What is FOREX trading?
Introduction to Forex
Foreign Exchange Market (Forex) is the arena where a nation's currency is exchanged for that of another at a mutually agreed rate. It was created in the 70's when international trade transitioned from fixed to floating exchange rates, and nowadays is considered to be the largest financial market in the world because of its tremendous turnover.
All currencies are traded in pairs and each is assigned with an abbreviation. Here are some of them:
Currency Abbreviations (Table 1)
New Zealand Dollar
The rate at which currencies are exchanged one for another is called the currency exchange rate. For example, "EUR/USD exchange rate is 1.2505" means that one Euro is exchanged for 1.2505 US Dollars.
The exchange rate of any currency is usually given as the Bid price (left) and the Ask price (right). The Bid price represents what will be obtained in the quote currency (US Dollar in our example) when selling one unit of the base currency (Euro in our example). The Ask price represents what has to be paid in the quote currency (US Dollar in our example) to obtain one unit of the base currency (Euro in our example). The difference between the Bid and the Ask price is referred to as the spread.
1.0 lot size for different currency pairs (Table 2)
1.0 lot size
EUR 100 000
EUR 100 000
* 1% of transaction size for account balances below $ 100,000
* 2% of transaction size for account balances up to $ 250,000
* 4% of transaction size for account balances above $ 250,000
For example, EUR/USD exchange rate is 1.2505/1.2509 and your leverage is 1:100. You believe that EUR/USD will go up and buy 0.1 lot (minimum contract size) of EUR/USD at 1.2509 (Ask price) - for the contract size refer to Table 2. As we can see from Table 2, 1.0 lot of EUR/USD is 100,000 EUR, which means that 0.1 lot (our example deal size) is 10,000 EUR.
So, you buy 10,000 EUR and sell 10,000*1.2509=12,509 USD. In fact to fund this position you do not have to have 12,509 USD but only 125.09 USD. The rest of the money (in our example 12,383.91 USD) is leveraged to you by Alpari (UK).
Leverage (or gearing) mechanism allows you to open and hold a position much larger than your trading account value. 1:100 leverage means that when you wish to open a new position, then you need to support a deposit 100 times less than the value of the contract you are interested in.
For example, you believe that EUR/USD is moving higher and buy 10,000 EUR and sell 12,509 USD. Assuming you are right and EUR/USD goes up to 1.2599/1.2603 and you decide to close the position: when you close a long position you sell the base currency (10,000 EUR in our example) and buy the quote currency (10,000*1.2599 = 12,599 USD):
Open a position: buy EUR and sell USD
Close a position: sell EUR and buy USD
NB: When you close a short position you buy the base currency and sell the quote currency.
To fund this position you only need 100 EUR (approximately 125 USD) not 10,000 EUR. The profit on this position is 90 pips (1.2599-1.2509=0.0090). A pip or point is a minimal rate fluctuation. For EUR/USD 1 pip is 0.0001 of the price (see Table 2).
This example shows a favourable outcome. If EUR/USD had fallen you would realise a loss not a profit and with leverage this loss will be magnified. For example, if you close the position at 1.2419, your loss would be $90. Should you have doubts about your understanding of risks, please consult your financial adviser.
Rollover / Interest Policy
Foreign exchange trading at Alpari (UK) is dealt on a "Spot" basis only. This means that all trades settle two business days from inception, as per market convention. The settlement date is referred to as the value date. Alpari (UK) does not arrange physical delivery of currencies hence, all positions left open from 10:59:45 p.m. to 10:59:59 p.m. (London time) will be subject to a rollover.
A rollover involves closing and immediately reopening the position at a slightly different level from that of the closing price. The difference in closing and opening prices depends on the prevailing interest rates of the underlying countries whose currencies your trade relates to.
For example, letís assume that the interest rates in the EU and USA are 4.25% p.a and 3.5% p.a respectively. Every currency trade involves borrowing one currency to buy another. If you have a buy position of 1.0 lot in EUR/USD, then you earn 4.25% on your Euros and borrow USD at 3.5% per year.
In other words:
* If you have a long position (i.e. bought) and the first currency in the currency pair has a higher overnight interest rate than the second currency, then you receive a gain.
* If you have a short position (i.e. sold) and the first currency in the currency pair has a higher overnight interest rate than the second currency, then you lose the difference.
* If you have a long position (i.e. bought) and the first currency in the currency pair has a lower overnight interest rate than the second currency, then you lose the difference.
* If you have a short position (i.e. sold) and the first currency in the currency pair has a lower overnight interest rate than the second currency, then you receive a gain.
Please note that if you open and close a position before 10:59:45 p.m. (London time) you will not be subject to a rollover.
As mentioned above, Alpari (UK) rolls all open positions by closing and immediately reopening the position at a slightly different level from that of the closing price. Rollover charges, (or Swap Points), can be found on the "Rollover / Interest Policy" webpage. See the examples below for detailed explanations.
Letís assume that:
* you have a long position in EUR/USD. Swap points for rolling over open long positions in EUR/USD are +0.890 pips. This means that the position will be reopened at the closing price + 0.890 pips. So as a result of the rollover, you will be charged 0.890 pips.
* you have a short position in EUR/USD. Swap points for rolling over open short positions in EUR/USD are +0.660 pips. This means that the position will be reopened at the closing price + 0.660 pips. So as a result of the rollover, you will earn 0.660 pips.
* you have a long position in USD/CHF. Swap points for rolling over open long positions in USD/CHF are -1.140 pips. This means that the position will be reopened at the closing price - 1.140 pips. So as a result of the rollover you will earn 1.140 pips.
* you have a short position in USD/CHF. Swap points for rolling over open short positions in USD/CHF are -1.320 pips. This means that the position will be reopened at the closing price - 1.320 pips. So as a result of the rollover you will be charged 1.320 pips.
The act of rolling the currency pair over is known as tom.next, which stands for tomorrow and the next day.
NB: When you roll an open position from Wednesday to Thursday, then Monday next week becomes the value date, not Saturday; therefore the rollover charge on a Wednesday evening will be three times the value indicated on the "Rollover / Interest Policy" webpage.
Why trade Forex?
Unlike other financial markets Forex has no physical location, like stock exchanges, for example. It operates through the electronic network of banks, computer terminals or via telephone. The lack of a physical exchange enables Forex to operate on a 24-hour basis, spanning from one time zone to another across the major financial centres (Sydney, Tokyo, Hong Kong, Frankfurt, London, New York etc). In every financial centre there are many dealers, who buy and sell currencies 24 hours a day during the whole business week. Trading begins in the Far East, New Zealand (Wellington), then Sydney, Tokyo, Hong Kong, Singapore, Moscow, Frankfurt-on-Maine, London and ends in New York and Los Angeles. Below there are approximate trading hours for regional markets (London time):
Continental Europe 06:30-13:00
Great Britain 8:30-15:30
Forex has some advantages which make it very popular among investors:
* Liquidity. Forex is the largest financial market in the world, with the equivalent of over $3-4 trillion changing hands daily whereas traded volume on the stock markets equates to only 500 billion US dollars.
* Flexibility. Forex is a 24-hour market, which offers a major advantage over other markets, for example, stock exchanges which are only open during regional business hours. You can respond to breaking news immediately if the situation requires it and customise your trading schedule.
* Lower transaction costs. Traditionally there are no commissions or charges on Forex, except for the spread.
* Margin. Our 1:100 leverage (only for deposits below $ 100,000) is a powerful tool. You need to support a deposit of 1,000 US dollars to make a deal with $100,000. Such high leverage combined with rapid rate fluctuations can make this market profitable but at the same time risky: please see Risk Warning below.
Under margin trading conditions even small market movements may have a great impact on the customer's trading account. You must consider that if the market moves against you, you may sustain a total loss greater than the funds deposited. You are responsible for all the risks, financial resources you use and for the chosen trading strategy.
More about risks Ľ Risk Warning
Base currency is the first currency in the pair. Quote currency is the second currency in the pair.
This abbreviation specifies how much you have to pay in quote currency to obtain one unit of the base currency (in this example, 120.25 Japanese Yen for one US Dollar). The minimum rate fluctuation is called a point or pip.
Most currencies, except USD/JPY, EUR/JPY, CHF/JPY and GBP/JPY where a pip is 0.01, have 4 digits after the period (a pip is 0.0001), and sometimes they are abbreviated to the last two digits. For example, if EURUSD is traded at 1.2389/1.2394 the quote may be abbreviated to 89/94.
The currency pairs on Forex are quoted as the Bid and Ask (or Offer) prices:
USD / JPY =
Bid is the rate at which you can sell the base currency, in our case it's US dollar, and buy the quote currency, i.e Japanese Yen.
Ask ( or Offer) is the rate at which you can buy the base currency, in our case US dollars, and sell the quote currency, i.e. Japanese Yen.
Spread is the difference between the Bid and the Ask price.
Pip is the smallest price increment a currency can make. Also known as a point. e.g. 1 pip = 0.0001 for EUR/USD, and 0.01 for USD/JPY.
Currency Rate is the value of one currency expressed in terms of another. The rate depends on the supply and demand on the market or restrictions by a government or by a central bank.
Lot Size is the number of base currency, underlying asset or shares in one lot defined in the contract specifications. For details refer to the Table 2.
Lot is an abstract notion of the number of base currency, shares or other underlying asset in the trading platform.
Transaction (or deal) size is lot size multiplied by number of lots.
Long Position is a buy position whereby you profit from an increase in price. In respect of currency pairs: buying the base currency against the quote currency.
Short Position is a sell position whereby you profit from a decrease in price. For currency pairs: selling the base currency against the quote currency.
Completed Transaction consists of two counter deals of the same size (open and close a position): buy then sell or vice versa.
Leverage is the term used to describe margin requirements: the ratio between the collateral and the value of the contract. 1:100 leverage means that you can control $100,000 with only $1,000 (1%).
Margin is the collateral required by Alpari (UK) to open and maintain a position.
Balance is the total financial result of all completed transactions and deposits/withdrawals on the trading account.
Floating Profit/Loss is current profit/loss on open positions calculated at the current prices.
Equity is calculated as balance + floating profit - floating loss.
Free margin means funds on the trading account, which may be used to open a position. It is calculated as equity less necessary margin.