Forex, an acronym for Foreign Exchange is an over-the-counter (OTC) market and is the largest financial market, the world has invented so far. Forex market is a mechanism by which currencies are exchanged according to each currencies value depending on various macro-economic factors. Its volume amounts to the value of New York Stock Exchange, with a daily average of $20 billion. Forex trading is done in currency pairs by which one currency is bought or sold for another in anticipation of gain or loss in value against another. An example of a currency pair is shown using notation- EUR/USD or USD/JPY.
Major players in Forex market include inter-world investment and commercial banks, money portfolio managers, money brokers, large corporations, and retail traders. Earlier, currency movement has been determined by supply and demand force, but now its having a new face such as for risk management purpose such as hedging by Corporate and individuals. Popularity of Forex trading is increasing day by day provided by the industry’s competitive leverage offers with more and more individual traders getting into the market for speculation, hedging and transaction purposes.
Forex Trading Tools
– Savvy traders across the world make decision in Forex market using Fundamental & Technical Analysis to identify perfect timing of entry & exit levels of right financial instruments.
– Fundamental Analysis: Fundamental factors such as GDP, CPI, Monetary and fiscal policy, economic and political events, Unemployment rate etc. will be seriously watched by professional traders before making investment decisions. Normally consensus of economic data will be contrasted with actual data by the fundamental observer for trading decisions. Markets normally have a tradition of factoring in outlook of major events before actual event comes into the market. If the actual event matches with market expectation, then there will be normal market movement as it has been factored quite early by the market. If the actual event varies widely with expected expected levels, then markets will react fastly to current market prices.
– Technical Analysis: Traders have secondly, the most widely accepted choice of trading tool called Technical Analysis which is forecasting future price movements based on past price movements using wide variety of charts and studies based on the fact that price discounts everything in a market. Studies are based on using charts, trends, support and resistance levels, technical indicators and studies inorder to mimic market behavior in an early manner. Forex trading is mostly done using technical analysis by professional traders wide across the globe as it provides accurate entry and exit points for profiting their invested money.
Considering the risk involved in Forex trading while enjoying maximum leverage, traders should be aware of risk management tools in Forex inorder to mitigate losses arising from trades. 24 hour Forex market is unpredictable in the sense, sharp moves may happen on an intraday basis due to unexpected events like political, economic and other issues like natural disasters, war etc. So its prudent to use strict stop losses so as to reduce risk. Hence traders has to use order risk management tool such as Limit orders and stop orders depending on the risk appetite of every individuals. These orders will automatically cover the positions once when prices reaches a certain level as set by the trader.
o Limit orders
Limit orders are set by the trader to buy or sell currency pairs at a predetermined price thereby benefiting traders to have advantage on highly volatile market. For taking long positions, limit orders are called as Buy Limit orders and for short positions, they are called Sell limit orders. Limit orders to buy are placed below the current market price for taking long positions. And for short positions, limit orders are placed above the current market price.
o Stop Orders
Also known as Stop Loss Orders, these are orders used by most intraday traders across the world inorder to minimize losses arising from price moves against a trader’s position. They are used to exit positions and to protect against trading losses. This order places an order to buy or sell once the price reaches a certain price. Stop orders are normally placed below the current price for long positions. For short positions, stop orders will be placed above the current price.
Trading Terminologies in Forex Trading
A Bid price is the rate at which the market is prepared to buy a specific currency pair in the Forex trading market. This is the price that a trader will receive when selling (shorting) a currency pair.
An Ask price is the rate at which the market is ready to sell a particular currency pair. This is the price that a trader will have to pay in order to buy (long) the currency pair. The bid/ask combination comprises a quotation, which is based on a floating exchange rate. The quotation lists the bid price first, then the ask price. For the USD/JPY pair the quote will be 120.93/96.
Base currency is the first currency of a traded pair (For EUR/USD, EUR is the base currency). If a trader is said to take a long position, he or she will be buying the base currency. If a trader is said to take a short position, he or she is selling the base currency.
Counter currency is the second currency in a pair (For EUR/USD, USD is the counter currency).
Pip is the smallest increment move by which a currency can make. Pip varies for different currencies. It is the fourth decimal point, which is 1/ 100 th of 1%. All major currencies usually have four decimal points , except for Japanese yen. For example, 1 pip = 0.0001 for EUR/USD, whereas 1 pip = 0.01 for USD/JPY.
Pip Value is the value of a pip for different currencies. It can be fixed or variable according to currency pairs. For example, pip value for 1 lot of EUR/USD is $10.Pip value Calculation is done by multiplying 1 Pip with lot size.
For example pip value for EUR/USD = 0.0001 x 100000 = $10
Spread is the difference between Sell price and Buy price. It will be greater for less frequently traded currencies and will be very small for major trading currencies. If Bid-Ask price of EUR/USD is at 1.3010/1.3006, then Spread = 1.3010 – 1.3006 = 0.0004.
Leverage is the ability to gear your account into a position greater than your total account margin. For instance, if a trader has $1,000 of margin in his account and he opens a $100,000 position, he leverages his account by 100 times, or 100:1. If he opens a $200,000 position with $1,000 of margin in his account, his leverage is 200 times, or 200:1. Increasing your leverage magnifies both gains and losses.
To calculate the leverage used, divide the total value of your open positions by the total margin balance in your account. For example, if you have $10,000 of margin in your account and you open one standard lot of USD/JPY (100,000 units of the base currency) for $100,000, your leverage ratio is 10:1 ($100,000 / $10,000). If you open one standard lot of EUR/USD for $150,000 (100,000 x EURUSD 1.5000) your leverage ratio is 15:1 ($150,000 / $10,000).
Lot is a standard unit size of a transaction. Typically, one standard lot is equal to 100,000 units of the base currency, 10,000 units if it’s a mini, or 1,000 units if it’s a micro. Some dealers offer the ability to trade in any unit size, down to as little as 1 unit
Margin Call is an automatic system in which forex dealer closes trader’s positions due to lack of sufficient amount of margin in trader’s account, as a result of opposite direction of price move against a trader’s position. The Forex dealer closes the trader’s positions and limits the losses for the client so as to prevent trader’s account from credit to debit.
A long position is a situation in which one purchases a currency pair at a certain price on expectation to sell at a higher price. In Forex, when one currency in a pair is rising in value, the other currency is declining, and vice versa.
If a trader thinks a currency pair will fall he will sell it and hope to buy it back later at a lower price. This is considered a short position, which is the opposite of a long position.