The Basics of Currency Trading

With over $3.5 trillion in daily turnover, the foreign exchange market is 5 times the size of the US futures market, making it the largest market in the world. Surprisingly, this sleeping giant is unfamiliar terrain for most individual traders and investors. Until the popularization of Internet trading a few years ago, forex was primarily the domain of large financial institutions, multinational corporations, and secretive hedge funds. But times have changed: the US dollar has fallen to record lows, and everyone from your local car dealer to bartender is waking up to the impact of currencies.

How does this Market Differ from other Markets?

Unlike the trading of stocks, futures, or options, currency trading does not take place on a centralized exchange, but instead through different forex brokers. At first glance, this ad hoc arrangement must seem bewildering to investors who are used to structured exchanges such as the NYSE or CME. However, this arrangement works exceedingly well in practice: participants in forex must both compete and cooperate with each other, and self-regulation provides an effective amount of control over the market. Furthermore, reputable retail forex dealers in the United States become members of the National Futures Association (NFA), and by doing so, they agree to binding arbitration in the event of any dispute. Therefore, it is critical that any retail customer who contemplates trading currencies do so only through an NFA-member firm.

Here are 5 other factors that make the currency market different from other markets that are sure to raise eyebrows:

1.Liquidity:In the FOREX market there is always a buyer and a seller! The FOREX absorbs trading volumes and per trade sizes which dwarfs the capacity of any other market. On the simplest level, liquidity is a powerful attraction to any investor as it suggest the freedom to open or close any position at will 24 hours a day.

2.Access:The FOREX is open 24 hours daily from about 6:00 P.M. Sunday to about 3:00 P.M. Friday. An individual trader can react to news when it breaks, rather than waiting for the opening bell of other markets when everyone else-has the same information. This allows traders to take positions before the news details are fully factored into the exchange rates.

3.Two-Way Market:Currencies are traded in pairs,for example dollar/yen, or dollar/Swiss franc.Every position involves the selling of one currency and the buying of another.If a trader believes the Swiss franc will appreciate against the dollar,the trader can sell dollars and buy francs (“selling short!’). If one holds the opposite belief, that trader can buy dollars and sell Swiss francs (“buying long”). The potential for profit exists because there is always movement in the exchange rates (prices).

4.Leverage:Trading on the FOREX is done in currency “lots.” Each lot is approximately 100,000 U.S. dollars worth of a foreign currency. To trade on the FOREX market,a “margin account” must be established with a currency broker. This is, in effect, a bank account into which profits may be deposited and losses may be deducted.These deposits and deductions are made instantly upon exiting a position.

Brokers have differing margin account regulations,with many requiring a $1,000 deposit to “day-trade” a currency lot. Day-trading is entering and exiting positions during the same trading day.For longer-term positions, many require a $2,000 per lot deposit. In comparison to trading in stocks and other markets,which may require a 50% margin account FOREX speculators excellent leverage of 1% to 2% of the $100,000 lot value,The trader can control each lot for I to 2 cents on the dollar!

5.Trendiness:Over long and short historical periods,currencies have demonstrated substantial and identifiable trends. Each individual currency has its own “personality,” and each offers a unique historical pattern of trends, providing diversified trading opportunities within the spot FOREX market.

What is Pip?

A pip stands for "percentage in point," and it is the smallest increment of trading in forex. In the forex market, prices are quoted to the fourth decimal point. For example, if a bottle of water in the drugstore were priced at $1.20, in the forex market, the same bottle of water would be quoted at 1.2000. The change in that fourth decimal point is called 1 pip, and it is typically equal to 1/100th of 1%. Among the major currencies, the only exception to that rule is the Japanese yen. One yen is now worth approximately US$0.08; so, in the USD/JPY pair, the quotation is only taken out to two decimal points (i.e., to 1/100th of yen, as opposed to 1/1000th with other major currencies).

Which Currencies are Traded?

Although some retail dealers trade exotic currencies such as the Hungarian forint or the Malaysian ringgit, the majority trade the eight most liquid currencies:

1. US dollar (USD)
2. euro (EUR)
3. British pound (GBP)
4. Japanese yen (YEN)
5. Canadian dollar (CAD)
6. Australian dollar (AUD)
7. New Zealand dollar (NZD)
8. Swiss franc (CHF)

Collectively, they form the seven most actively traded currency pairs in the world:

. EUR/USD (euro/dollar)
. USD/JPY (dollar/Japanese yen)
. GBP/USD (British pound/dollar)
. USD/CHF (dollar/Swiss franc)
. AUD/USD (Australian dollar/dollar)
. USD/CAD (dollar/Canadian dollar)
. NZD/USD (New Zealand dollar/dollar)

Let’s take a deeper look at the key characteristics of each of the major currencies:

US Dollar

. Nicknames: Greenback, Buck
. Reserve currency of the world
. Represents 90% of all trading activities
. Critical to settlement of trade in major commodities, including foodstuffs and industrial metals,but most importantly—OIL
. Responds to growth and interest-rate data

Euro

. Nickname: Anti-dollar
. Represents the second largest economy in the world
. The only currency that can challenge the hegemony of the dollar
. The currency without a country
. Central bank fears strong currency because of export– dependent economy

British Pound
. Nicknames: Cable, Sterling
. Former reserve currency of the world
. Fourth largest economy, a magnet for free market principles in Europe
. Business-friendly regulations promote—acquisitions
. UK: Member of the EU but NOT the EC

Japanese Yen

. Nickname: None
. Represents the dominant economy in Asia
. Serves as a free-market proxy for the Chinese yuan
. Laden with speculators, short carry, interest rate the focus
. Major oil importer

Canadian Dollar

. Nickname: Loonie
. Highly correlated to oil—second only to Saudi Arabia
. The only G-7 nation with BOTH a trade and budget surplus
. Benefits from Chinese demand

Swiss Franc

. Nickname: Swissie
. The safe-haven currency of choice but losing that luster
. Stronger growth and better balance sheet than its next-door neighbor

Australian Dollar

. Nickname: Aussie
. World’s second largest producer of gold
. Huge beneficiary of China's growth

New Zealand Dollar

. Nickname: Kiwi
. Liquid because of its proximity to Australia
. Highest interest rates in OECD

Many more Educational Articles are coming soon…