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Thread: The Basics of Currency Trading

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    Default The Basics of Currency Trading

    Quoting Conventions
    In the Foreign Exchange market, currencies are traded in pairs. For instance, a speculator may trade the Euro versus the US Dollar, EUR/USD, or the US Dollar versus the Japanese Yen, USD/JPY. The base currency is the term for the first currency in the pair. The counter currency is the term for the second currency in the pair. The exchange rate represents the number of units of the counter currency that one unit of the base currency can purchase.

    Traders in the Foreign Exchange market are speculating on the exchange rate between two currencies. Exchange rates measure the relative strength of one currency to another. Speculators make buy and sell decisions on currency pairs based on fundamental and technical analysis, with the intention of the exchange rate moving in their favor.

    EUR/USD
    In this example euro is the base currency and thus the basis for the buy/sell.

    If you believe that the US economy will continue to weaken and this will hurt the US dollar, you would execute a BUY EUR/USD order. By doing so you have bought euros in the expectation that they will appreciate versus the US dollar. If you believe that the US economy is strong and the euro will weaken against the US dollar you would execute a SELL EUR/USD order. By doing so you have sold euros in the expectation that they will depreciate versus the US dollar.



    USD/JPY
    In this example the US dollar is the base currency and thus the basis for the buy/sell.

    If you think that the Japanese government is going to weaken the yen in order to help its export industry, you would execute a BUY USD/JPY order. By doing so you have bought U.S dollars in the expectation that they will appreciate versus the Japanese yen. If you believe that Japanese investors are pulling money out of U.S. financial markets and repatriating funds back to Japan, and this will hurt the US dollar, you would execute a SELL USD/JPY order. By doing so you have sold U.S dollars in the expectation that they will depreciate against the Japanese yen.

    GBP/USD
    In this example the GBP is the base currency and thus the basis for the buy/sell.

    If you think the British economy will continue to be the leading economy among the G7 nations in terms of growth, thus buying the pound, you would execute a BUY GBP/USD order. By doing so you have bought pounds in the expectation that they will appreciate versus the US dollar. If you believe the British are going to adopt the euro and this will weaken pounds as they devalue their currency in anticipation of the merge, you would execute a SELL GBP/USD order. By doing so you have sold pounds in the expectation that they will depreciate against the US dollar.

    USD/CHF
    In this example the USD is the base currency and thus the basis for the buy/sell.

    If you think the Swiss franc is overvalued, you would execute a BUY USD/CHF order. By doing so you have bought US dollars in the expectation that they will appreciate versus the Swiss Franc. If you believe that due to instability in the Middle East and in U.S. financial markets the dollar will continue to weaken, you would execute a SELL USD/CHF order. By doing so you have sold US dollars in the expectation that they will depreciate against the Swiss franc.

    Sample Trade
    A trader wishes to speculate on EUR/USD. Believing that the EUR will rise against the USD, or that the exchange rate will move upwards, the trader places an order to buy EUR/USD at a market rate of 1.3050. Let us also assume that the trader is speculating on 100,000 units of the base currency, which is the standard lot size, or trading increment, used in the Foreign Exchange market. Since the base currency is the first currency in the pair, the trader is speculating on the value of 100,000 Euros with respect to the US Dollar.

    In this example, the trader is buying Euros, since he believes the Euro will rise in value with respect to the US Dollar. Accordingly, he finances the transaction of buying 100,000 Euros by borrowing an equivalent amount of US Dollars.

    For the trader, the value of the amount borrowed is a function of the exchange rate. Since the exchange rate at the time of the transaction was 1.3050, the market cost for 1 Euro was 1.3050 US Dollars. Hence, 100,000 Euros cost $130,500 (1.3050 * 100,000). This borrowed amount of 130,500 USD must be paid back when the transaction is closed.

    Lets assume that the trader is correct in assuming that the Euro would rise in value with respect to the USD, and that the exchange rate moved to 1.3150, 100 pips above the rate at which the trader entered. If the trader were to close his position now, the 100,000 Euros he purchased at the onset of the transaction would be sold, and his debt of 130,500 US Dollars would be paid off.

    At an exchange rate of 1.3150, the traders 100,000 Euros are now worth 131,500 US Dollars (100,000 * 1.3150). After repaying the borrowed amount of 130,500, this leaves him with a profit of $1,000.

    Traders have equal opportunities to profit regardless of whether the exchange rate is rising or falling.

    Spreads & Bid/Ask
    When viewing quotes, you will notice that there are two prices for each currency pair. Similar to all financial products, FX quotes include a "bid' and "ask". The bid is the price at which a dealer is willing to buy and clients can sell the base currency in exchange for the counter currency. The ask is the price at which a dealer is willing to sell and a client can buy.

    Bid = The Price at which the Trader (You) Can Sell
    Ask = The Price at which the Trader (You) Can Buy

    For example, say the EUR/USD is trading at 1.3050 x 1.3053. In this case, the bid is 1.3050 and the ask is 1.3053. The difference between the bid and ask constitutes the spread. In the above example, the spread is 3 pips, or points. This differential reflects the cost of the trade. Essentially, the market would have to move 3 pips in your favor for you to break even, and 4 pips for you to be in your profit zone.

    Structure of the Market
    The FX market is an over-the-counter market with no centralized exchange. Traders have a choice between firms that offer trade-clearing services.

    Unlike many major equities and futures markets, the structure of the FX market is highly decentralized. In other words, there is no central location where trades occur. The New York Stock Exchange, for example, is a totally centralized exchange. All orders pertaining to the purchase or sale of a stock listed on the NYSE are routed to the same dealer and pass through the hands of a single clearing firm. This structure requires buyers and sellers to meet at the NYSE in order to trade a stock that is listed on this exchange. It is for this reason that there is one universally quoted price for a stock at any given time.

    In the FX market there are multiple dealers whose business is to unite buyers and sellers. Each dealer has the ability and the authority to execute trades independently of each other. This structure is inherently competitive as traders are faced with a choice between a variety of firms with an equal ability to execute their trades. The firm that offers the best services and execution will capitalize on this market efficiency by attracting the most traders. In the equities markets, the execution of trades is monopolized and there is no incentive for a clearing firm to offer competitive prices, to innovate, or to improve the quality of their service.

    Margin
    In standard cash stock accounts, money should be deposited for the full amount of the position you are trading, or if you have a margin account, for at least half of the position. This is in contrast to the FX market, where only a small percentage of the actual position value needs to be deposited prior to taking on the trade. This small deposit, known as the margin, is not a down payment, but rather a performance bond or good faith deposit to ensure against trading losses. The margin requirement allows traders to hold positions much larger than their account value (up to 200x the size).

    Margin requirements are as low as .5% meaning for every standard lot size of 100,000 units, you must commit $500. However, if you wanted to control a $100,000 in the stock market, you would have to deposit at the very least, $50,000. Even in the futures market you would have to deposit at least $5,000 to control a $100,000 position

  2. The Following User Says Thank You to powerman605 For This Useful Post:

    enjoylife (03-26-2012)

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    Hey man this is interesting basics you have posted here. I would recomend this all newbies.

    By the way you could have reduced the font size.. It's kinda hard to read.

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    Japanese government going to reduce the power of yen to empower its exports. Hmm, that's interesting, never knew why yen was low.

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    very nice piece really very good for newbies venturing into the forex market.

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    Thanks a lot for all the information and it is very good information for the newbies and they must read them and go through them.It will help them in their trades .

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    Quote Originally Posted by umaranjum View Post
    Japanese government going to reduce the power of yen to empower its exports. Hmm, that's interesting, never knew why yen was low.
    post here according to the thread, so that we discuss a specific topic and understand it easily in easy language. thanks...and nice information above.....

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    Quote Originally Posted by adnan10076 View Post
    post here according to the thread, so that we discuss a specific topic and understand it easily in easy language. thanks...and nice information above.....
    I did notice in various threads that discussions being held is not relevant with the topic of the thread and it goes hay wire . So we must stick to the thread and discuss on the same topic and not deviate from it .

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    Ok so putting the discussion back on track. The basics of trading is necessary and must be first step in your trading career. Then we should move onto demo account.

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    The first thing we need to know as traders is the basic of currency trading. That will enhance better understanding.

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    learn the basics of the forex business is a good and true as possible to learn from the basics will have strong basics in understanding the forex business.

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    cutedani
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    the basic is that it is the relative supply of one trader to demand of other trader of both currencies will Determine the Value of the Exchange Rate.

  13. #12
    umar.ctn
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    All currency trades involve the buying of one currency and the selling of another, Simultaneously. currency quotes are given as Exchange Rates; That is, the Value of One currency Relative to Another. The relative Supply and Demand of both Currencies will Determine the Value of the Exchange Rate.

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    seahawks90
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    Quote Originally Posted by puji View Post
    learn the basics of the forex business is a good and true as possible to learn from the basics will have strong basics in understanding the forex business.
    basic knowledge of forex trading in the main thing for every trader because if he knows the basic then it become easy for him to survive in this field.

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    @seahawk, of course, without known what makes the currencies move or at least whats happen to it, you're going nowhere on this bussiness

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    Quote Originally Posted by puji View Post
    learn the basics of the forex business is a good and true as possible to learn from the basics will have strong basics in understanding the forex business.
    I think to know the basics of currency trading it is important for a trader to know about the currency first he wants to trade in and the pair and then the factors that can affect the prices of those pairs and how to analyze those factors .

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