Forex
In terms of both size and liquidity, FOREX is the world’s largest financial market. To give you a sense of scale, an average of $3 trillion is exchanged each day around the world. On a daily basis, no other stock market in the world trades as much as the New York Stock Exchange.
The concept of FOREX is simple: it is the exchange of one country’s currency for another country’s currency. FX involves buying one currency and selling another, so it’s no surprise that it’s exchanged in pairs, such as the pound and the US dollar [GBP/USD]. Euro vs. US Dollar [EUR/USD], British Pound vs. US Dollar [GBP/USD], US Dollar vs. Japanese yen [USD/JPY], and US Dollar vs. Swiss Franc [USD/CHF] are some of the most popular “FX pairs.” The four most popular currency pairs are known as “the Majors.”
There is always a financial centre open for business somewhere in the world at practically any time of day. The foreign exchange market is open 24 hours a day, with the exception of weekends, when it closes between 22:00 (GMT) on Friday and 22:00 (GMT) on Sunday.
The Foreign Exchange market is nomadic, which means it doesn’t have a fixed physical location. OTC [Over-the-Counter] markets are homeless markets in which all trades are handled electronically 24 hours a day between banks all over the world. Because Forex, unlike other financial markets, does not have an exchange centre, you can trade FX from anywhere in the world at any time, however each region has its own peak trading session times.The following is a general outline:
REGION | CITY | Session OPEN [GMT] | Session CLOSE [GMT] |
EUROPE | London | 08:00 | 17:00 |
Frankfurt | 07:00 | 16:00 | |
AMERICA | New York | 13:00 | 22:00 |
Chicago | 14:00 | 23:00 | |
ASIA | Tokyo | 00:00 | 09:00 |
Hong Kong | 01:00 | 10:00 | |
PACIFIC | Sydney | 22:00 | 07:00 |
Wellington | 22:00 | 06:00 |
Quotes In Forex
We mentioned above that currencies are always traded in pairs; this is because when you buy one you’re essentially selling the other and vice versa.
So how do you read an FX quote?
E.g. EUR/USD = 1.1200
This means that 1 € = 1.12 $
EUR; in this quote EUR is known as the base currency.
USD; in this quote USD is known as the counter or quote currency.
This quote is also referred to as a direct quote which is where US Dollar is the counter or quote currency
E.g. USD/JPY = 125.00
This means 1 $ = 125 ¥
USD; in this quote USD is known as the base currency.
JPY; in this quote JPY is known as the counter or quote currency.
This quote is also referred to as an indirect quote which is where US Dollar is the base currency
The bid, the ask and the spread
There are two prices associated with all forex quotes: a bid price and an ask price.
The bid price – you would click on the bid price if you wanted to SELL the base currency.
The bid price is the price at which the opposite party is willing to buy the base currency in return for the quote currency you want to sell.
The ask price is what you would click on if you wanted to BUY the base currency.
The ask price is the amount that the other party is ready to offer you the base currency in return for the quote currency.
The BID price is always lower than the ASK price, and the spread is the difference between the two.
The spread is the difference in price between buying and selling the base currency – this difference is charged to the client and paid to the Market Maker
Going long or going short
Going long or going short is just trader lingo for buying or selling.
As long as you remember LONG = BUY and SHORT = SELL then you’re half way there.
The next bit is a bit trickier…
When to go Long and when to go Short in FX
“Going long” in FX terms is buying the base currency and selling the quote currency. It is what you would do if you thought the base currency was going to rise.
E.g. EUR/USD = 1.1200
If you thought that EUR was going to rise, you would “go long” meaning that you would buy EUR with the hope that you would be able to sell it for a higher price once it has risen.
You go long Euro @ 1.1200
Euro rises in value; EUR/USD = 1.1400
Your Euro is now worth $1.14 instead of $1.12
“Going short” in FX terms is selling the base currency and buying the quote currency. It is what you would do if you thought the base currency was going to fall.
E.g. EUR/USD = 1.1200
If you thought that EUR was going to fall, you would “go short” meaning that you would sell EUR with the hope that you would be able to buy it for a cheaper price once it has fallen.
You go short Euro @ 1.1200
Euro falls in value; EUR/USD = 1.1000
Your Euro is now worth $1.10 instead of $1.12
Watch your pips grow into a lot more
You’ve certainly heard the terms “PIPs” and “LOTs” a million times; they may be small, but they’re big in the trading world. You won’t be able to understand trading until you grasp these concepts.
What the pip?
The smallest possible increment in a quote is PIP, which stands for “percentage in point.”
Example: The GBP/USD rate is 1.5696, thus a PIP would be 0.0001.
With a rate of 123.45 USD/JPY, a PIP would be 0.01.
So, a PIP is the last decimal place of quotation; most currency pairs will have a PIP of 0.0001 because they are quoted to four decimal places. However, as the example above shows, this isn’t always the case.
How much is a lot?
Standard lots and micro lots are two of the first topics you should learn as part of your Forex trading education. What are they and how do they differ?
What is the definition of a Forex Lot?
A regular forex lot is equal to 100,000 of the base currency, which is EUR 100,000 in the instance of EUR/USD. For a typical lot with four decimal places, the average pip size is 10 of the counter currencies, or $10 in this case. On a normal EUR/USD contract, a loss of 10 pips equals a loss of $100.
Pip Movements (e.g. EUR/USD @ 1.28205):
5th Decimal Place (Micro pip movement) = 100,000 (1 Lot) x 0.00001 = $1.00 P&L
4th Decimal Place (1 pip movement) = 100,000 (1 Lot) x 0.00010 = $10.00 P&L
3rd Decimal Place (10 pip movement) = 100,000 (1 Lot) x 0.00100 = $100.00 P&L
2nd Decimal Place (100 pip movement (Big Figure)) = 100,000 (1 Lot) x 0.01000 = $1,000.00 P&L
1st Decimal Place (1,000 pip movement) = 100,000 (1 Lot) x 0.10000 = $10,000.00 P&L
Pip Movements (e.g. USD/JPY @ 76.850):
3rd Decimal Place (Micro pip movement) = 100,000 (1 Lot) x 00.001 = Y100
2nd Decimal Place (1 pip movement) = 100,000 (1 Lot) x 00.010 = Y1,000
1st Decimal Place (10 pip movement) = 100,000 (1 Lot) x 00.100 = Y10,000
Big Figure move = 100,000 (1 Lot) x 01.000 = Y100,000
Let’s take another example in the form of USD/JPY. The standard lot size is USD 100,000 as USD is the base currency. As USD/JPY is quoted only to 2 decimal places then a pip is equivalent to JPY 1,000 so if you are up 10 pips on a standard USD/JPY contract you have made JPY 10,000.
Standard lots in forex are usually for institutional sized accounts; we’re talking big rollers, who should have $25,000 or more to make trades using standard lots.
What is a Forex lot?
So, let’s face it, if you want to enter into Forex Trading, you’ll need to start small and work your way up. Micro lots are ideal for newcomers to Forex trading who are still learning the ropes. A micro lot is the equivalent of 1,000 worth of the base currency you want to trade, as opposed to regular forex lots, which are worth 100,000 of the base currency. Similarly, 1 pip in a micro lot is only worth 0.10 (4 decimals) or 10 (2 decimals) of the counter currency, unlike regular lots [where 1 pip=10 of the counter currency on pairs quoted to 4 decimal places and 1 pip=1,000 of pairs quoted to 2 decimal places.
To summarize:
| Base Currency | Counter Currency | Quoted Decimal Places | Standard Lot | Micro Lot | Standard Pip | Micro Pip |
| EUR | USD | 4 | EUR 100,000 | EUR 1,000 | USD 10 | USD 0.1 (10 cents) |
| USD | JPY | 2 | USD 100,000 | USD 1,000 | JPY 1,000 | JPY 10 |
Leverage and Margin
Now that we understand what a pip is, we can see that it is a teeny-small amount, thus you’ll need to trade a LOT for these tiny PIPs to make a significant difference.
‘By allowing you to control a relatively substantial asset for a fraction of its cost, you may magnify your profit potential at the risk of greater losses.’
Example: 0.25% margin deposit means you are trading 400 times leverage, for example;
Buying 1 lot of GBP/USD @ 1.5700 with a margin requirement of 0.25% will cost you $250.
The margin requirement means that you can trade a volume of $100,000 in the market.
By trading high volumes, leverage trading allows you to profit from very minor pip moves in the market. Don’t worry if you don’t grasp what “Leverage” means yet; we’ll go over it in greater depth in coming modules.
Calculating your profit and loss in forex
Show me the money!
Now that you know what a pip and a lot are, you must comprehend why you learned about them in the first place.
To calculate our profit and loss, we need pips and lots, therefore here are the essentials of your Ps and Ls.
Remember when we talked about the differences between DIRECT and INDIRECT Forex quotes? Now is the time to put your newfound knowledge to use!
In forex, there are two rules for measuring profit and loss, and they both revolve around the dollar.
Whenever you have a direct quote [where the quote currency is USD] you can calculate your profit and loss by using the following formula
P/L = (SELL PRICE – BUY PRICE) x STANDARD LOT SIZE x NUMBER OF LOTS
Remember that the standard lot size is $100,000 and for mini lots the standard size will be $10,000
Example: You buy 2 lots of EUR/USD at 1.1205 and sell at 1.1210
P/L = (1.1210 – 1.1205) x 100,000 x 2 = $100
Whenever you have an indirect quote [where the quote currency is NOT USD] you can calculate your profit and loss by using the same formula.
Example: You buy 1 lot of USD/AUD at 1.2917 and sell at 1.2932
P/L = (1.2932 – 1.2917) x 100,000 x 1 = 150 AUD
CAREFUL: the profit figure stated here is in AUD, not USD. It is important to remember that with indirect quotes (where USD is not the quote currency) you need to convert the profit and loss figure to USD by dividing by the relevant exchange rate.
You have 150 AUD; divide by the sell price [because you’re selling AUD and buying USD]
150 AUD/1.2932 = 115.99 USD
