Forex Trading
As a new online forex trader you firstly have to understand that trading currencies does not come in short cuts, learning the fundamentals of trading is a process that requires both time and dedication by both practicing through a forex demo account and by widening your knowledge through basic study of the markets and the terminology used during trading. It is important to fisrt of all understand that forex is the acquisition or purchase of one currency from a trader or a financial institution in with the goal to exchange the currency for another at an equivalent rate. As the currency market fluctuates based on a number of related and unrelated factors currencies will go up and down therefore bringing opportunities for profits during exchange. The forex market is a speculative market; meaning that predictions (speculations) are calculated on clear speculations that traders will come to based on breaking news, political pressures or other information released internally or through the media which might cause currencies to fluctuate upscale or downscale. The clear speculative form of the online currency market enhances it to rank as the most liquid online trading market with more than $1,9 million traded daily. Savvy investors are getting out of the stock market and into forex trading and this industry has seen may other professionals and normal people join in the fun and games. It is a very new industry, only emerging in 1978. This was seven years after the Gold Standard was discarded, and when currency was first allowed to float in relationship to supply and demand. By the same token, till 1995, as usual the only traders who could benefit from this market was banks, and large multi-nationals, but all that has now changed. It is all thanks to the internet and computer technology that market which were once closed to the man in the street have opened up. Internet entrepreneurs are becoming rich and benefiting from many highly profitable markets today and the growth in popularity of forex trading has been fast, exponential as well as explosive. This is not surprising that it has fast become the worlds most profitable trading market.
Forex is unlike the traditional form of trading in which there is a central trading floor and buyers and sellers are brought together. Forex floats on the air waves of the internet, it is virtual money, and trading takes place through foreign exchange clearing houses or brokerage firms. All around the word trader are conducting business over high speed broadband and they have all the information they need at their fingertips. This market is the most profitable, because it is the largest marketplace in the world and it accounts for trading in excess of $1.9 trillion daily. These figures have been confirmed by 1998 figures from the fourth Central Bank Survey of Foreign Exchange and Derivatives Market Activity. Obviously it is believed that these amounts are significantly higher now twelve years down the line. To give this amount some perspective, activity in the Forex market is 75 times more than the New York Stock Exchange on any given day. The trading which takes place on this trading market, also using figures from 1998 are $16 billion, and the London Stock Exchange is $11 billion. From this we see that activity in Forex is vastly superior to that taking place in stock market trading. As well as being the most profitable market in the world foreign exchange is also the most persistent and powerful, even when under threat of negative economic indicators. Forex is of a macro-economic nature and currency “trends” far better than any and every other market commodity. Most commodities are fundamentally of the supply and demand nature and can change dramatically over night. This was seen with the September 11 disaster and the dot com market adjustment. Currency is predictable and stable and the fundamentals are less random, much like interest rates which only adjust in small increments, and gradually over time. This fundamental predictability is illustrated quite simply by looking at the US$. Of the 1.2 trillion dollars of Forex traded daily 83% is spot foreign exchange and 95% is swap activity and all of this involved the US$. The second most active is the Euro at 37% and at 24% the Japanese yen in thirds. Pounds Sterling is fourth at 10% and at 7% the Swiss Franc is in fifth place; CAD (Canadian $) and AUD (Australian $) rank 6th place jointly at 3%.
In forex trading self traders concentrate mostly on spot Forex the definition of this is a trading transaction which takes place and is liquidated, and settled within 2 working days. So the reason for this type of trading is because it is highly profitable, fast and easy. In the majority it allows for good profits because of constant market fluctuations and only entails buying weaker and selling stronger. Leverage is applied with regard to Forex trading and it allows the trader to amplify profit by holding a position with $100 000 with a margin deposit of only $1 000. This is known as managing risk, and the end result is a very profitable trade which is potentially very liquid. Traders should understand that when trading forex trades will be based on the limitations or the frames set by his broker; as his forex broker which in the vast majority of cases is the online forex operator or forex site as abbreviated commonly by users. The forex market is a 24 hour market and starts operations at 6:00 PM EST on Sundays in Sydney all the way to Friday at 4:00 PM EST when it will close its doors to traders for the weekend in New York.
Profits and Losses in Forex Trading
Before you even get to forex profits and losses and how to calculate them, make sure you understand how forex is traded. Once you understand the basic concept of this form of trading it is simple to calculate profit or loss and this is basically the trade close out price (on sale), subtracted from the purchase price of the base currency and the difference is the spread which is multiplied by the size of the transaction.
The equation is: price (or exchange rate) on sale of currency – purchase price of the base currency x the size of transaction = either profit or loss. An example would be; if you purchase Euro and each Euro costs you US $1,2188 you sell it at, and the size of the transaction is €200 000. Subtract the sale price of US $1,2198, from the purchase price of US$1,2188, and multiply the difference by 200 000: US$1,2198 – US$1,2188 x 200 000 = $200. Therefore this transaction earned you a profit of $200. Regardless of what currency you buy and sell, the formula for calculating profit and loss remains the same. Try it a few times and you will soon get the hang of it. In the same way unrealized profit or loss can be calculated on an open position. Simply exchange the ask rate or current bid for the action to intend to take when you close out and this will give you an idea of where you will stand. This is a good exercise for getting out of a position when anticipating a loss. If the forex you are trading is not in US$, you will also obviously have to convert any unrealised profits or loss into this currency after completing the formula, and you will need to do this at the exchange rate the broker quotes for you. Most trading does however take place coupled with US$ it is one of the strongest currencies, and in fact only the GBP, the AU$ and the Euro is stronger currently.
It is also important for you to be fully aware of what the dealer or any other participants in the transaction take for their share on your trade. Forex brokers always take a cut of the spread or commissions on every trade you make, remember they are providing the funds for you to leverage your position in a forex trade, and they have to make money too. Liquidating a position too soon and having to pay commissions could result in a profitable trade actually becoming a loss. Below you will find a short quiz to help you assess your understanding of forex trading and the concept of spread as well as profit and loss.
Quiz
Q: The forex speculator is of the opinion that the Swiss Franc is going to appreciate against US dollars. He/she then enters into a trade with a US$/CHF spread of 1.2584/1.2586, what will this speculator do in order to ensure they can open a trade on CHF.
A. Buy Swiss Francs at 1.2586 by selling US dollars
B. Buy Swiss Francs at 1.2584 by selling US dollars
C. Buy US dollars at 1.2586 by selling Swiss Francs
D. buy US dollars at 1.2584 by selling Swiss Francs
A: B is the correct answer
Explanation
In this instance the need is to purchase CHF and this done by selling US$, so this immediately eliminates both C and D as answers. If you don’t understand why, it is best to review your understanding of bid/ask spread. Selling dollars to the broker in return for the Swiss Franc, means you will receive 1.2584 for each dollar sold. The broker will have purchased these at the bid price on behalf of the speculator.
Q: If a speculator were to purchase a 1.1020/24 Euro /US$ spread from a dealer and sell this back right away at the same amount, what would be the result of this trade?
A. 4 gain of points
B. A loss of 4 points
C. No loss or gain
D. There is not sufficient data available in order to answer this question
A: B is the correct answer.
Explanation
If a broker quotes a spread price, they want to buy low and sell for a higher amount. A speculator entering this spread has purchased the currency for 110.24. Selling it back immediately for 110.20 is obviously a four point loss, and in fact this could be an even higher loss if the speculator is required to pay other costs also.
Q: A trader has an amount of $500,000 to trade and wishes to purchase CA$ at a time that the spread is 1.1957/62. The spread is 1.1862/66 when the position is liquidated. What is the end result of this transaction?
A. A Gain of US$ 5,000
B. A loss of US$ 5,000
C. A gain of US$ 3,834
D. A loss of US$ 3,834
A: C is the correct answer.
Explanation
In this instance the trader sold US$ to purchase CA$; they received 1.1957 CA$ for each of the UD$ they had available to invest. This was the bid price they received for Canadian dollars from the broker. In return for the 500 000 US$ they sold, they received an amount of CA$ 597,850; calculated by multiplying 500 000 x 1.1957. When the position was liquidated the US$ had depreciated in value against the CA$ and they closed the position by selling back Canadian dollars for 1.1866. The broker asking price was CA$593,300 and the balance of funds remaining in the traders account is CA$ 4 550. This money represents the profit they made on this trade, but before the question is answered CA$ need to be converted back to US$ resulting in an amount of US$ 3,834. Answering this question takes the calculation of profit and loss in forex trading full circle, as we already know that the exchange rate of the US$ was 1.1866. So divide CA$ 4 550 by this amount to get to the end result.
