Basic Concepts
What Is Forex
Forex / FX is a commonly used abbreviation for “foreign exchange”. It typically describes trading in the foreign exchange market, especially by investors and speculators. “Buy Low and Sell High” means a forex trader purchases currencies that are undervalued and sells currencies that are overvalued; just as stock trader purchases stock that is undervalued and sells stock that is overvalued.
This is similar to stock trading. Stock traders buy a stock if they its price will rise, and vice versa. Forex traders employ this same pattern- to buy a currency pair if its exchange rate will rise and to sell a currency pair if its exchange rate will fall.
Example
Imagine a situation where the U.S. dollar is expected to weaken in value relative to the euro. A forex trader in this situation will sell dollars and buy euros. If the euro strengthens, the purchasing power to buy dollars has now increased. The trader can now buy back more dollars than they had to begin with, making a profit.
Exchange Rate
Exchange rate is the relative value of different currencies which are determined by a decentralized foreign exchange marketplace. Unlike other markets, there is no centralized depository or exchange where transactions are conducted. Instead, these transactions are conducted by several market participants in several locations. It is rare that any two currencies will be identical to one another in value, and it’s also rare that any two currencies will maintain the same relative value for more than a short period of time. In forex, the exchange rate between two currencies constantly changes.
Example
In November 2015, one euro was worth about $1.05. By April 2016, one euro was worth about $1.16. The euro increa-sed in value by about 10.5% relative to the U.S. dollar during this time.
EUR/USD Exchange Rate
A currency’s value fluctuates as its supply and demand fluctuates.
- An increase in supply or a decrease in demand for a currency can cause the value of that currency to fall.
- A decrease in the supply or an increase in demand for a currency can cause the value of that currency to rise.
A big benefit to forex trading is that you can buy or sell any currency pair, at any time subject to available liquidity. So if you think the Eurozone is going to break apart, you can sell the euro and buy the dollar (sell EUR/USD). If you think the price of gold is going to go up, based on historical correlation patterns you can buy the Australian dollar and sell the U.S. dollar (buy AUD/USD).
CURRENCY PAIRS
Currencies are quoted in pairs, such as EUR/USD or USD/JPY. The first listed currency is known as the base currency, while the second is called the counter or quote currency. The base currency is the “basis” for the buy or the sell.
Example
If you BUY or “GO LONG ON” EUR/USD you buy Euros (and simultaneously sell dollars). You would do so in expectation that the euro will appreciate (go up) relative to the US dollar. On the other hand if you thought that there were reasons that demand for dollars would rise compared to the Euro you would SELL or ‘SHORT” EUR/USD (selling Euros for dollars).
PRICE QUOTE
Forex is quoted in pairs, how much one unit of the base (first listed) currency is worth in counter/ quote (second listed) currency.
Example
The EUR/USD at 1.1699 shows how much one euro (EUR) is worth in us dollars (USD). Therefore, 1 EUR = 1.1699 USD
CURRENCY SYMBOLS
3-letter symbols are commonly used to denote currencies such as USD for the US dollar and EUR for the Euro.
CURRENCY | SYMBOL | CURRENCY | SYMBOL |
|---|---|---|---|
US dollar | USD | Canadian Dollar | CAD |
European Euro | EUR | Australian Dollar | AUD |
British Pound | GBP | New Zealand Dollar | NZD |
Japanese Yen | JPY | Norwegian Krone | NOK |
Swiss Franc | CHF | Hong Kong Dollar | HKD |
Chinese Yuan | CNH | Mexican Peso | MXN |
Swedish Krona | SEK | Turkish Lira | TRY |
South African Rand | ZAR | Singaporean Dollar | SGD |
LOT SIZE
A lot is the smallest trade size available. Rakuten Securities HK accounts have a lot size of 1K (1,000) units of currency. Account holders can however place trades of different sizes, so long as they are in increments of 1K units like, 2K, 3K, 15K, 112K etc.
Example: Spread of EUR/USD is
0.7 pips which is 0.00007 USD.
SPREADS
Just like in all markets, there are two prices- buy and sell, for every currency pair. The difference between the buy price and sell price is the spread, or the cost of the trade. An example on the left, the spread is 0.7. On a Rakuten Securities HK 1K lot size USD-denominated account, a pip on the EUR/USD currency pair is worth US$0.1.
PIP
A pip is the unit used for price quotation change and counting profit or loss in Forex market. In Rakuten Securities HK, most currency pairs are quoted to five decimal places, the fourth spot after the decimal point (at one 100th of a cent) is typically what one watches to count “pips”. For Japanese Yen-related currency pairs, prices are quoted to 3 decimal places, whereas the second spot after the decimal point (a cent of yen) is what one watches to count “pips”. Every point that place moves is 1 pip of movement.
Example
EUR/USD rises from 1.16997 to 1.17007, the EUR/USD has risen 1 pips.
USD/JPY drops from 110.200 to 110.145, the USD/JPY has dropped 5.5 pips.
LEVERAGE AND MARGIN
At Rakuten Securities HK, leverage of 20:1 allows you to trade with $1,000 in the market by setting aside only $50 as a security deposit. All trades are executed using borrowed money. This allows you to take advantage of leverage. This means that you can take advantage of even the smallest movements in currencies by controlling more money in the market than you have in your account. On the other hand, leverage can significantly increase your losses. Trading foreign exchange with any level of leverage may not be suitable for all investors.
The specific amount that you are required to put aside to hold a position is referred to as your margin requirement. Margin can be thought of as a good faith deposit required to maintain open positions. This is not a fee or a transaction cost, it is simply a portion of your account equity set aside and allocated as a margin deposit.
In short, the leverage ratio is determined by the % of margin requirement as you use margin to create leverage.
ROLLOVER INTEREST
Traders holding positions for more than one day will receive or pay the interest difference between the two currencies in the pair they are trading. Though daily interest is tiny, leverage* can make this interest significant.
* Without proper risk management, this high degree of leverage can lead to large losses as well as gains.
| Free Education Resources to Learn FX Trading | |
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