD at a Bid rate 96.400 getting 19.280.000 JPY

A differential between the initial Ask and the last Bid prices is 75 pips.

 

There are two ways of calculating our profit:

• 19,280,000 - 19,130,000 = 150,000 JPY
• A pip value (price) is 200,000 x 0.01 = 2,000 JPY; 75 x 2.000 = 150,000 JPY

Our profit is 150,000 JPY (or 1,555,5325 USD)

 

You may also use our Trader's Calculator.

 

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Margin Trading and Trading Volumes

 

Forex Trading is trading on margin. WIth trading leverage offered by broker you only need your margin to cover positions you open.

 

If you have 1,000 USD in your account and your maximum available leverage is 1:100, you are able to trade 100 times the volume of your balance which is 100,000 USD.