Wednesday, 21 November 2007

Forex Trading

I have always heard of Forex Trading but I do not really understand how it works? The booster session last night by Conrad is another intriguing lesson. Before I forgot everything I learnt about Forex trading, I would like to share with the readers of this blog. I actually did more research once I reached home last night at around 1 am. I was too excited to go and sleep even though I am very tired. Here is what I found and learnt.

What is Forex Trading?

Forex or Foreign Exchange is the simultaneous buying of one currency and the selling of another. Currencies are traded in pairs.

The Forex market has more buyers and sellers and daily volume than any other market in the world and takes place in major financial institutions across the globe. The forex market is open 24 hours a day and five days a week.

In the Forex Market, currencies are always priced in pairs and all trades result in the simultaneous buying of one currency and the selling of another. The objective of currency trading is to buy the currency that increases in value relative to the one you sold. If you have bought a currency and the price appreciates in value, then you must sell the currency back to lock in the profit.

Currencies are quoted in pairs. The front or first currency is known as the base currency and the second is called the counter or quote currency. You always trade based on the front currency. For example, EUR/USD quote, you can only trade on the EUR currency by buying or selling. It is a norm to quote the stronger currency as the base currency. Currencies are quoted using five significant numbers, with the last placeholder called a point or a pip (percentage in price). For example, a EUR/USD quotes 1.1345/1.1350.

If you have studied Global Economic before, you may have come across quotes like American terms, European terms, Direct quote or Indirect quote. What do all these mean?
  • American terms means the quote is in the form of USD$ per unit of the foreign currency. There are generally four currencies that are quoted in American terms. They are Euro, Kiwi, Aussie and Sterling.
  • European terms means the quote is in the form of foreign currency per USD$. This is normally the case.
  • Direct quote means the quote is in the form of domestic currency per unit of foreign currency.
  • Indirect quote means the quote is in the form of foreign currency per unit of domestic currency. This is generally used in UK, Canada and US only.

Like all financial products, forex quotes include a "bid" and "ask" or a "sell" and a "buy" price. By quoting both the bid and ask in real time, brokers ensure that traders always receive a fair price on all transactions. As in any traded instrument, there is an immediate cost in establishing a position. This cost will vary between the different brokers and is sometimes called "spread". For example, USD/JPY may bid at 132.20 and ask at 131.25, this five-pip spread defines the trader's cost, which can be recovered with a favourable currency move in the market.

The Forex Market is a seamless 24 hours market and is open 5 days a week. At 5pm Sunday, New York time, trading begins as markets open in Sydney and Singapore. At 7pm the Tokyo market opens, followed by London at 2am, and finally New York at 8 am. (Time is based on New York time).

As a trader, this allows you to react to favourable and unfavourable news by trading immediately.

The trading of Forex takes place all over the world and is not located in any one central location. Deals are done between a variety of traders, from banks to managed funds to individual traders.

Forex trades approximately around US$1.85 trillion a day and is by far the most liquid market in the world. It takes the NYSE 3 months to trade the same USD value as the Forex trades each and every day making it the largest and most liquid market in the world. The Forex Market is always liquid, meaning positions can be liquidated and stop orders executed without slippage.

Traders can trade a variety of currency pairs, limited only by which pairs each broker provides. Major currency pairs are typically the USD pairs. For example,

  • EURUSD
  • GBPUSD
  • AUDUSD
  • USDJPY
  • USDCHF

Cross currency pairs are pairs which do not involve the USD for example

  • EURGBP
  • EURJPY
  • GBPJPY
  • EURCHF

Point/Pip values is the USD$ value for each point or Point/Pip. These are typical values and can vary between the different brokers and market makers.

You can sign up for a Forex account with InterbankFx. You can find more information at Forex Factory, Forex Capital Market, Daily Forex and also a good Forex Trading guide here. Trading is approximately 20% technical and fundamental and 80% psychological. With the psychological side of trading, it is important that you understand the sentiment of the market and have good money management skills.

2 comments:

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