Foreign Exchange

Forex is derived from the words, Foreign Exchange. Simply put, forex trading involves trading of currency pairs, or the simultaneous purchase of one currency and sale of another. The exchange rate is expressed as the value of one currency in terms of another. If the exchange rate for EUR/USD is 1.2100, it is showing that 1 Euro is worth $1.21 USD. The first currency referred to in a currency pair is called the base currency and the second one is referred to as the counter currency or the terms currency. For each transaction, it is the base currency that is being bought or sold.
The Forex market is the largest financial market in the world, with an estimated daily transaction volume of $1.3 Trillion. Its very size makes it a very liquid market, which is very desirable for traders. It operates 24 hours per day throughout the week (M-F).
It has been estimated that approximately 80% of the Forex market is speculative. Speculators engage in Forex transactions to profit from currency swings or perceived currency inequities. They have no intention of taking delivery of the currency that they are purchasing. Speculators often do online forex trading while using Forex trading software to evaluate positions. Forex software comes in different types. Traders can use Option-Aid for trading Forex options. Many traders use a Forex trading system which generate Forex trading signals using various Forex trading strategies.
Merchants engage in Forex transactions to hedge risk, essentially transferring the risk to speculators who hope to profit by taking on the risk. An exporter who sells products in the currency of another country at a future time runs a risk because by the time the product is shipped and sold, the revenue may be lower if the value of that currency drops by the time the goods are actually sold. An importer who buys goods in the currency of another country runs a risk because the currency may have risen in value when the actual transaction is made, increasing his costs and decreasing his profit. Even a tourist visiting a country runs a risk that the currency of that country rises, increasing the cost of his visit. Each of these occurrences can motivate forex transactions to mitigate the risks involved. Forex transactions can help stabilize cash flows and profits, improve forecasts, and decrease uncertainty
It is important to understand what actually moves floating exchange rates. The following factors play a role in setting fair exchange rates.
* the trade balance (based on import and export flows)
* the flow of capital or funds between countries
* relative inflation rates
Forex trading is done in a Foreign Exchange Market, referred to as Interbank. This is an over-the-counter (OTC) market; there is no central clearinghouse or fixed exchange. It is traded through banks, brokers, dealers, and financial institutions, as well as individual traders.
The Spot Market is for buying and selling currencies marked for settlement within two business days, on the "Value Date." Most dealers can automatically roll over an open position, which essentially allows you to hold a position for any time period you wish. The rollover cost is based on the interest rate differential between the two currencies.
The most common currency codes are:
* USD = US Dollar
* EUR = Euro
* JPY = Japanese Yen
* GBP = British Pound
* CHF = Swiss Franc
* CAD = Canadian Dollar
* AUD = Australian Dollar
* NZD = New Zealand Dollar
Forex trading is facilitated by market makers who provide liquidity by taking the opposite side of your trade. Brokers match buyers and sellers, taking a commission for their services.
When a currency transaction takes place, the seller sells at the bid price (also called the sell quote), and the buyer buys at the ask price (also called the buy quote). The difference between the bid and ask price is the spread.
The Price Interest Point (pip) is the smallest price increment a currency can make. The lot is the standard size of a contract, typically 100,000 units of the base currency (traded in standard accounts) or 10,000 units for a mini (traded in mini accounts). For example, the currency pair EUR/USD has the following parameters:
* 1 pip = 0.0001
* pip value = $10 for 100,000 lot size
* pip value = $1 for 10,000 mini lot size
Contracts are typically traded in margin accounts, so the transactions are highly leveraged. A 1% margin account gives 100:1 leverage. The normal margin requirement is between 1% and 5% of the trade. A margin call occurs if the funds in your margin account drop below the minimum required to support your open positions, requiring you to deposit additional funds to avoid automatic close-out of your position. Trading with this kind of leverage can greatly magnify your profits, but also your losses - so it must be used judiciously.
Typically trades are made with limit orders and stop losses for protection.